‘Fatal flaw’ may derail euro project, says Axa

Global head of fixed income at Axa says a more cohesive political union is needed if the Eurozone is to survive.

Theodora Zemek

Speaking at a debate on June 14, Theodora Zemek, global head of fixed income at Axa Investment Managers, said the sovereign debt crisis had exposed a “fatal flaw” in the Eurozone, and made the break-up of the currency union a real possibility.

Zemek said the Eurozone’s response to the crisis had been hampered by a lack of political co-ordination, and that a more cohesive political union – akin to that of the United States – was a "precondition" for the lasting stability of the single currency.

“It would be helpful if the member states of Europe were talking as one, saying that the system must prevail. But the rhetoric is completely toxic: we are getting national self-interest over what is good for all.

“It’s difficult to see in the current political climate how things can be worked out, especially since there is no legal override in the system, as there is in the US, to release something for the common good. One of the reasons the US currency union persists is that the federal government receives a separate set of taxes, and has the ability to write laws that supersede everything beneath it. That isn’t something that’s acceptable in Europe, but I think it is the precondition for the system working. The markets are beginning to understand that,” she said.

In May, the EU created a $750 billion pool of money designed to cover the funding needs of Europe’s heavily indebted peripheral economies – Greece, Portugal, Spain and Ireland – for the next three years. But Zemek said it was a “total pipedream” to believe the bailout package had solved the Eurozone’s problems, and suggested the three-year timeframe for struggling economies to address their fiscal difficulties was optimistic.

“The markets are very nervous; they know there is a fatal flaw internal to the system, and they know there is no clear way things can be worked out. They are frantic with worry. While [the bailout] has bought us a small amount of time, it’s nowhere near three years. It’s 18 months at maximum.”

On June 15, rating agency Moody’s downgraded Greece four notches to Ba1 from A3, citing “macroeconomic and implementation risks” associated with the bailout programme. Zemek believes Greece will “probably default,” spreading contagion across Europe. That view is reflected in the country's credit default swap level: despite the various support measures Greece has received in recent months, its five-year CDS spread was 808 basis points at 1500 GMT today, pricing in a 48.4% probability of default.

Lacking the political co-ordination to mount an effective response, the Eurozone could face disintegration.

“The long-term implications for Greece defaulting are pretty horrendous. It probably involves at best a split in the Eurozone, at worst the destruction of the euro,” Zemek said. “Most people don’t want it to happen. But most people don’t want wars to happen, and they tend to happen whether you want them or not. The unthinkable is very much a reality.”