03 November 2011

Stewart Fleming: In search of salvation

In his article for European Voice, Fleming observes that weak governments in Greece and Italy now threaten the eurozone's strategy for shoring up the single currency. Dysfunctional decision-making once again threatens efforts to salvage the single currency.

For much of the past year, it was doubts about Germany's commitment to the euro that hobbled efforts to shore up the single currency in the face of Europe's debilitating sovereign-debt and banking crises. But on Monday night (31 October), only days after a eurozone summit in Brussels had patched together a revised crisis-management strategy, it was Greek Prime Minister, George Papandreou, the head of a divided government, who recklessly put the summit's conclusions in doubt.

The immediate impact of the Greek referendum announcement was to sow doubts about both the new crisis-management strategy and international help for the single currency. Jacques Cailloux, the chief European economist at Royal Bank of Scotland, warned that the prospective Greek referendum was “a major negative for Greece and the rest of the monetary union”, adding that it would probably “block any new potential financial support from countries outside the monetary union to the EFSF”.

If the likes of China and Brazil hesitate, who can blame them? The political turmoil in Greece is threatening the euro even as the eurozone's biggest potential headache, Italy, remains unresolved.

Regime change in Italy is seen as something the European Central Bank (ECB) may be encouraging, as it fine-tunes its purchases of Italian government bonds. On this view, nothing would do more to take the pressure off Italy, and to ease the wider eurozone sovereign-debt and banking crisis, than a new Italian government committed to the economic reforms without which Italy's economy will continue to present a mortal threat to the single currency.

Tough ECB line

Mario Draghi, who chairs his first meeting of the governing council today, has every incentive to take a tough line with his Italian countrymen. To do otherwise would quickly undermine the credibility of his leadership of an already divided institution. The ECB's governing council is deeply split both about the support that the central bank gives to Italian bonds in the secondary market and about setting the conditions on which this support is provided.

The sudden deterioration in the global and European economic outlook was confirmed this week by the OECD, the Paris-based think-tank for rich countries. In forecasts prepared ahead of the G20 summit, the OECD projected that, instead of expanding by 1.6 per cent in 2012, as it had earlier predicted, growth in the eurozone would peter out, limping at best 0.3 per cent higher.

Faced with this outlook, and with the evidence that their 21 July initiatives had failed to restore confidence, eurozone governments had moved at last week's meetings to reinforce the debt strategy. Initial reactions were positive. But experts remained uneasy. “The ‘Grand Plan' is sorely lacking in detail”, wrote Stephen King, the chief economist at HSBC, an international banking group. Within five days, that guarded assessment had been overtaken by events.

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