ANALYSIS:WILL THE range of measures agreed in Brussels in midweek herald the beginning of the end of the euro crisis?
Possibly, if Europe has lots of luck and lots of economic growth. But in the current circumstances, abundant good fortune and strong economic growth – particularly in the weak and indebted countries which need it most – are too much to expect. It is likely that, just as emergency agreements in May 2010 and July 2011 were insufficient to address the scale of the euro zone’s problems, this week’s package to save the euro will not be the last.
But if there is reason to worry about the durability of the deal, the initial market reaction was good. By far the most positive development yesterday was a non-development. The weakest links in the euro chain held firm. Vulnerable bonds and banks were not victims of panic selling.
Yesterday, the price of Italian and Spanish government bonds barely moved. This was in stark contrast to the aftermath of the July deal. Then EU leaders confirmed for the first time that private holders of Greek bonds would be the first such investors since the middle of the last century to suffer losses on a developed country’s sovereign debt.
The setting of that precedent triggered a sell-off of Italian and Spanish bonds (on the logic that if writedowns can happen in one country, they can happen in others). By early August Italy, in particular, was heading towards the abyss omnipresent for so long. Since then, emergency (and very controversial) intervention by the European Central Bank has been needed to prevent weak countries sliding further. Nor did yesterday’s deal involving much bigger losses for private investors in Greek government bonds cause a weakening in the shares of banks likely to suffer those losses. Almost amazingly, their share prices rose sharply.
Why was the reaction yesterday so different from the aftermath of the July announcements? Policymakers would claim it is because the new response is more comprehensive and has built-in “firewalls” designed to halt the spread of panic. It is certainly more comprehensive, but the anti-contagion mechanisms and measures look shaky. They include complicated financial engineering to leverage up the EU bailout fund, a concrete if limited plan to recapitalise banks and a commitment to extend to banks the kind of guarantee the Irish government gave financial institutions in 2008, albeit on a more circumscribed basis.
However, leveraging up the bailout fund is risky, and all the more so when it stands on fragile foundations.
The recapitalisation figures calculated by EU leaders are approximately half the size estimated by the less involved, and therefore more objective, International Monetary Fund. And bank guarantees can weaken governments’ creditworthiness if banks end up having more rotten assets than anticipated.
Other reasons could explain the positive market reaction yesterday. It may be that financial market participants have reached the point of crisis fatigue and have made the transition to the “new normal” of semi-permanent upheaval in the euro area.
It may also be that as the fiasco has dragged on for so long, expectations of what governments and the ECB might do to address it have been permanently lowered. The world could be getting used to accepting the sort of plodding and unsteady gradualism with which EU leaders have addressed the crisis to date. But whatever the reason for yesterday’s rally, big problems and acute uncertainties remain for the entire euro project. Europe is not out of the woods.
If there is uncertainty over the effectiveness of the measures to staunch Europe’s bleeding, there is none over Ireland following Greece into default. Even if the Irish Government wanted to take the plunge and renege on its debts, other countries wouldn’t wear it.
Almost two years of turmoil has been caused by one small country’s debt crisis, and its implications for the rest of the continent. A second defaulting country would likely cause even more mayhem. Taking such a risk just when the latest package stands a chance of stabilising the situation would be madness. For a country that stands a good chance of clambering out of the hole it is in, defaulting would be even more insane.
Ireland’s only (slim) hope of a large reduction in its debt burden remains the possibility of offloading some of the bank debt if the opportunity should arise. One can live in hope. The chance of a new headache for the Government comes with the growing possibility of treaty changes. That would most likely require a referendum. A decision on whether to go down the treaty changing route will be finalised by next March, according to the new plan to save the euro. But even if the member countries do not collectively decide to set the euro’s redesigned architecture in treaty stone, it is possible a challenge in the courts could result in a referendum anyway.
Yesterday’s deal included yet another deepening of the scrutiny euro zone participants are to face when framing budgets and other economic policies. A whole series of new disciplines have been put in place or are coming down the line. Yesterday’s deal includes a provision whereby countries in breach of fiscal rules (as Ireland is now) would be obliged to present their budgets to EU institutions for consideration before national parliaments.
That could trigger a challenge in the courts – article 28 of Bunreacht na hÉireann says budget matters must go to the Dáil for consideration.
If yesterday’s deal creates a potential headache for Ireland, it is much worse for Greece. It provides for a new “monitoring capacity on the ground” in Athens. Given that troika officials have been permanently based there since shortly after Greece’s first bailout, yesterday’s announcement amounts to the further internationalisation/denationalisation of the institutions of government in that country. Administrative weakness and the complete erosion of trust in Greek decision makers has led to the move. Greece looks ever more like a failed state.
Italy is a distance from that point, but frustration with the Berlusconi regime is reaching boiling point. The package contains a list of policy measures that Italy is expected to implement. It look similar – in content if not in detail and scope – to the bailout terms Ireland, Portugal and Greece are obliged to put into effect. Given that Italy has been partially bailed out already by the ECB, it does not seem unfair that it also takes some unpalatable reform medicine.
Dan O’Brien is Economics Editor.