Despite a Bold 'E-Bond' Pitch, Europe Will Likely Keep Muddling

European Union flag
European Union flag

After months of brinkmanship and posturing in Washington, D.C., signs of a political compromise on taxes led stocks to rally for most of Tuesday. But investors shouldn't loose sight of a somewhat similar bout of grandstanding taking place across the Atlantic regarding the big questions that remain about how to deal with future European crises in the wake of the Irish bailout.

Even as they're looking for a fix, European politicians keep pushing for a national edge, and they're playing to domestic audiences. And despite plenty of rhetoric about sweeping changes, the ad hoc measures Europe has been taking to put out fires are likely to remain the status quo.

With markets anxious about the ability of struggling periphery economies like Spain, Portugal and Ireland to make good on their debts, a proposal to issue "E-bonds" created by the European Debt Agency is the new big idea. The theory behind a eurozone-wide bond is that speculators would have a hard time doubting these new instruments, and their increased size and liquidity could also help the bonds mirror U.S. Treasurys.

Keep Each Step in Context

For countries struggling with debt, the logic here may be airtight. Indeed, in Italy -- a nation that's often counted among the European economies that could face the wrath of the bond markets -- the minister of finance and economics is among those recently pushing the E-bond proposal.

Just as predictable are the objections from eurozone members with strong balance sheets that would find themselves on the hook for their more easy-spending neighbors. That's why Germany quickly moved to put down the notion of E-bonds.

Still, much like the high-stakes proposals, counterproposals and mutual concessions playing out in the U.S. tax brawl, investors should look at the European wrangling in continuity. If nothing else, the ambitious E-bond idea helps move the goalposts back following aggressive thrusts by Germany to hold both free-spending countries and their enabling private investors more accountable.

After all, it was the loud push by German Chancellor Angela Merkel for formal mechanisms to resolve the troubled finances of EU members that could include haircuts for creditors that set off the latest round of anxiety in the bond markets. Proposals by European Central Bank head Jean Claude Trichet to vastly expand the amount of funds available for the bailout of troubled members have been another point of deep contention.

Pressure and Rhetoric Are Rising

Markets may have been calmed for now with an overwhelming show of force by the ECB. But German politicians have to cater to voters at home, who are growing increasingly resentful at the perception of bailing out profligate neighbors, and Merkel came out against increasing available bailout funds. So, the pressure and rhetoric are likely to mount ahead of key regional elections in Germany at the start of the next year.

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For now, expanding bailout funds "would be politically difficult for Germany, and they will try to avoid doing this," analysts at political risk consultancy Eurasia Group wrote in a note to clients this week. But if push came to shove, enough votes could be scrounged up in parliament to make it happen. "There are enough 'committed Europeanists' in the abinet and the main political parties to move this forward if there is no plausible alternative."

The issuance of rock-solid E-bonds is hardly likely anytime soon. But neither are the dramatic German moves some pundits have predicted that threaten the very viability of the euro. Investors should look for the Continent to keep muddling through, much as it has been doing so far.