The sobering date at the top of the page – the eleventh day of the eleventh month – is a fitting one on which to be discussing the fate of the single currency. It can’t be said too often: the euro is the most visible manifestation of a European integration project that originated not in the optimal currency area textbooks, but in the deep-seated desire of European politicians to avoid another continental war. The architecture of the single currency is certainly imperfect and incomplete, but after more than 60 years of peace, who is to call the wider project a failure?
This is often overlooked by US-based commentators – who also forget that there was a civil war before a single currency emerged there, and that the ex ante gap in living standards between Mississippi and Massachusetts may not be that much smaller than that between Finland and Portugal. UK membership has never looked enticing to this reformed economist, but that doesn’t mean we wish the euro ill.
We still think that some progress has been made since early August, and we’d note that euro area stock markets, and the euro itself, remain above their recent lows. The crisis may even be moving politicians in the right direction more quickly – as we write, a “technocratic” government in Italy remains a possibility, and with it the prospect of more convincing supply-side reform.
It may seem odd to be reiterating the muddle through scenario given the febrile talk of “tipping points” and indeed the “death of the euro”. But the single currency – and the European banking system – doesn’t suddenly become that much more likely to implode the instant that the BTP yield nudges above 7%. The Italian government is not obviously insolvent, is running a primary surplus and does not have to refinance its debt immediately. Bond markets are no less prone to emotion than others.
The Japanese government has borrowed much more than Italy’s, at shorter average maturities (and with a much larger 2012 refinancing need), and faces a structural growth outlook every bit as feeble, yet pays much lower nominal and real yields. The reason is that its debt is mostly domestically-held, a reminder that the drivers of bond yields are much more subtle than the simple headlines suggest.
Remember, a quick resolution to the euro issue is not likely – indeed, it’s not possible. But in our view the ECB, the EFSF and maybe the IMF between them will manage to backstop the banking system until a more unified fiscal architecture is built. And for the global markets, ongoing growth in the US economy – visible again this week in solid net trade data and a further improvement in the weekly unemployment claims data – trumps the recession risk visible in the euro area this winter.
Kevin Gardiner, Global Head of Investment Strategy