It is concerning when the President of the World Bank Group writes in an FT editorial, “The summer of 2012 offers an eerie echo of 2008. Markets are signalling anxieties about a major asset class. In this round, Eurozone sovereign debt has replaced mortgages as the risky investment. Banks are under stress. Depositors have not yet begun to run, but they are starting to jog.”
All week, the country on everyone’s minds has been Spain. This is because it is a litmus test of what can be tolerated in the ever growing European crisis. Only yesterday, Spain revealed a capital flight of €97bn in the first three months of this year as investors fled from the creeping contagion of Europe’s embattled debt and austerity debate, and from Spain’s own floundering response to its major banking crisis.
The theme emerging from business is common: “trouble in the periphery” was unnerving yet bearable, but Spain is certainly too big to allow to fail. The problem is that Europe’s political performance over the past year has provided no reassurance that it has the will or unity required to stem this crisis. In the height of the global financial crisis of 2007-2008, national governments were required to back their banks and protect savings deposits. Their responses were at times unwieldy, but allowed for by the common empathy (and rationale) that all were groping for a way forward in the darkness of the unknown.
This is not the case for Europe. It has been evident to many for months now that, on account of national indebtedness and poor public finances, national reassurances will not be enough to fight European-wide contagion. What the world has wanted to see again and again is a consolidated, unified approach to this crisis. This has been shamefully absent.
Of course, the issue is complicated. Moral hazard would say that collectively guaranteeing “profligate” states is unwise. Furthermore, the trade deficits and surpluses of countries within the region make a squaring off of debts necessarily difficult (not to mention awkward). But isn’t this the downside risk and grim reality of entering into a currency union in the first place? If you want the greater hegemony of a common currency – for global impact and economic strength – you have to accept the realities of that choice.
World Bank Group President, Robert Zoellick, has speculated that Europe lacks the support of sovereigns to back the ECB to “overwhelm” any crisis that were to begin: “Some argue that if a crisis begins the ECB can overwhelm it. Yet the differences of views on the ECB board raise doubts about its ability to respond fast, fully and forcefully. Moreover, the states that stand behind the ECB would have to decide to permit it to provide further funds to banks with poor collateral…” Germany’s lack of support for ECB action has been vocal thus far.
ECB president, Mario Draghi, yesterday issued a timely reflection on the implications of Spain’s poor handling of its banking crisis: “There is a first assessment, then a second, a third, a fourth,” Mr Draghi said. “This is the worst possible way of doing things. Everyone ends up doing the right thing, but at the highest cost.” Arguably, his words are as fitting for Europe as a whole as they are for Spain.