Europe of late has demonstrated that it is as big a mess as ever.
The Cyprus urgency had just begun to dissipate when Portugal suffered a political crisis over the austerity demanded by EU and IMF aid. Greece failed—again—to take the required steps for its aid. France, also failing to meet EU strictures, turned to partial sales of state-owned firms to raise money. Talk of default and a contagion of problems returned. EU leadership, however, has responded with less anxiety than in the past. Markets are calmer, too. There is a general confidence, not present in past episodes of difficulty, that the common-currency zone will hang together for the foreseeable future. The calm will not last, however, unless the zone’s members use the time bought with confident words and the palliatives of aid to initiate fundamental economic and market reforms.
However well people have taken the recent stress, this latest spate of problems speaks to the tenuous state in which Europe still lives. Portugal is especially significant in this regard. The details of its political problems matter less than that they exist. Portugal, after all, had been the poster child for European cooperation. It readily embraced EU and IMF demands for austerity, raising taxes and cutting spending in a variety of ways. Its persistent, severe recession may have offered proof that austerity alone was never the answer to Europe’s economic and financial problems, but the recent ministerial resignations and cabinet reshuffles now argue forcefully that austerity also lacks political viability. Failure in Greece, of course, hardly surprises. Athens has fallen short of all its policy objectives since it started the European crisis. Nor are Cyprus’ problems resolved. All is a reminder that Italy, Spain, Ireland and perhaps even France probably could not bear too much scrutiny.
In the past, official Europe would have responded to those problems very differently than it has. It would have called summits, reconsidered past measures, and surely assembled a raft of recriminations. This year, however, the authorities have behaved as if nothing much has gone wrong. Though Portuguese problems reflect sharply on EU policies, they have gone unremarked. More amazing, no one has raised a critical word against Greece. Its finance minister has publicly voiced misgivings about further spending cuts, while Athens has fallen short on budget reform and the privatizations demanded by its official EU creditors. Yet neither Brussels nor Berlin nor the IMF has raised a question or an objection. On the contrary, Europe’s finance ministers and IMF officials have said flatly that the problems are insufficient to stop the flow of aid and readily approved Athens’ next €4.0 billion financing tranche. The Germans, once Greece’s toughest critic, have actually become boosters. German finance minister Wolfgang Schäuble has spoken of the “great respect” Berlin has “for what Greece has done,” adding that “[i]t wasn’t easy, but this is the right way.”
This new approach surely reflects some important lessons learned during the past three years of crisis. For one, European officials have acquired a greater understanding of and sensitivity to markets. They can see that when they have made a fuss in the past, market participants have picked up the emotion and uncertainty, raised interest rates on questionable credits, and so compounded the financing problems that the authorities, in the beleaguered periphery and the rest of Europe, have dearly wanted to overcome. By keeping calm, they have reduced the chance of such complications. There is more. The Germans in particular, but also the European Central Bank (ECB), can now see that their particular, narrower interests lie with avoiding turmoil and keeping the Eurozone intact, even if it costs a lot.
The ECB’s zeal for a broad-based euro has at least two motivations. First is the bank’s genuine desire to stimulate economic activity across Europe. ECB President Mario Draghi has certainly committed the bank to a monetary policy of stimulus. Just recently he reminded all: “Our Policy stance has been, is, and will stay accommodative for the foreseeable future.” Because he knows that any breakdown in the common-currency system would present a huge impediment to this objective, he has also reaffirmed his powerful remarks from last year that the bank will do whatever it takes to preserve the euro in its current form. This stance has done much to calm markets during the past twelve to eighteen months, even as member nations have repeatedly failed to meet agreed budget targets. The second ECB motivation is narrower and more cynical but no less powerful. Draghi and all at the bank can see that without a euro there is no need for a European Central Bank, and a diminished euro diminishes the power and prestige of the institution. Germany too, has powerful interests in holding the larger Eurozone together. There are at least three.
First, Berlin has finally come to realize that it cannot avoid paying. It will either help Europe’s periphery stave off default, or it will have to bail out its own banks. If it refuses to do either, Germany, as well as Europe generally, will suffer an even more severe recession than exists presently. The degree of pressure is impressive. A report by German banks some months ago indicated that they have a €400 billion exposure to Greek, Spanish, Portuguese and Irish debt alone. Italian holdings would add substantially to this vulnerability. But even just the exposure to these four smaller nations amounts to 260 percent of the banking system’s primary capital and over 16 percent of the German economy. Default in any member nation, or just the fear of default, could then easily cripple German finance and render it incapable of supporting the German economy, much less Europe generally. Financially and politically, it is easier for Berlin to rally support for a European rescue of its weaker member nations than face a need to channel public funds into what otherwise would become a zombie banking system.
Second, German industry has come to love the euro. It may have gone into the common currency kicking and screaming, but now it surely sees the advantages. Consider, as no doubt German business has, the problems it would face today if Germany were alone with its old deutschmark. As the only viable economy of size in the Eurozone, money is pouring into the country. A separate deutschmark long ago would have risen into the stratosphere, pricing German exports off world markets by raising their price in terms of dollars, yen, yuan, reals, whatever. The euro, particularly because it has weak members that hold down its foreign exchange rate, has allowed German exporters to compete around the globe much more effectively than they otherwise would. There can be little doubt that their representatives have repeatedly explained this important fact of economic life to policy makers in Berlin.
Third, the common currency also serves German interests within Europe. If the euro were to go, a rising deutschmark would, of course, impair the competitiveness of German product elsewhere in Europe as well as in the rest of the world. But there is more. Because Germany joined the euro while the deutschmark was momentarily weak, and other nations, those in Europe’s periphery in particular, joined when their respective currencies were strong, the common currency effectively enshrined a German pricing edge within the Eurozone. When the euro was launched, that edge, according to IMF figures, amounted to some 6.0 percent. Since, German economic gains, especially compared to the disruption and high financing costs in Europe’s periphery, have widened that pricing edge further, well into double digits according to recent calculations from IMF figures. Even if the data and calculation techniques leave ample room for cavil over the exact extent of Germany’s pricing advantage, Berlin knows that a dissolution of the euro would erase it.
The resulting willingness to extend support to Europe’s beleaguered periphery could serve a longer-term, more lasting solution to the Continent’s fiscal-financial problems. The aid, of course, is just a palliative. Alone it is no solution. But it could buy time from chaos and disruption to allow these nations to implement needed, fundamental economic reforms that would ultimately lift Europe out of this mess.
Former Italian prime minister Mario Monti stressed this need. He effectively advocated that Italy, and the rest of Europe’s periphery, pursue reforms similar to those taken in Germany some years ago under former Chancellor Gerhard Schröder. Monti wanted to make Italian product and labor markets more flexible and efficient, and hence more competitive, as Germany had. He started the effort in 2012, removing legal restrictions on hiring, firing and work scheduling. The flexibility he introduced would in time, he argued, encourage growth and employment by making business more responsive to changing supply and demand conditions. Ultimately, such growth and employment would enhance government revenue flows. Monti’s example prompted other nations in Europe’s periphery to consider similar fundamental reforms. Greece, Spain and Portugal all started down this road. Though Monti and others knew that the ultimate benefit of such reform would take a long time to develop, they could see more immediate help, as markets, reassured that these nations were working to solve their problems, would provide credit more readily and at better prices.