What’s behind the new crisis of confidence hitting global markets: Maley

Global markets were engulfed in a crisis of confidence overnight, with investors selling off stocks and commodities and seeking out safe haven investments such as US and German bonds.

The crisis erupted as markets fretted about possible splits at the heart of the eurozone in the wake of the $1 trillion rescue package. Even though the eurozone has launched massive financial support programs to support the PIGS (Portual, Ireland, Greece and Spain), investors steered clear of Portuguese, Greek and Spanish bonds overnight. Meanwhile, German bond prices soared to record highs.

There were also worrying signs of increasing strain in the banking market, with banks having to pay a higher interest rate to borrow money from other banks. Banks are increasingly concerned about the exposure that other banks have to the PIGS.

Meanwhile, there are fears that Germany’s determination to push through with its proposal to impose tough penalties on eurozone members that fail to maintain rigorous budget standards could create a split in the eurozone. Some questioned whether France supported the German proposal to hit ill-disciplined countries with penalties such as losing eurozone financial aid, and the suspension of their voting rights on the European Council.

But Le Monde reports that French president Nicolas Sarkozy said at a press conference overnight that he had “no disagreement” with Angela Merkel over eurozone reforms.

Sarkozy said he worked with Merkel on an almost daily basis, and both were acutely aware that Germany and France could not disagree on such an important issue. He added that he agreed with Merkel “on the principle of new sanctions” against eurozone countries that failed to control their deficits.

Nevertheless, Le Monde reports that frictions between France and Germany have escalated in recent days. After Berlin banned naked short selling of some securities earlier this week, French finance minister, Christine Lagarde described the move as “debatable, because there was no prior discussion.” Similarly, she claimed the euro was “absolutely not” in danger, despite Merkel’s assertion to the contrary.

German chancellor, Angela Merkel, now faces the task of convincing German lawmakers to approve Germany’s contribution to the $1 trillion rescue package later today.

The measure is hugely unpopular, because Germany will bear the brunt of the cost. There are widespread accusations that the eurozone has become little more than a ‘transfer union’, with money flowing from the frugal Germans to the big-spending Greeks, Spanish and Portuguese.

Merkel is attempting to defuse criticism of the rescue package, by pushing for increased market regulations and tougher penalties for eurozone countries that run lax budgets. Germany is also encouraging other eurozone members to adopt its ‘culture of stability’ and enshrine debt reduction targets into their respective laws to provide binding limits on growth.

This idea has gathered more traction in Paris, with French president, Nicolas Sarkozy indicating overnight hat he supports the idea of passing a new law that would require each new government to set itself a five-year target for reducing the budget deficit. French deficit now at 7.5% of GDP but could get to 8.2% this year.

In an interview with the Financial Times, Germany’s finance minister, Wolfgang Schäuble, reinforced the German message that the eurozone needed to re-write its rules to prevent another Greek crisis. He also underscored the need for eurozone members to bring their debt and deficits under control.

Schäuble also called for more market regulation, saying: “I’m convinced the markets are really out of control. That is why we need really effective regulation, in the sense of creating a properly functioning market mechanism.”

Germany is also pushing for a global financial transaction tax to force financial institutions to bear more of the cost of financial crises. He said that if the G20 summit in June failed to approve the idea, “we will once again work intensively to see if we cannot have a transaction tax at a European level”.

Meanwhile, there are growing fears that debt-laden eurozone countries could see an eruption of political instability as a result of adopting unpopular austerity budgets.

Thousands of Spanish public servants demonstrated in Madrid, protesting against the 5 per cent salary cuts proposed as part of an austerity budget by Spanish prime ministre José Luis Rodriguez Zapatero.

And Greece was gripped by its fourth general strike since February, with 20,000 protestors gathering in Athens to protest against the Greek government’s austerity budget.

This article first appeared on Business Spectator.