Successful summit didn’t solve crisis

July 2, 2012

Cuando despertó, el dinosaurio todavía estaba allí. “Upon waking, the dinosaur was still there.”

This extremely short story by Guatemalan writer Augusto Monterroso sums up the state of play on the euro crisis. Last week’s summit took important steps to stop the immediate panic. But the big economies of Italy and Spain are shrinking and there is no agreed long-term vision for the zone. In other words, the crisis is still there.

The summit’s decisions are not to be sniffed at. The agreement that the euro zone’s bailout fund should, in time, be able to recapitalise banks directly rather than via national governments will help break the so-called doom loop binding troubled lenders and troubled governments. That is a shot in the arm for both Spain and Ireland. Meanwhile, unleashing the bailout fund to stabilise sovereign bond markets could stop Rome’s and Madrid’s bond yields rising to unsustainable levels.

Insofar as this restores investors’ confidence, Spain and Italy could avoid the need to obtain a full bailout or restructure their debts. And Ireland, which is in a full bailout programme, could exit that and fund itself in the market again.

The immediate market reaction on Friday was positive. The yield on 10-year bonds fell: for Spain from 6.9 percent to 6.3 percent, for Italy from 6.2 percent to 5.8 percent and for Ireland from 7.1 percent to 6.4 percent. But these rates are still high. And, with the exception of Ireland, Friday’s market movements only take prices back to where they were in May.

What’s more, as the details of Friday’s agreement are picked over, some of the market euphoria may well fade. After all, Germany, the zone’s paymaster, hasn’t written a blank cheque.

Take the bank recapitalisation plan. Madrid is planning to inject up to 100 billion euros into its banks and Dublin has already sunk 64 billion euros into its lenders. The big question is whether the euro zone will reimburse them the full amount invested, given that the stakes in the banks aren’t worth as much. That seems unlikely. But if the full sum isn’t paid, the debt relief for Spain and Ireland may not be as big as some are hoping.

Or look at the market stabilisation mechanism. The euro zone bailout fund’s resources are limited, so it might not be able to keep Italian and Spanish borrowing costs down in the long run. What’s more, to access this mechanism, a country would have to agree to a memorandum of understanding setting out its policy commitments to reform its economy. This means that there will still be some stigma attached to the scheme – which probably explains why Rome and Madrid aren’t rushing to sign up.

To point out that Germany’s Angela Merkel hasn’t agreed a blank cheque is not to criticise the summit compromise. It is essential that Italy’s Mario Monti and Spain’s Mariano Rajoy take further measures to restore their countries’ competitiveness. A second wave of reforms is needed, but both prime ministers have lost momentum in recent months. Money for nothing will take away pressure to do more.

However, the continued uncertainty about exactly how bank bailouts and market stabilisation will work means that the summit did not produce a neat package. As the loose ends are tied up, there could be further wrangling that unnerves investors.

Meanwhile, GDP in both Italy and Spain are continuing to shrink. This means that they won’t hit their deficit reduction targets and that their debts and unemployment will rise further. The summit’s 120 billion euro growth pact isn’t likely to move the needle. More may need to be done to shore up growth. One obvious suggestion would be still looser monetary policy from the European Central Bank.

Recession also has political consequences, especially in Italy, where elections are due next spring at the latest. Both Beppe Grillo, a comedian whose populist Cinque Stelle movement has come from virtually nowhere to 20 percent in the opinion polls in recent months, and Silvio Berlusconi, the former prime minister, are playing the eurosceptic card. In the circumstances, Monti’s technocratic government will struggle to gain political support for any more reforms. Investors and Italy’s euro partners will, in turn, worry about what comes after him.

The euro zone leaders also agreed, in principle, on the first step towards a long-term vision for the region: the creation of a single banking supervisor “involving the ECB”. If this cleans up the mess in large parts of the European financial system, it will be good. But some countries will not wish to surrender control over their banks to a centralised authority and so it is quite possible that some messy fudge will emerge.

If the question of a single banking supervisor is likely to be subject to future disputes, even more disagreement can be expected over whether there should be a full political and fiscal union. Some countries like Germany want much more common decision making, but others fear the loss of sovereignty. Meanwhile, many weaker nations want to pool their debts – an idea rightly rejected by Merkel.

Europe’s people are not ready for full political union. So the best solution would be to keep the loss of sovereignty and debt-sharing down to the minimum. But the summit kicked these big issues into touch.

The dinosaur is less terrifying than it was a few weeks ago. But it is still there.


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The problem with Europe is that no amount of austerity, loans, bailouts, or defaults can fix the structural problems that exist. Economic disparities that are deeply rooted in culture and politics could take decades to resolve. The burden of subsidizing the entire european periphery for a protracted period falls almost exclusively on Germany. Right now Germany is reluctant to assume that resonsibility. That is unlikely to change. That unfortunate fact remains that Germany will be better off financially by abandoning the euro.

Posted by gordo53 | Report as abusive

“gordo53″. How is Germany going to be better off by abandoning the euro? what about the 1 trillion that is due to the bundesbank from other central banks? if Germany goes back to the Deutschemark, their new currency will appreciate massively, while the money due to Germany’s central bank will be converted to drachmas, liras, escudos, etc… Germany will lose trillions overnight. Not to mention the devaluation of foreign assets owned by Germany’s private sector including banks, foreign income by dividends and german exports. That’s why Germany’s politicians will keep doing what they can, for as long as they can to keep Germany in the eurozone

Posted by fernando80 | Report as abusive

“Last week’s summit took important steps to stop the immediate panic.”

Yet, they have no plans to actually DO anything until next year when they’ll create plans to do something, sometime. The optimistic view is that they might do something within five years or so. So far, like every other summit over the past two and a half years, they’ve agree to consider doing something, someday in the future.

This is progress? The Emperor has no clothes.

Posted by ptiffany | Report as abusive

The problem is that Keynesian deficit stimulus subtracts from economic growth during the repayment period. Hayek predicted such and Keynes agreed. There is no escape from repayment. Inflating the debt away is not an option. Reneging would collapse the banking system. The method of achieving budget surpluses to repay is to dismantle the socialist welfare system. All socialist systems to date have failed and Europe is not exceptional in this regard.

Posted by mulholland | Report as abusive

The weak nations in the Euro are weak because they do not have a enough export industries to pay for imports and being small their trade is a greater percent of GDP.

The only solution for them is to create export industries and tax other enterprises so investment for the time being only flows into export industries. Since they engaged in height of folly of loaning to boost local real estate prices of import more, they may have default to do any solution.

The people of those nations should make sure those responsible for the above dysfunctional policies get big jail time.

Posted by SamuelReich | Report as abusive

Well Hugo this time you are not just a big wind.

Posted by whyknot | Report as abusive

To get long lasting fix. The weak nations have to tax their non-exporting industries high enough so the rich put their money in exporting endeavors and the workers are forced go into them (where the jobs are). That means little money for real estate bubbles as well.

Also they need to pay off their debt with script good only for buying goods of 80% locally produced. The later is a form of default but one that subsidizes the long term solution.

Posted by SamuelReich | Report as abusive

Of course the “dinosaur” is still there — meaning the wealthy bankers and their “absentee landlord” investors, who are real underlying problem in the eurozone, as elsewhere — but I strongly disagree that “the dinosaur is less terrifying than it was a few weeks ago”.

We will NEVER fix the problem until we can understand what the problem really is — and we aren’t even close.

Posted by Gordon2352 | Report as abusive