Economic imperatives of political uncertainty*

At this stage in the development of the eurozone debt crisis, it would hardly be an exaggeration to single out the lack of political will at the national and European levels and the institutional immaturity of the union as the main obstacles to making effective decisions to resolve the accumulating problems.

Unpopular but necessary measures to restore financial stability in individual countries have been and continue to be postponed or implemented hesitantly at national level. This is partly due to the ongoing search for some increasingly vague and difficult-to-define pan-European plan to deal with the crisis. Despite the alarmingly regular “emergency meetings” of European leaders and their daily assurances that solutions are not far away, the specific interests, peculiarities, needs and problems of the member states make it extremely difficult to formulate a comprehensive pan-European response to the crisis.

At the same time, the lack of political will to introduce difficult decisions at the national level and the strong dependence of the eurozone member states on each other have created the feeling that problems are piling up on the periphery, and solutions are being awaited from Brussels.

Can solutions be found at a pan-European level?

Before the global financial crisis, the spread (difference in yield) between German bonds and those of other eurozone countries was relatively narrow and constant. The mere membership of the countries in the monetary union was seen as a guarantee of their stability and solvency, which for a long time determined the markets' perceptions of the individual sovereign risk that each individual country carries. The development of the eurozone debt crisis over the past three years has put an end to this phenomenon.

The constant stream of new chapters in the proverbial Greek drama has managed to somewhat push the “elephant in the room” – Italy – out of the spotlight. However, the country’s political instability and weak economic data have not escaped the attention of bond markets:

• The spread between German and Italian bonds increased from 360 basis points on October 16, 2011 to a whopping 462 basis points as of November 2, 2011. For comparison: during most of the period 1999-2007, the spread in question varied between 10 and 50 basis points.
• Perhaps even more indicative of the ongoing instability in the eurozone is the widening spread between French and German bonds, which has increased from 93 basis points to 141 basis points in the past two weeks – a gap unseen since the introduction of the euro.

In these circumstances, the only surprising thing about the debut move by the new ECB President Mario Draghi was that the markets were surprised. Another question is to what extent the reduction in the key interest rate will be able to stop or at least slow down the further rise in bond yields of troubled member states and the widening of spreads, as well as what effect this move will have on the already high inflation.

The new European reality

It is hardly an exaggeration to conclude that the debt crisis has caught Europe at the worst possible moment in the integration process. Integration is at a crossroads – both too deep and not effective enough. European countries need concrete solutions and formulas, and the European Union is too fragmented to give them.

Investors will not easily regain their faith in a “united and homogeneous” Europe. While European politicians lurched from plan to plan and “agreed to get along” month after month, the markets systematically fragmented the risk profile of the union. At least when it comes to inalienable prerequisites for an investment decision such as assessing a country’s solvency, economic prospects and political stability, European countries fall into radically different categories. The unprecedented widening of spreads clearly shows that the market is beginning to single out and increasingly value a new factor for the reality of the European Union – the independence and self-sufficiency of its constituent economies.