Europe: have we just had some good news?

It is easy to get weary with the Euro soap opera of never ending last chance summitry. But last week’s episode may have been an important positive turning point. Commitments were made that represent necessary steps on the road to ensure the survival and eventual success of the Euro.

An economist’s view…

Some of these commitments, such as arrangements for banking supervision in the Eurozone, are arcane and sleep inducing. But Mrs Merkel and her colleagues may have been awakened from their slumber by scary scenarios of the consequences of mass withdrawals of deposits from the banks at the periphery of the Eurozone. The run on the UK’s Northern Rock in late 2007 would have been a picnic in comparison.

Seriously standing behind the banking system

Last week the time came for northern Eurozone countries to decide whether they are serious about their commitments to the single currency, and they decided that they are serious. One important decision was to centralise banking supervision for the Eurozone, probably with the European Central Bank in Frankfurt, and to take it away from national authorities.

Implicitly, at least, this is a major step toward a Eurozone-wide commitment to stand behind its banking system. Previously, national governments (which in the Eurozone, are mere regional governments) had full responsibility for standing behind their banks and this has caused enormous problems in Ireland and more recently in Spain.

Mrs Merkel does not want to spend any German money on rescuing the banks of other countries…

…but German money is probably now there, as a backstop, in a way that it was not before. Notably, the new European Stability Mechanism rescue fund’s money is to flow (not just yet, but soon) directly to weak Spanish banks and will not be a liability of the Spanish government. This does not necessarily mean that Eurozone bank shareholders or bank creditors are being bailed out, and they may have more pain to suffer, but it does mean that the Eurozone financial system and economy are probably safer now than they were just one week ago. 

Meanwhile, there are signs of some narrowing of cost competitiveness

This is between Eurozone countries; the  budget deficit of Italy is not so big; and Spain, potentially free from shouldering the cost of recapitalising its banks, is no longer such a financial worry. Greece is still in great difficulties but it serves as a dire warning to others. Ireland (and, just outside the Eurozone, Poland) may yet show that virtue is rewarded, probably with some more help to Ireland to meet the cost of bailing out its banks.  At the same time, we probably will not see the return of fiscal largesse in Europe for a very long time.

Turning in the corner

So far as financial markets are concerned, we may have just turned an important corner.  But the deeply concerned tone from the Bank of England’s Mervyn King, shows that there has been, and probably still is, much to worry about. 

Peter Stanyer, Independent Economic Consultant to FPC and author of  The Economist Guide to Investment Strategy, Profile Books, 2010
4th July 2012

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