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Reflecting on the Latest ‘Solution’ to the Eurozone Crisis

Expectations were not particularly high going into last Thursday’s emergency European Council meeting in Brussels, due partly to the fact that German Chancellor Angela Merkel had warned spectators not to anticipate any grand solution to the debt crisis. In addition to this, underwhelming results from a number of previous such summits had conditioned onlookers to expect that the proverbial can would be merely kicked further down the road. However, what emerged from the roughly 16 hour negotiations late Thursday in fact appeared a step in the right direction.

Key points from the hard fought compromise include enhanced flexibility of the European Financial Stability Facility (EFSF), so that this fund can now purchase bonds of troubled countries on the secondary market, offer lower interest rates and longer maturities on loans and recapitalise banks. The involvement of the private sector was also agreed, to the stated tune of 37 billion euros, and it was agreed that the Eurozone would reduce interest rates on its share of the future Greek bailout, as well as extending maturities on existing and upcoming loans to Greece.

The mood of European leaders following the long talks was broadly triumphant, with Merkel proclaiming satisfaction, French President Nicolas Sarkozy celebrating the beginnings of a European Monetary Fund as seen in the reformed EFSF and Commission President Jose Manuel Barroso declaring that this represented the first coming together of markets and politics since the crisis began. These positive perceptions accorded with movement in the markets, where Greek two-year bond yields on Friday saw the biggest one day fall since Greece joined the euro in 2001 and the euro jumped to a two-week high against the dollar.

So, does all this mean that European leaders can head off on their summer holidays, confident that they have got the job done? Not necessarily. While Thursday’s agreement was significant insofar as it overcame long-held opposition by various camps – the ECB to private sector involvement in the bail out and Germany and the Netherlands to expanding the role of the EFSF, for instance – it seemed bold only compared with the bleak record in dealing with the crisis thus far. It is not the case that original or extraordinary measures were agreed, but rather measures were finally accepted that had been fought over for months. The more controversial, and likely most effective proposals, such as Euro bonds backed by the whole Eurozone, were absent from the final agreement.

The most striking realisation in the face of the hype with which this deal was greeted is that its measures stand to reduce the Greek debt burden to around 148% of GDP, small comfort for a country stuck in recession, with limited growth prospects and a penchant for political turmoil. Sure enough, it didn’t take long for the markets to reach the conclusion that perhaps this deal wasn’t so reassuring as it first appeared, not least because it does nothing to address the likes of Spain and Italy, a bail out of which would wipe out the EFSF funds many times over. Hence rising yields on Spanish and Italian bonds over the course of trading Friday, and reversal of the euro’s climb against the dollar.

Yet, if the markets ultimately determined that too little had been done, some of Europe’s citizens might feel things have gone too far. As noted in Der Spiegel International, the results of last Thursday’s summit may fuel fears that the Eurozone is becoming a transfer union, in which profligate countries can borrow at will, safe in the knowledge that wealthier neighbours will be there to bail them out. Although the official statement is that the terms extended to Greece through Thursday’s deal are exceptional, there is nothing that makes Greece exceptionally worth saving, aside from the fact that it is a Eurozone member. Personally, I was already convinced that the European Union had no plans to bail out troubled states in general.

So, despite the enthusiasm that initially greeted Thursday’s agreement, it seems that the proverbial can just went a bit further this time. To be sure, Europe’s leaders confirmed that they could compromise when the situation demanded it, but that does not solve much when the compromise is over a host of proposals that ultimately fall short. It will be all the more troubling if this latest deal does inflame anti-euro rhetoric from those in wealthy member states who want nothing to do with a transfer union, because this is certainly no transfer union. If it were, then Eurozone leaders probably could holiday without fear for the euro’s stability, though they would surely be distracted by thoughts of the next general election.

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