Pact for the Euro: Is There A Catch?

While all eyes were focused on the tragedy that struck Japan over the weekend, we seem to have overlooked more upbeat developments in the euro zone.

In a way similar to, but a notch less cool than that infamous rooftop scene in comedy movie “The Hangover,” European leaders made a pact dubbed “Pact for the Euro” in the wee hours of Saturday. In a nutshell, the pact is basically an agreement on a long-term program to fix the economic imbalances in the region.

Below is what I imagine notes would look like from the meeting:

pactgoals.png

Of course, each country has the freedom to select which courses of action to take to ensure it meets the region’s goals. However, they will all be monitored according to the same criteria: wage and productivity developments, labor market progress, public finance sustainability, and financial stability.

I took a peek at the next page of the notepad to find out how they plan to achieve their goals:

policyinstruments.png

Does this pact sound familiar to you? Well, it should! The idea came from the “Pact of Competitiveness” spearheaded by euro zone hotshots Germany and France a few months ago. Recall that, under this proposal, several measures were aimed at strengthening the euro zone economy in the midst of a debt crisis. These measures included laws for debt limits, tight budget controls, a higher retirement age, and a minimum corporate tax rate.

Naturally, these tight guidelines were met with plenty of opposition, particularly from smaller EU states. Several leaders worried about losing their sovereignty if they give in to the rules set by the top guns in the region. Come to think of it, wouldn’t it be unfair to subject everyone to the same set of standards when each country is facing its own set of problems?

Although German Chancellor Angela Merkel assured that the pact was more of a guidelines than actual rules, the rehashed “Pact for the Euro” was met with similar criticisms. Just the same, Merkel and her buddy French President Nicolas Sarkozy tried their best to convince their fellow heads of state that the new pact is aimed at promoting cooperation among the EU members.

Many are unconvinced that the “Pact for the Euro” is the solution to the euro zone’s growing list of problems, but this still looks promising for the region. Recall that last Friday the euro gained on its major counterparts when markets thought that EU leaders were a few steps closer to reaching agreements for the pact. Heck, EUR/USD climbed by 114 pips!

The optimism probably comes from the thought that a pact may iron out a few issues within the euro zone clique. For one, an agreement might prevent debt-ridden countries like Greece and Ireland to sink deeper into debt by giving them lower borrowing rates for their loans. Also, a set of rules can help other euro zone countries prevent another debt crisis or at least help them survive another one.

Aside from its economic benefits though, a euro zone pact would also address the region’s “design flaw” of not having common economic policies. After all, how can a group of countries share a common currency and not share economic policies as well? A united front on economic policies would go a long way towards reassuring investors of the monetary union’s stability, and might even support the euro in markets.

Now that the wheels have started churning for the “Pact for the Euro,” markets will be watching closely to see if euro zone leaders are in it to win it. Granted, the agreement is only at its initial stages and still has a lot of ground to cover, but we can’t deny that it’s a step in the right direction.