The eurozone’s seminal moment?
July 22, 2011 4:07 pm by Gavyn Davies - dal Financial Times
The European summit on Thursday has resulted in a belated, but still impressive, step towards a resolution of the sovereign debt crisis. The measures were clearly more significant than the markets expected, but at the same time they have fallen short of a once-and-for-all resolution of Europe’s debt problem. Several key compromises have been made, notably between the German government and the European Central Bank, and these have removed some previously immovable obstacles to progress.
The institutional plumbing is therefore now in place to resolve the crisis completely. But this still leaves one crucial question: how much money will be sent down the pipes? On that, the summit offered no new guidance.
On February 23, 2009, with pessimism reaching new heights about the sub prime debt crisis, the US authorities unconditionally guaranteed that no systemically important bank would be allowed to fail. In retrospect, that was the moment when a critical corner was turned in the global banking crisis, even though that was not recognised very clearly at the time. Does the eurozone Summit of July 21 represent an equally seminal moment?
In one sense, it does. Since the peripheral debt crisis started in the spring of 2010, the deteriorating situations first in Greece, then in Ireland, then in Portugal, have hugely undermined financial confidence throughout the eurozone. Widening bond spreads have been a signal of financial stress, and have made the solvency problems of the indebted countries worse. For the three most troubled economies, the decisions of the summit should eliminate this negative feedback loop.
The eurozone is now formally committed to filling the Greek financing gap for as long as its government adheres to its budget consolidation programme. Following the “voluntary” default on private debt, almost all of the Greek government’s remaining debts have been taken into official hands.
In the case of Ireland and Portugal, the situation is less clear cut. The eurozone is committed to continue providing financial support until they regain market access, provided they adhere to their budget programmes. These countries “solemnly reaffirm their inflexible determination to honour fully their own individual sovereign signatures”, so they are still responsible for standing behind all of the debt they have issued to the private sector up to now. The Greek situation is, rather unconvincingly, described by the heads of government as “exceptional and unique”.
So how can problems still arise for the three most troubled economies? In the case of Greece, it could happen because the government fails to stick to the budget tightening which has been agreed. The eurozone would then either have to provide more money, or the Greek government would default on its official debt and possibly leave the euro. That clearly remains a possibility.
For Ireland and Portugal, there is plenty of debt left in private hands, and markets have seen what happens when a sovereign nation reaches the limit of its financing ability – ie sovereign default. But for as long as these two countries remain inside the programme, they will be able to refinance their debt as it falls due, at low interest rates from the European Financial Stability Facility. This means that the markets cannot make the solvency position of these countries any worse by raising bond yields. Like Greece, these two countries might still be ultimately insolvent, but only if the pain of their budget tightening proves too much to bear inside the euro.
This greatly reduces the scope for financial crises stemming from the three most troubled economies, at least for as long as the EFSF has sufficient money to refinance Irish and Portuguese debts. Since it probably does have that money, that represents a major change in the situation. And we should note in passing that if the EFSF issues bonds to absorb all of this debt, it amounts to a very large issuance of Eurobonds to bail out the troubled economies, which is exactly what Angela Merkel, German chancellor, said she would not do.
What about Spain and Italy? We have known for some time that, as things stand, the EFSF emphatically does not have enough money to deal with these countries. However, the Summit does allow the EFSF to act in advance of these countries needing to enter a financial programme, and to provide more capital if the banking sectors of these countries should need it. As the economist Willem Buiter has said, this means that the EFSF now has a superior gun, but the same amount of ammunition as before.
Until the amount of ammunition is increased, the existential threats to the eurozone stemming from Spain and Italy have not been removed. Sooner or later, the eurozone will have to increase the resources available to the EFSF very substantially, or the markets will once again call its bluff. It will be interesting to see whether any guidance is given on this question after the meeting of eurogroup finance ministers on Sunday.
One last, and more fundamental, thought. The statement by the US authorities on 23 February 2009 effectively ended the financial market panic connected to the sub prime crisis, but it certainly did nothing to end the long term economic problems caused by that crisis. The US is still dealing with them. Similarly, even if the European summit of July 21 has ended the financial crisis in the eurozone, which is debatable, its longer term economic problems remain.
These problems revolve around inadequate GDP growth in many eurozone economies. Paul Krugman correctly reminds us of the scale of the fiscal tightening they now face. On top of that, the Summit may lead to a stronger euro, and may induce the ECB to tighten monetary policy further. That combination does not sound like a great recipe for strong economic growth.
Mrs Merkel said on Wednesday that the summit would represent a big advance, but that there would still be much more work to be done. She’s right.
Nessun commento:
Posta un commento