So Merkel and Sarkozy have achieved agreement on a fiscal union, provided no referendums trip it up, but what does this mean for the Euro and the global economy. A fiscal union while nice in theory is a bit late to solve the crisis. For a start it does not deal with the growing sovereign debt and the current austerity measures have only intensified the problems. In fact countries that are fined for breaching the 3% deficit target are most likely to borrow to pay the fine which will exasperate the problem.  The EFSF has so far proved itself incapable of raising the funds required to bail out the larger nations such as Spain and Italy. As far as China coming to the rescue, they have problems of their own and don’t appear to have any appetite for risky European sovereign debt. Stronger European countries are finding their cost of financing increasing and as of the week S&P issued a warning that it is reviewing the ratings of a number of euro zone countries.  

 So can Merkel and Sarkozy really clap each other on the back and say well done? This crisis has just lurched forward clumsily one more step to global financial ruin. European banks are required to increase capital to cover losses and may need to sell assets or reduce lending. On the other hand sovereign nations require to rollover debt. To make bonds attractive the European Central Bank will reduce interest rates further as the Federal Reserve has done in the US. Of course there comes a point where rates will go no further and we are not to far from that point.

The knock on effect to the US of a collapse of the euro zone is huge. For a start Europe accounts for a large part of US exports. Indeed some of the US exports to China eventually make their way to Europe and traditionally if one economy does badly it affects the other. US banks are exposed to Europe through sovereign debt, derivatives etc. Pension funds have invested in Europe and many US companies have subsidiaries there which will affect profits. China has over $800 billion in Euro currency reserves and losses here would mean less available to purchase US treasuries. Any move by the ECB to print would devalue the Euro and strengthen the dollar. This would affect the US competitiveness and would also force the Fed to print and devalue the dollar.   

So the debt spiral continues downwards. We are putting off the final day of reckoning and when it comes it’s really going to hurt.

Related:Eurozone leaders deluded if they think this ‘sticking plaster’ treaty can solve the debt crisis