Is the Euro Crisis Over?

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Financial crises tend to start abruptlyand end by surprise. Three years ago, the euro crisis began when Greece becamea cause for concern among policymakers and a cause for excitement among moneymanagers. Since the end of 2012, a sort of armisticehas prevailed. Does that mean that the crisis is over?
By the usual standards of financial crises, three years isa long time. A year after the collapse of Lehman Brothers in September 2008,confidence in the United States’ financial system had been restored, andrecovery had begun. A little more than a year after the 1997 exchange-ratedebacle triggered Asian economies’ worst recession in decades, they werethriving again. Has the eurozone, at long last,reached the inflection point?
Many battles were fought in the last three years – overGreece, Ireland, Spain, and Italy, to name the main ones. The European Union’sfinancial warriors are exhausted. Hedge fundsfirst made money betting that the crisis would worsen, but then lost moneybetting on a eurozone breakup. Policymakers first lost credibility by beingbehind the curve, and then recouped some of itby embracing bold initiatives. Recent data suggest that capital has startedreturning to southern Europe.
The current change in market sentiment is also motivated bytwo significant policy changes. First, European leaders agreed in June 2012 ona major overhaul of the eurozone. By embarking on a banking union,which will transfer to the European level responsibility for bank supervisionand, ultimately, resolution and recapitalization, they showed their readinessto address a systemic weakness in the monetary union’s design.
Second, by launching its new “outright monetarytransactions” scheme in September, the European Central Bank tookresponsibility for preserving the integrity ofthe eurozone. The OMT program was a serious commitment, and markets interpretedit that way, especially as German Chancellor Angela Merkel backed it, despiteopposition from the Bundesbank.Moreover, Merkel visited Athens and silenced the voices in her coalitiongovernment who were openly calling for Greece’s exit from the euro.
Unfortunately, however, there remain three reasons to beconcerned about the future. For starters, politics lags behind economics, whichin turn lags behind market developments. Sentiment on trading desks in New Yorkor Hong Kong may have improved, but it has deteriorated on the streets ofMadrid and Athens.
Indeed, the economic and social situation in southernEurope is bound to remain grim for severalyears. As things stand, all southern European countriesare facing the prospect of a true lost decade: according to the InternationalMonetary Fund, their percapita GDP will be lower in 2017 than it was in 2007. As long assustained economic improvement has not materialized, political risk will remainprevalent.
Political upheaval in any ofthe southern countries would be sufficient to reignitedoubts about the eurozone’s future. Furthermore, French competitiveness, andthe gap between its performance and that of Germany, is a growing cause ofanxiety.
The second reason to worry is that there is limitedconsensus in Europe on what, exactly, is needed to make the monetary union resilient and prosperousagain. Banking union is a positive development, but there is no agreement onadditional reforms, such as the creation of a common fiscal capacity or acommon treasury.
In particular, northern Europe continues to interpret thecrisis as having resulted primarily from a failure to enforce existing rules,especially the EU’s fiscal-stability criteria. Southern Europe is more inclinedto view the crisis as having resulted from systemic flaws. Furthermore,northern Europe regards austerity as the mother of all reforms, while southernEurope fears that governments may not have enough political capital to doeverything at the same time.
Finally, the last three years have revealed a clear patternin the management of crises: Almost no decision results from serene deliberation,with most taken under financial-market pressure in an attempt to avoid theworst. Each time the pressure abates, plans forpolicy reform are put off – an attitude best captured in Merkel’s famous ultima ratio: actionis undertaken only if it is indispensable to thesurvival of the euro. In other words, Europe displays a strong sense ofsurvival, but not a strong sense of common purpose.
None of this means that the euro will collapse. The widelyheld conviction that letting the monetary unionbreak up would amount to collective economic suicide provides a strongmotivation to weather storms and overcomeobstacles. Moreover, the results achieved so far may well prove sufficient tocontain risks in the near future, while plans for a fiscal capacity, commonbonds, and the creation of a European treasury are still being sketched. So, in practical terms, the differencebetween reforms that could be implemented and those that are being or will beimplemented is less significant than it seems.
But, by consciously eschewingdiscussion about which reforms would make membership in the eurozone less hazardous and more beneficial for all, Europeanleaders are missing an opportunity to signal that the euro is a stepping stone toward a prosperous, resilient, and cohesive union; and they are missing an opportunity tosignal that the harsh economic adjustment that continues to dominate the policyagenda for much of the continent is not an end in itself.

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The current change in market sentiment is also motivated bytwo significant policy changes. First, European leaders agreed in June 2012 ona major overhaul of the eurozone. By embarking on a banking union,which will transfer to the European level responsibility for bank supervisionand, ultimately, resolution and recapitalization, they showed their readinessto address a systemic weakness in the monetary union’s design.

Second, by launching its new “outright monetarytransactions” scheme in September, the European Central Bank tookresponsibility for preserving the integrity ofthe eurozone.



Unfortunately, however, there remain three reasons tobe concerned about the future.

For starters, politics lags behind economics,which in turn lags behind market developments.Sentiment on trading desks in New York or Hong Kong mayhave improved, but it has deteriorated on the streets of Madrid and Athens.Indeed,the economic and social situation in southern Europe is bound to remain grim for several years.Political upheaval inany of the southern countries would be sufficient to reignitedoubts about the eurozone’s future.



The second reason to worry is that there is limitedconsensus in Europe on what, exactly, is needed to make the monetary union resilient and prosperousagain.In particular, northern Europe continues to interpret thecrisis as having resulted primarily from a failure to enforce existing rules,especially the EU’s fiscal-stability criteria. Southern Europe is more inclinedto view the crisis as having resulted from systemic flaws. Furthermore,northern Europe regards austerity as the mother of all reforms, while southernEurope fears that governments may not have enough political capital to doeverything at the same time.



Finally, the last three years have revealed a clearpattern in the management of crises: Almost no decision results from serene deliberation,with most taken under financial-market pressure in an attempt to avoid theworst.




.