The euro zone has cut yet another deal to ease the strain of its ongoing debt crisis. Markets were encouraged. The euro has risen against the dollar, and stock markets, on balance, have advanced. It looked to some as if the Germans had at last made concessions on austerity. But though this deal has made genuine progress, matters substantively have remained of a piece with past, partial solutions. As before, negotiating positions reflected long-standing national interests. Europe will need to do more—and no doubt will—though the best chance of comprehensive relief still lies with a reengagement of the European Central Bank (ECB).
France, Italy, Spain and others close to the periphery pursued these negotiations as they always have. Knowing that Germany would bear the lion’s share of the expense, whether through the European Stability Mechanism or the European Financial Stability Mechanism, they pushed for the most liberal use of all funds and urged the softest of austerity conditions. This time, they looked for automatic lending for some borrowers, direct aid to beleaguered banks in Spain and elsewhere, and, as before, the issuance of so-called euro-zone bonds. These bonds would finance Europe’s stability mechanisms and perhaps capitalize its banks through zone-wide credits (mostly German).
And Germany, as before, took a less one-sided approach. Because Berlin knows it will carry the bulk of any financial and economic aid, it continued to insist, as any financier would, on both control and assurances that its expenses would have a payoff: in this case, a change in profligate fiscal and banking policies. But Berlin balanced this position with its clear understanding that Germany gains a great deal from the zone. Because the euro has enshrined the German price advantages that existed when it joined the common currency, the zone has become a critical, almost captive market for German products. Berlin is also aware that the zone, with its weaker members, has kept the euro from rising as high as a separate deutsche mark would have, giving Germany competitive advantages outside Europe. Certainly Germany’s leadership has no desire to throw these advantages away for the sake of a rigid insistence on strict austerity.
All these elements were present in this latest round of negotiations, as they have been from Europe’s first efforts at crisis control. France and others pushed for liberality, and the Germans made what concessions were necessary to protect the integrity of the euro zone but, as before, made as few as it could. Last week’s deal seemed to make greater headway then past deals—less because the substance changed and more because it rhetorically separated the desires of France, Italy, Spain and others from the inevitable German caveats and conditions.
To be sure, Berlin reversed two former positions. It relented on its previous resistance to direct lending to banks from the zone’s stability funds. This concession was more apparent than real. The initial German resistance stemmed from a need to ensure the funds were not wasted, something Berlin believed could only arise from government-to-government arrangements. But since then, talk of zone-wide bank supervision has offered Berlin an alternative means of control, allowing it to relent on this point, or at least appear to do so. Similarly, this alternative source of control softened Berlin’s former insistence on special credit status for the rescue funds, allowing it to encourage private lenders by placing their claims on a hierarchical par.
For the rest, the old German balance was more obvious. When Italy’s Mario Monti pushed what he referred to as a “semi-automatic” mechanism for Europe’s funds to the support “well-performing” nations by buying their bonds in the secondary market, German finance minister Wolfgang Schäuble did not dispute him. He simply rendered the term “automatic” moot by noting that such loans would still require a formal request that would give Berlin the control it has always sought. Neither was there need to insist on austerity with “well-performing” nations, since presumably the designation speaks to their own greater degree of control.
Similarly, the debate on common debt, the euro-zone bonds, followed the old patterns. France and Italy talked them up, while Berlin insisted that such issues would have to wait until the European Commission, and hence Germany, have strict, “irreversible” control over national budgets, including the power to strike them down and sanction nations in violation of monetary-union rules.
Enter the Central Bankers
Notably missing in all these efforts was the presence of the European Central Bank (ECB). It, of course, cannot address the underlying fiscal imbalances. But by using its huge resources to decisively ease financial strains, it can buy time for nations to correct their fundamental problems by freeing them from new bouts of financial panic and the punitive borrowing terms they impose.
The ECB demonstrated its effectiveness in reassuring investors late last year. When a wave of investor panic attacked Spanish and Italian debt, ECB purchases of such obligations calmed markets immediately. Long-term Italian and Spanish bond yields fell by more than one hundred basis points in short order. As the ECB extended its support by lowering its benchmark interest rate and offered €1.0 trillion in subsidized three-year loans to Europe’s banks, Spanish and Italian bond yields fell by an additional 150 basis points, and markets easily absorbed the first quarter’s Spanish, Italian and Greek refinancings. Only later in the spring, when the ECB suddenly declared that it had done enough, did the markets again become vulnerable to a new wave of panic.
The ECB could make this all a lot easier by returning to those policies of late 2011 and early 2012. In this way, it could do for Europe what the Federal Reserve has done for American markets. Chances are, if matters go to extremes, the ECB would return to such supportive policies. After all, if conditions threaten the euro’s existence, they would also threaten the ECB’s existence. Fewer motives are more compelling.
The ECB’s latest interest-rate cuts may be the beginning of a renewed supportive approach. But even if the ECB were to back away again, or is willing to contemplate suicide, there is a clear commitment among the members of the euro zone—especially the German desire to keep the monetary union together, whether out of principle or out of self-interest. Thus, the smart money remains on the side of continued existence for the euro and its zone.
Milton Ezrati is senior economist and market strategist for Lord, Abbett & Co. and an associate of the Center for the Study of Human Capital at the State University of New York at Buffalo. He writes frequently on economies and finance and is just completing a book on demographics and globalization.
Image: European Council