Europe’s economic situation is viewed with far less concern than was the case six, 12 or 18 months ago. Policy makers in Europe far prefer engaging the United States on a possible trade and investment agreement to more discussion on financial stability and growth. However, misplaced confidence can be dangerous if it reduces pressure for necessary policy adjustments.
There is a striking difference between financial crises in memory and financial crises as they actually play out. In memory, they are a concatenation of disasters. But as they play out, the norm is moments of panic separated by lengthy stretches of apparent calm. It was eight months from the South Korean crisis to the Russian default of 1998, six months from Bear Stearns’ demise to Lehman Brothers’ fall, and there were several 30 per cent stock market rallies between 1929 and 1933.
Is Europe out of the woods? Certainly a number of key credit spreads, particularly in Spain and Italy, have narrowed substantially. But it is far from clear that market conditions have improved. Investors are still limite. Restrictions limit the ability of pessimistic investors to short European debt. Regulations enable local banks to treat government debt as risk free. This allows them to access funding from the European Central Bank on non-market terms. And there is the suspicion that in extremis the central bank would come in strongly and bailout bond holders. Remissions are sometimes followed by cures and sometimes by relapses.