We’ve been dragged back into the same old debates about Europe that we had in the latter part of 2011. By now, under free floating currencies, the foreign exchange markets would have forced a solution on the eurozone’s imbalances. Under a single currency this is impossible, but with separate sovereign debt markets, the task of forcing a solution falls to bond markets.
The big question in the immediate future is whether Spain will fall into a full blown programme of assistance, like Ireland and Portugal. Inevitably, this would trigger worries about whether any firewall was large enough, or would actually be used, short of Eurogeddon.
History would suggest that in most debt crises, the creditors tend to end up paying, so in the longer term, the main question is how much Germany is willing to pay to save the euro, and what their bottom line for action is. Germany is caught between the need to reduce Greece’s unsustainable debt burden and keeping up the pressure for reform – if the pressure is relaxed, there will be little incentive to reform and it would also set an unhelpful precedent.
Greece would probably agree to a more acceptable balance between debt forgiveness and reform, although realistically they can only remain in the euro if there is a permanent transfer union and they become a ward of state.
There is now some talk of a growth pact to supplement the fiscal compact agreed in December. Monti’s rhetoric on this issue has increased, while Hollande’s five-point plan for growth includes using the European Investment Bank to finance a programme of infrastructure spending and revising the ECB’s mandate. Germany may warm to the former, but not the latter.
With similar fiscal constraints still to be faced by the US, it looks unlikely that global growth will be strong enough to give Europe enough time to grow out of the crisis, without some pooling of fiscal sovereignty. We’re back to the inconvenient truth that, at its heart, this is a solvency crisis, not a liquidity one.
