You can always trust the Americans, Churchill said, because in the end they will do the right thing, after they have exhausted all the other possibilities. For the last 18 months, Europe has made of this famous phrase its roadmap: it has taken the necessary decisions, but always as a last resort.
Once again, on 21 July, the euro area's leaders proclaimed that what they previously said was unthinkable was in fact necessary. They gave up the pretence that Greece was solvent, agreed to extend more and longer-term loans to it, admitted that excessive interest rates could only make the problem worse, called for private lenders to bear some of the burden, gave a guarantee of continued funding for Greek banks, recognised the need to support growth, and agreed to broaden the scope of the European financial facility, making it a more flexible tool for intervention.
For Germany, France, the European Central Bank and other players in the European game, these about-faces have a cost in terms of reputation, political capital or legal leeway. Although decisions taken on 21 July were wide-ranging enough for everyone to be able to claim success, the players are going to have to explain why red lines were crossed. All no doubt will claim that this is the last time.
Is this true? Have the last taboos been broken? Or will another crisis summit need to be convened soon with even bolder denials and measures?
In the case of Greece, there is real aggiornamento. In place of an equation without a solution, European leaders have substituted another, which no longer seems unsolvable. In deciding to provide cheaper loans and in agreeing to a debt reduction, they have started reducing the burden – though not enough, as far as private lenders are concerned.
A reduction in public debt will not make companies more competitive or create jobs for the unemployed -- even though it will help. There is a view that for Greece to recover, it will be necessary to break the 'euro taboo' and reintroduce a national currency. The certain outcome of this would be immediate devaluation, much beyond what restoring competitiveness requires. When in 2002 Argentina broke its link to the dollar, the peso lost four-fifths of its value. But financial claims in Greece are denominated in euros. Forced conversion would destroy much of the value of savings and resulting currency mismatches would unleash a wave of bankruptcies (in Greece or the rest of the euro area depending on the exact terms of the conversion). Even before the shock, there would be a bank run as savers would move their assets, resulting in a bank collapse. Furthermore, far from being reinforced the rest of the euro area would be weakened, as speculation on the true value of the German, French or Portuguese euros would start. All this renders adjustment within the euro area preferable, despite all the difficulties it presents.
For the euro area as a whole, the measures announced on 21 July will not dispel the concerns about other countries, in particular Italy and Spain. One of the most striking vulnerabilities revealed during the last few months is the correlation between banking crises and sovereign crises. In Greece, the state of the public finances is a threat to the banks, which have a portfolio of government securities twice the size of their capital. The same fear is present in Italy. In Ireland, it was the banks going off course that brought the government to its knees. Spain has been weakened for the same reasons. The vicious circle sucks in one party or the other, but the logic is the same: a state in difficulty weakens the banks because of the falling value of government securities; banks in difficulty weaken the state because of anticipated bailout costs.
This dangerous vicious circle results from the refusal to diversify and share risks. In the United States, banks incorporated in Delaware feel no obligation to hold bonds from that state. Instead, they hold federal securities. And it is Washington DC, not the state of New York, which is responsible for bailing out Wall Street. This does not eliminate all the risks, but spreads them and means that, in the face of financial hurricanes, calls can be made on the central bank. Europe is not a federal state but the weakness of the euro area would be greatly diminished if deposit insurance was pooled -- which obviously implies relevant changes in banking supervision -- and if the banks diversified their bond holdings so that they are more representative of the euro area as a whole (the famous Eurobonds).
Europe has cautiously started to move in this direction by broadening the scope of its financial facility. But the pooling of risk remains taboo. It is not clear if this taboo will remain unbroken by the end of the crisis.
A version of this column was also published on Le Monde and Handelsblatt