Back in October, another major leap was taken.
The French President helped the German Prime minister with an intractable European problem. Their Dauville plan called for investor losses on bonds of “bailed out” countries. This was risky, but it has created a closer European Union.
Originally, Germany wanted countries with excessive deficits to face automatic penalties. This would instill fiscal discipline. But only Finland and The Netherlands supported them. As a compromise, they offered the notion of investors taking a haircut on the bonds of supported countries. In a private conversation, the French agreed to this halfway measure.
When the deal was circulated, it caused a fracas. The notion of haircuts on sovereign debt had been unthinkable. But such a measure enforces market discipline on profligate spenders. It has always been the hallmark of sound finance. The market’s reaction was swift: sell the bonds of the lower-rated countries, because now they posed de-facto, rather than theoretical, credit risk.
But there’s a compromise: a permanent bailout fund that makes every euro-zone country partly responsible for its free-spending brethren. This will involve countries more deeply than ever in each other’s finances. The details are still being worked out.
Amid the planning and compromise, the pull of independence will continue to face the push of coordination. But the result will be a more perfect European Union.
Douglas R. Tengdin, CFA
Chief Investment Officer
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