It's half-time in the euro zone crisis. So gather round and take a knee, and let's figure out what we've learned from the first half.
1. The bond markets work one way and the EU works another. Their methods are wholly incompatible. That's what caused the crisis to explode in the way it did. But a synthesis was reached between the two, because the EU's leaders ultimately showed the big institutional players in the bond market they were serious about tackling not just Greece's problems, but government deficits throughout the euro zone.
Government leaders who did not get with the program were removed. Once governance issues were resolved, the bond markets began to calm down.
This is a key lesson for American economic commentators to remember. Bond markets don't entirely rely on spread-sheet data. They care about unquantifiable things like good governance. Italy under Berlusconi was a joke, under Mario Monti it is a country whose governance gives hope of being as effective as its luxury goods businesses, which dominate their sector of world trade.
2. Who's in charge of the central bank is equally important. I'm not bragging when I say that GlobalPost spotted Mario Draghi's abilities earlier than others. His low-interest 3 year loan program for Europe's commercial banks was the game changer in terms of stopping the bond market assault on euro zone sovereign debt.
Beyond that Draghi clearly has good chemistry with the German leadership, starting with Chancellor Angela Merkel.
3. Merkel is Europe's she who must be obeyed. Margaret Thatcher was the Iron Lady. Merkel is the Iron Lady Chancellor. But she is much more flexible and pro-European than the former British Prime Minister.
She did not want to go down in history as the leader who blew up the euro. For the moment it is still a 17-member currency bloc with others, like Poland, due to join at some point in the future. Greece may yet have to leave, but only pathological euro haters - of which there are dozens in high places in London, New York and Washington - now think that Greece leaving means contagion spreading around the peripheral countries of the single currency area.
4. Most important: Governments and citizens want the EU to succeed. They may grouse about it, but when push comes to shove, the majority want to be a part of the union. It is why the Spanish, Irish, Portuguese and Italians are willing to tolerate austerity, even when it is overdone and doesn't really address the central economic problem now that sovereign debt yields are coming down. That problem is growth. How you create conditions for it while trimming government payrolls and generally reducing wages is something no one can quite figure out.
But this is for certain: government's and citizens know what would be lost by a euro zone break-up and they will do what they have to fix the situation. It will be messy - but, as I said at the start, bond markets are getting used to it. Now if the New York hedge fund managers and economic commentators start taking this into account the dynamics of the second half of this crisis might be different.
The Second Half:
Next week, there is an EU summit at which the new fiscal compact putting strict rules on the size of government deficits is due to be signed. This article in the Warsaw Voice underlines point 4 above:
It quotes Jerzy Buzek former Polish Prime Minister, praising the current Polish government for signing up for the fiscal compact even though it is not part of the euro zone. “We wanted very much to have the eurozone repaired, so as to help Greece and possibly other countries... although we are not taking part directly in this assistance and we are not incurring financial burdens … Today, Poland is fully taking part in all preparations for a new eurozone, its restructuring, as well as action designed to prevent crises from recurring in the future. This is extremely important.”
Beyond that, who knows? The Greeks may still have to leave the euro. I am someone who has argued consistently that the Anglo-American eurosceptics were wrong, that the currency would survive, and I still hold that point of view. I don't think that Greece leaving will lead to contagion. Greek society may not be able to handle the terrible depression it must endure to stay in the currency and it may still have to leave, but the rest of the currency will hold together.
The big question for the euro zone is how to redress the internal trade imbalances between Germany's very strong economy and the weak ones at the periphery - This interesting - if technical - report at Elliott Wave Market Service by Michael Pettis of Beijing University’s Guanghua School of Management makes the point more clearly than I can:
"Europe’s underlying problem is not budget deficits or even unsustainable debt. These are mainly symptoms. The real problem with Europe is the huge divergence in costs between the core and the periphery – in the past decade costs between Germany and some of the peripheral countries have diverged by anywhere from 20% to 40%. This divergence has made the latter uncompetitive and has resulted in the massive trade imbalances within Europe."
That's where the real action of the second half is going to take place. What steps can Angela Merkel take - consistent with keeping her coalition partners and her electorate sweet - to redress these imbalances?
I'm not sure she knows - or anybody else does. Although she has said, realistically, that the crisis demonstrates the need for more EU integration, not less.
It would not surprise me if it took another market created panic to concentrate European minds to take those steps to a closer - if not more perfect - union.