Too long an illness

THEY barely dare say it, but the doctors are strangely confident: after a long illness, the euro may be recovering. This week’s all-night surgery by finance ministers to excise a festering lump of Greek debt went better than expected. “We have put in place almost all of the elements we need to make the crisis gradually go away,” says one. “We may be beyond the acute phase, and could be making the transition to normalisation.” It is the optimism of despair: the patient has not died, so must be improving.

Many are sceptical. But consider the evidence. Greece may now stabilise. It must meet conditions to get its money and will endure pain for years. But the risk of chaotic default and exit from the euro has receded. Private creditors have taken a big loss, yet the markets are muted. Elsewhere the signs are good. Italy is reforming, as is Spain. Most European Union countries have agreed to a new fiscal compact that will strengthen budget discipline. The European Central Bank (ECB) has averted a credit crunch by injecting liquidity into banks. And the defences against contagion may soon be boosted. On March 1st EU leaders will debate calls to enlarge their rescue fund by half. This could prompt others to pay more into the IMF, which would also help.
In this section

    Erdogan at bay
    A secularist’s lament
    Enter Gauck
    A Balkan cliffhanger
    Backing down gently
    Frontal assault
    »Too long an illness
    Corrections: Spanish cities and Finnish politics
    Nico Colchester journalism fellowship

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The recession this year is now forecast to be short-lived and mild. The euro zone’s temperature chart—the spread of bond yields over German bunds—is gradually narrowing. For the first time in six months, a week has passed without the ECB making emergency bond purchases.

So is the crisis over? Not so fast, say critics.

Start, again, with Greece. Far from curing the patient, the medicine is coming close to killing it. Its slump (a cumulative contraction of 16% of GDP and shrinking) may enter the record books. The pressure to chase an ever-receding deficit target has created a death spiral. Success will be slow and take a generation; failure will be an ever-present risk. The programme is “accident-prone”, says a leaked assessment by EU and IMF experts. Any number of problems—deeper recession, slower privatisation, fewer structural reforms—could bust the forecast that Greek debt should drop to 120% of GDP by 2020. This threshold was chosen for political reasons: it is roughly Italy’s debt ratio. Yet Italy is hardly healthy; it too struggles to convince investors that its debt is sustainable.

In several countries, fiscal and structural reforms are still at a fragile stage. They could provoke stronger opposition, particularly if they are seen to be imposed by foreigners. Greek newspapers’ depiction of German leaders in Nazi uniform, and German tabloid calls to throw Greece out of the euro, show how tempers can fray. Better market sentiment may be down to nothing more than the aspirin from the ECB. Liquidity is more like a painkiller than a cure, and the ECB is itself worried about creating an addiction to cheap money. Creditor countries have criticised, with reason, the fecklessness of those they have rescued. But they have been slow to admit their own errors, not least delay and excessive austerity as the cure for excessive deficits. They have yet to fix the instability of a currency union built on an incompatible triad: no bail-out, no default and no exit.

The second bail-out for Greece implicitly recognises some of the errors in the first one. It softens the deficit target for 2012 and puts more emphasis on overhauling the sclerotic economy through structural reforms. It is striking that, even after this, the “tough” IMF wants to ease up on budget cuts whereas the “soft” EU remains mulish about sticking to austerity. Conversely, it has taken the EU too long to accept standard IMF practice: when a country is bust its debt must be restructured. The euro zone has vacillated between ineffective bail-out and ineffective bail-in. Its first Greek rescue was too short-term and exacted punitive interest rates. Loose talk of future debt-restructuring (“private sector involvement”) at a Franco-German summit in Deauville in October 2010 served only to alarm markets.

The ECB’s former president, Jean-Claude Trichet, resisted all attempts to make Greece’s creditors take a hit. When he finally yielded a bit last summer, the euro zone negotiated a timid 21% loss in the lifetime of the bonds, for fear of triggering a “credit event”. Tougher negotiation has now made creditors take a more realistic 75% loss. The ECB, now led by Mario Draghi, has even chipped in some money, indirectly, by surrendering profits it would have made on Greek bonds it bought at a discount. The euro zone has also softened the terms of its loans to Greece.

Time heals, maybe

An end to quack remedies is welcome, though it may have come too late for Greece. Had today’s policies been adopted from the outset, the Greek crisis might have been controlled sooner, the adjustment for debtors might have been less onerous, and the cost to creditors might have been lower. That said, mistakes were to be expected, particularly when the euro zone was both badly designed and ill-prepared for a crisis.

Fear of catastrophe has forced EU leaders to think more clearly. Debtors know they must reform, and creditors know they must help. The first hints of stabilisation, if that is what is happening, may even bring new problems. Will a reduction of market pressure slow weaker countries’ long and painful march to reform? Will stronger ones ignore the design flaws that make the single currency needlessly unstable?

A hopeful prognosis makes sense only if leaders use a moment of relief to push through structural reforms, remove barriers to the single market, enhance the firewall against contagion and move towards greater fiscal union. One lesson of this week is that, faced with market meltdown, politicians from both debtors and creditors will compromise. But another is that the euro crisis is still far from being resolved for good.