The euro crisis
May 14th 2012, 14:43 by R.A. | WASHINGTON
TODAY is a bloody day on markets, on the heels of what was a very bloody week on markets. Euro-area equities are plunging and sovereign-debt yields are soaring. The Spanish 10-year yield is up to 6.3%, a level not seen since late last year. Awful news from the real economy is partly to blame; industrial production dropped sharply in March across the euro zone. But the possibility of and potential fall-out from a Greek exit seems to loom largest. With odds growing that Greeks will need to have a new election to produce a government (which government will almost certainly press to renegotiate the country’s bail-out terms, an outcome core members are firmly against), a departure seems ever more probable. As the Financial Times’ Ralph Atkins reports today, euro-zone central bankers are openly discussing how to cushion the rest of the single-currency area against the blowback from a Greek exit.
The talk is leading to speculation like that in this Paul Krugman post, which has generated quite a bit of attention. In it, Mr Krugman suggests that Greece is on the way out, that it may be gone within a month, and that this will lead to a pivotal choice for Germany which may result in the end of the euro zone. I don’t know if that’s right. Everyone involved would prefer that Greece not go, and so even if the result of the next Greek election is a seeming impasse between its government and the core, I’d expect there to be months of negotiations between the two groups to see if something can’t be accomplished. In the meantime, markets may continue to apply intense pressure on other peripheral members, which could force the hands of core governments or the ECB toward another set of interventions (or something else). But there’s no event looming in the immediate future that might lead to a Greek ejection. And the euro zone has been on the brink several times in the past couple years, only to step back as leaders do one thing or another that looked unthinkable only months before.
But don’t get me wrong; I am not optimistic. For beneath the main crisis plot, the euro zone is already coming undone. For a decade prior to the crisis, euro-area financial markets rapidly knit themselves together. This process helped sow the seeds of crisis, in the form of massive cross-border capital flows from north to south. Eventually, markets had (for lack of a better phrase) an “oh shit” moment. Europe might have responded by building out regulatory and fiscal institutions equal in scope to capital-market integration. Instead, they hesitated. Markets have since reacted by undoing, at an accelerating pace, the previous knit-up. The euro zone is de-euroising. Efforts to buy time to resolve the crisis are often enough being used to facilitate the renationalisation of financial markets. This is proving an extremely disruptive process to the real economy (though not, for the moment, in places reabsorbing lots of capital). But markets took the measure of governments’ commitment to the single currency and found it wanting.
I don’t know how this ends exactly, but one answer may be that the single-currency area will ultimately have the membership that markets find credible. That could mean a Germanic northern union or a complete break-up. It is quite unlikely to be the current configuration.