Euro Zone: From Crisis to Complacency

By Elizabeth Pond

What a difference a year makes!

Twelve months ago the euro was peering over its own cliff. Volatile financial markets were doing their best to shove Europe's fledgling common currency into the abyss. "Grexit" became the popular nickname for expected Greek expulsion from the European Monetary Union. Euro zone members were entering a marathon year of 22 crisis summits that they would muddle through on one bleary weekend after another, only to face a new blow-up and reagitated markets a fortnight later.

At that point Washington Post columnist Robert J. Samuelson thundered, "By now, it’s obvious that adopting the euro was a colossal blunder. It may rank as Europe’s worst policy mistake since World War II." Even the anti-sensational Financial Times chimed in with an unwonted "Capitalism in Crisis" subhead.

And today? A year later, by contrast, euro zone chieftains are, well, complacent.

By common consent, the turning point came late last summer. The 2-1/2-year-old euro crisis had reached a new peak in the weak peripheral euro zone countries. Yields on Greek 10-year bonds, after dropping by half to 18 percent in response to a second tranche of credits from the rich northern members of the euro zone, had climbed back up to 30.5 percent. A constant 18 million Europeans were unemployed, including, in Greece and Spain, close to 25 percent of all workers and more than 50 percent of youths. Ireland was clawing its way back from recession, but Italy, Europe's fourth-largest economy, was verging on financial disaster. Portugal was lurching into political crisis over the austerity measures demanded by creditor nations. Cyprus was threatening to join the queue of supplicants for aid. Even France, Europe's second-largest economy, was looking wobbly.

Moreover, economic hardship was fueling the growth of the extreme right on the continent. Journalists and historians pointedly recalled the depression of the 1930s that precipitated Hitler's rise. Street protesters in Athens torched banks, threw Molotov cocktails, and called German Chancellor Angela Merkel a Nazi for not giving Greece more money from the coffers of the continent's economic dynamo.

For her part, once she finally became convinced in mid-2011 (rationally if not sentimentally) that Germany had to rescue Greece and the euro in its own self-interest, Merkel kept repeating the mantra that "if the euro fails, then Europe fails." She didn't put it this way, but the crucial question was whether the monetary union that her mentor, Chancellor Helmut Kohl, promoted two decades ago for political reasons—to embed post-Cold-War unified Germany irreversibly in a cooperative European Union—might implode for the economic reasons that Samuelson highlighted. And if so, whether the historical "German question" of a behemoth too big for its less populous and powerful neighbors might rise again to plague the 21st century.

In this febrile climate, European Central Bank President Mario Draghi suddenly asserted that the ECB would do "whatever it takes to preserve the euro." Subsequently, he won a vote from his Governing Council—against the single dissent of the German central bank representative—to purchase unlimited amounts of distressed governments' bonds on the secondary market and buy time for weak euro zone members to enact structural reforms and jack up their competitiveness to converge at last toward the German benchmark.

At the hallowed Bundesbank, the keepers of the grail of financial orthodoxy recoiled at the ECB's mission creep from monetary into fiscal policy and its violation of the explicit treaty ban on bailouts of weak euro zone members. But Merkel, the continent's ultimate paymaster—while not leaving her own fingerprints on Draghi's promise—did not veto his commitment to action, which would cost Germany close to a quarter of any resulting outlays. Instead—despite the scandalized Bundesbank, a skeptical German constitutional court, and the opposition to further bailouts by a majority of German voters ranging from 54 to 75 percent—she let both unruly backbenchers and Bundesbank worthies fall on their own swords of fiscal rectitude. (The swords were relative; after seven years at the Bundesbank helm, Axel Weber moved on to become board chairman of the Swiss UBS investment giant.)

So far, Draghi's gamble on Merkel's acquiescence—and his dare to financial markets "to challenge the ECB's unlimited firepower," as the Financial Times put it—has worked. His pledge stopped speculation cold. Stock markets rose in financially troubled states. Italian and Spanish bond yields dropped. Greek 10-year bond yields fell to a welcome 21-month low, and by last month Standard and Poor's raised Greece's sovereign rating six notches, from selective default to B-. Simultaneously Goldman Sachs, Citigroup, J.P. Morgan, Pimco, and BlackRock all returned to the Italian bond market.

At the same time, Ireland's pioneering of the competitive reforms that the ECB and Germany were demanding of the weak peripheral states was starting to pay off and give hope to others. Last year, Ireland became the first stressed state in the euro zone to attain a current account surplus, amounting to some 9 percent of GDP. Madrid, Lisbon, Athens, and Rome (pending possible setbacks after Italy's election next month) are following Dublin's path in imposing austerity on their disgruntled voters. They have all legislated tough reforms that absent a crisis would have required a generational change to carry out—and they too aspire to reap current account surpluses of their own this year.

Notably, the ECB has not even needed to act on Draghi's threat of market intervention to contribute to these shifts. His Merkelesque precondition for emergency intervention—that needy governments must first accept strict budget cuts and other reform targets—has so far deterred Spain, the likely first candidate, from asking for help.

Meanwhile, Merkel has consistently refused to rush into swift decisions and more financial transfers just because there is a crisis. This has led perforce to an incremental approach of building new institutions to correct the "blunders" made in subordinating economic rationality to the priority of anchoring unified Germany in Europe. Merkel’s slowness has drawn criticisms that she is heartless and always does too little too late. But it has allowed time for a process of trial and error in designing new institutions in the midst of crisis.

Thus, Merkel's pact for fiscal discipline that 25 of the 27 EU members signed last March entered into force this past Tuesday and for the first time provides for compliance checks, on request, by the European Court of Justice. And the EU summit in mid-December took the first step to limit last year's dangerous metastasis of private bank debt into sovereign debt by writing the framework for the first Europe-wide banking union and the first Europe-wide supervision of too-big-to-fail banks, both under the purview of the European Central Bank.

So are the euro zone's three years of agony now over?

For Antonis Samaras, the beleaguered Greek prime minister, the answer is yes. After receiving another €34.4 billion tranche of euro zone credits two weeks ago, he exulted, "Grexit is dead!"

For Angela Merkel, the answer is no. Characteristically, in her New Year’s Day address to the nation, she repeated her usual warning to the continent’s leaders to not slack off. When they think they have solved one crisis, only to let down their guard. Europe must expect two more years of reforms, slow growth, and high unemployment, she preached. For good measure, she added that more needs to be done internationally, too, "to monitor the financial markets. The world has not sufficiently learned the lesson of the devastating financial crisis of 2008. For never again must such irresponsibility be allowed to take hold as it did then. In the social market economy, the state is the guardian of order, and the public must be able to place its trust in it."

Perhaps it's time to revise the conventional wisdom about who rescued the euro last summer. Let's just say that good-cop ECB President Draghi and bad-cop Chancellor Merkel filled the breach together.



Elizabeth Pond  is a Berlin-based journalist and the author of The Rebirth of Europe.

[Photo courtesy of Slolee]

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