We are now clearly in a new and troubling phase of the Euro-crisis. There is, like most things in life, a sense of diminishing returns to continued reference to “crisis”, “precipice” and similar doomsday pronouncements when in fact the Eurozone has continued to survive. And accompanied with modifications to the monetary-fiscal mix through increased liquidity support, moves toward a Fiscal Compact and a firewall to help Euro-members.
And yet, there is a clear sense of a worsening situation as Spain has become the country in the headlights but with less-pronounced but equally serious issues facing other countries – from Cyprus through to non-Euro peripheral emerging economies such as Serbia.
Mass withdrawals are a natural reaction by savers who fear either devaluation (Greece), likely freezing of FX accounts following a possible Euro-exit/devaluation (Greece again) or mass panic due to uncertainty and lack of confidence (Spain, Cyprus).
There is ample evidence of the outflow or transfer of a wall of money from Greece to safety in the northern Euro-zone countries or conversion to assets (just ask real estate agents in London and elsewhere).
We are now seeing the same in Spain with reports of mass withdrawals, which in turn feed into further bouts of risk-aversion aka the Mary Poppins moment.
And we know from the history of bank runs that contagion is not a linear process and no one can predict when and if the speed of withdrawals might accelerate and become a systemic crisis – both within the southern Eurozoners – but also to other Eurozone countries and to other non-Euro states such as the UK, or indeed to the ring of emerging economies ring-fenced in 2009 by the Vienna Agreement put-together by the EBRD.
We also know from historical bank runs that the role of the lender-of-last resort is vital, coupled with confidence provided through deposit-insurance.
Although the ECB has ramped up liquidity in recent months to Eurozone banks, a formalisation of this indirect fiscal liability is not forthcoming until and unless the Fiscal Compact becomes a credible reality which in turn allows net payers – particularly Germany – to feel that it is not going to be dumped with toxic and limitless uncontingent fiscal liabilities.
And the same argument applies for a common deposit insurance scheme.
Access to firewall financing, albeit do-able, would not itself tackle the core cause behind the bank solvency and attendant structural fiscal deficits in Spain – as well as other southern Eurozoners.
A cul-de-sac?
Potentially. But Spain’s volte-face in recent days toward reluctant acceptance of the idea that national budgets should be approved in Brussels highlights that there is no alternative when creditworthiness is declining, access to markets increasingly expensive and unsustainable and alternative policy options unavailable – including its first attempt for a domestic policy response of forced mergers between weak banks and cajas.
We are entering the central phase of the Euro crisis and I expect it to continue well into 2013 (the German Bundestag election is due by October 2013) and probably into 2014.
Spain will need external aid. This means a Programme – likely one based on the Troika-model for Greece.
Cyprus will likely need one too, given that largesse from Moscow is unlikely to continue and given its vulnerability to Greece, particularly through its banking system.
And what about Malta? How about Italy? Shhh but how about France?..
Very soon we may find that the entire flank of the Eurozone south is having to undergo forced structural adjustment – although hopefully on a more realistic macroeconomic framework than was the case for Greece.
Will such external programmes be politically feasible? Would they come with capitalisation for banks and in the scale that might be required? Would this be sufficient to give the Fiscal Compact credibility and in turn sufficient guarantees for Germany to agree to mutualisation of sovereign risk?
The risk of Spain entering the maelstrom of the crisis has indeed been a déjà-vu. Spain is too big to save through bailouts and so we may have reached a critical point in the crisis.
Iterative policy responses from Eurozone politicians may be a natural response to domestic politics but the very real threat of bank runs in Spain and possible spillover to the north (witness recent de-ratings for German and Austrian banks), however small the risk, could well become a self-fulfilling outcome.
In the short-term, confidence in the Spanish banks and Spain’s “irrevocability” with the Euro will require external support and I expect the IMF to play a key part.
However it is vital that any programme focuses beyond the narrow prism of re-capitalization of banks and fiscal reforms to also focus on measures to put in place
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