Medicine Wears Off Is the Euro Crisis About to Return?

The recent Italian elections demonstrated that the specter of the return of the euro crisis is never far away. Not a single problem in the currency zone has been definitively resolved and some are questioning if the European Central Bank might have to intervene again.
The Milan Stock Exchange: Interest rates are rising on Italian bonds after last week's election

The Milan Stock Exchange: Interest rates are rising on Italian bonds after last week's election

Foto: Vittorio Zunino Celotto/ Getty Images

Mario Draghi has a close relationship with the world of faith. The president of the European Central Bank (ECB) was educated at a Jesuit school in Rome, he wrote articles for the Vatican newspaper L'Osservatore Romano, and when he delivered remarks on the "crisis in the euro area" last week, he chose the Catholic Academy in Munich as the venue for his announcement. "Caring for the welfare of our neighbors is not only an ethical principle of the Christian faith," he preached, standing next to a candlelit crucifix, "it also makes eminent economic sense."

Europe's top monetary policymaker can certainly use the support of higher powers. Only a few weeks ago, he said "the worst" of the euro crisis was over. But since voters denied the proponents of the current reform policies a clear majority in Italy's recent election, providing former Prime Minister Silvio Berlusconi with a political comeback, the crisis is back.

Nervousness Returns

The markets reacted nervously, as expected. Stock prices crumbled from Milan to New York, there was a marked increase in interest rates on Italian government bonds and the euro's exchange rate fell on foreign currency markets. The flare-up shows that the euro crisis hasn't been overcome by far. By announcing that he intended to do everything possible to save the common currency, if necessary, Draghi was merely buying time.

For weeks, his promise felt like a strong cold remedy: It successfully treated the symptoms, but it didn't eliminate the virus causing the cold in the first place. On the surface, the patient seemed to have recovered, but in reality he was as sick as before. Politicians in Berlin, Brussels and Washington, the headquarters of the International Monetary Fund (IMF), are keeping an eye on about half a dozen hot spots in the euro zone. Their alarming conclusion is that some pathogens are now more dangerous than ever.

The combination of the Italian election results and the continuing stagnation of the French economy has been a serious setback to recovery in the euro zone, say officials close to German Finance Minister Wolfgang Schäuble, a member of the center-right Christian Democratic Union (CDU). Schäuble and his experts are especially worried about France's condition, as they note with disbelief how the government of President François Hollande has presided over a state of stagnation and decline for months.

Washington's view of the situation is similarly pessimistic. The first reforms on the French labor market, which employers and labor unions recently agreed to, point in the right direction, say IMF officials, but they are still too tentative. In her new World Economic Outlook, which will be released in mid-April, IMF Managing Director Christine Lagarde intends to bluntly expose the weaknesses of her native France, and to call upon Hollande to institute bold reforms.

But the IMF isn't just worried about France  and Italy , the second and third-largest economies in the euro zone. According to the Washington-based organization, the euro zone's fourth-largest economy, Spain, is everything but rehabilitated. The country's banking sector, in particular, is seen as a trouble spot. Late last week Bankia, one of Spain's largest banks, reported a record loss of close to €20 billion ($26 billion).

Problems at the Periphery

Finally, the problems of the peripheral Mediterranean countries of Greece  and Cyprus  haven't been solved yet, either. In the case of Greece, IMF officials say they are shuttling from one troika visit to the next. Every three months, experts from Washington, the ECB and the European Commission descend on the country to make sure that reforms  are succeeding. Although the situation is only slowly improving, last week the so-called Euro Task Force, a group of top officials tasked with preparing the monthly meetings of euro-zone finance ministers, released the February tranche for Greece in the amount of €2.8 billion. The fresh funds will keep the country afloat for a while, but almost all experts agree that the financial injections will not solve Greece's problems in the long run. Another debt haircut, this time by public creditors, is seen as unavoidable if Greece is to recover. But that won't happen before Germany's federal election in September.

Very little progress  has been achieved in Cyprus, either. Although the country recently elected a conservative president, a change in the way of thinking remains unlikely. Like his Communist predecessor, the new president opposes raising the business tax -- the lowest in the euro zone at 10 percent, compared to the 29 percent levied in Germany -- and allowing the country's financial sector to be investigated for money laundering. Both are conditions of aid imposed by the donor countries.

But those conditions are the only thing members of the euro zone can agree on. Otherwise, they are deeply divided over Cyprus. The German government still questions whether the Mediterranean island even needs an aid program. Conversely, EU Economic and Monetary Affairs Commissioner Olli Rehn believes : "Every euro-zone member is systemically relevant." He opposes plans to involve the creditors  of Cypriot banks in the costs of the aid program.

Finance Minister Schäuble and his French counterpart Pierre Moscovici recently spoke of finding a solution by the end of March, but no one in Brussels is taking that date seriously at the moment. According to participants, there is no evidence of Franco-German unity in the negotiations. But time is short. Cyprus will run out of money around Easter, which is when the monetary union could begin to totter again. "If Cyprus were to face a disorderly default, there is a high probability that the consequence would be an exit from the euro zone," warns Commissioner Rehn.

Growing Concern

There is growing concern in politicians' offices that the euro crisis could soon return in full force. "The mood in the financial markets, which signaled calm in recent weeks, was a little ahead of the actual situation," an IMF insider drily concludes.

No one is feeling the consequences with quite as much force as ECB chief Draghi, who notes with concern that credit is drying up and investment is shrinking in many countries. He fears that the ECB may have to step up to the plate even more than it has to date.

Last year, the ECB supported ailing Greece for months, because the EU couldn't agree on a bailout package for so long. It recently looked the other way when the Irish central bank came to the aid of a bank, and the prohibition on directly funding public budgets was cunningly circumvented. If the ECB were now forced to help an Italian government that is unwilling to institute reforms, its credibility would be destroyed once and for all. Many central bankers are no longer willing to cooperate with the lawmakers behind Europe's rescue programs.

Not surprisingly, Draghi's appeals to governments are slowly beginning to sound like sermons. "Individuals have to do what they can to help themselves before they seek help from the community," Draghi told his Munich audience  last week. "The same is true for the countries in the euro area."

Translated from the German by Christopher Sultan