The strength of the stockmarket this year has been partly due to relief that the euro crisis is apparently over. Yet the market is misguided.
Admittedly, the panic has subsided. Moreover, as regards the timing of the denouement at least, the most strident eurosceptics, including me, got it wrong. I suspected that Greece would come out of the euro by the end of 2012 . Mea culpa.
But before my regular europhiliac assailants (you know who you are), construe this as a throwing in of the towel, let me emphasise that the assumption of an early Greek exit was always a matter of probabilities and timing. Nothing critical depended upon a December deadline, and it still doesn’t depend upon any later deadline this year or subsequently.
There were two events that made a critical difference. The first was a decision around the middle of last year by Angela Merkel that it would be too dangerous to let Greece leave.
This meant that she would not be pushed out and it encouraged the Germans to be a bit more flexible.
The second was the ECB’s President, Mario Draghi, announcing in September (with Merkel’s acquiescence) that the ECB would buy the bonds of vulnerable countries “without limit” provided that they met certain conditions. As a result, the yields on 10 year Spanish and Italian debt plunged by about 2pc.
Yet, all along, a bond yield crisis was not the most likely way that the euro would fracture, precisely because, when push came to shove, an afflicted country would probably be kept afloat somehow. If a country were to be forced out in a panic, the most likely channel was through a banking crisis as funds left the banking system of a beleaguered country to be redeposited with German banks, which then led to the money being recycled to the weak country, with the scale of this transfer, and the associated risk of loss, climbing inexorably.
(This is the so-called Target2 issue.) As it happens, just as bond yields have subsided, so the deposit outflow from weaker members has reversed. But things aren’t bound to continue like this. Draghi has managed to pull off the remarkable trick of reducing bond yields without buying a single bond. When some new panic emerges, though, he will have to show the colour of his money.
According to the criteria that he announced, to qualify for ECB bond buying, a country must be in a relief programme with the eurozone bail-out funds. As things stand, however, that rules out buying the bonds of the two countries that most concern euro watchers, namely Spain and Italy. This means that if the markets were to get jittery about either of them, you could not count on the ECB stepping in immediately. They would have to ask for a bail-out and agree to be bound by the terms, which would involve both accepting more austerity and swallowing a massive dose of humiliation.
Whether or not they did this, and whether or not the ECB bond-buying managed to stop bond yields from rising, deposit outflows from these, and other vulnerable countries, could resume.
There are three other plausible routes to a fracturing of the euro: a weak country choosing to leave; a weak country being asked to leave; and a strong country choosing to leave. Each of these was always on a longer fuse than bank and bond panics for the simple reason that despite all the stresses, both the political establishment and ordinary people in all the relevant countries remained behind the euro project. It was always going to take time for their views to change. What would help to bring about such change is a further deterioration of the economic situation and a realisation that under the current set-up there is no way out.
In fact, as the financial aspect of the crisis has subsided, the real economy has continued to deteriorate. Admittedly, Germany has recently looked a bit better. But France looks much worse. Moreover, in Spain, Greece and Portugal, things remain grim, with the level of unemployment downright scary.
If the economy continues to be very soft, pressures will build. In the weaker countries, exasperation will grow, alongside the need for outside assistance. In the stronger countries alarm will mount about the size of current and implied future financial assistance.
Meanwhile, negotiations over the moves towards some sort of fiscal and political union will rumble on, and in the process it will become clear to all just what is involved in keeping this whole thing together.
It is perfectly possible, nevertheless, that this rickety structure will stumble on. The political will is still there to sustain it. Mind you, on its own this is not enough. It needs to be accompanied by action, and the bill attaching to that action will be rising.
The euro crisis is not over. It is in respite. There are several more episodes still to play out.
Roger Bootle is managing director of Capital Economics