There are two developments in Europe that seem particularly telling of what to expect in the period ahead. First, the market has been anticipating a formal request from Spain for assistance. It is not likely any time soon. Second, the ECB's Outright Market Transactions was not the only force to dampen the tail risk in the euro area, but there seems to be a significant shift in rhetoric regarding a Greek exit. It too is not likely any time soon.
Many observers had anticipated a Spanish request for aid. Yet, Prime Minister Rajoy has played the role of a school boy wanting to know if the girl he likes will say yes before he asks her out. And the girl does not want to answer until she knows the boy's intent.
However, there is another dimension as well. The threat of OMT has been enough to scare many asset managers in reducing their short European exposure. This is an example of what former US Treasury Secretary Hank Paulson said about the presence of a bazooka may make its use unnecessary.
For several weeks now Germany Finance Minister Schaeuble has argued against the need for Spain to request aid. France and Italy, in contrast, reportedly have been encouraging Spain to ask for assistance, which they assume would ease financial pressures within the region as whole.
The Eurogroup meeting of euro area finance ministers endorsed Schaeuble's position. Spain is taking necessary measures to overhaul the economy, they said. Spain is able to successfully fund itself in the capital markets. Aid is simply not needed now.
While there is a compelling logic to the argument, the problem is that it prevents officials from being proactive rather than continue to its reactive function. It means that when Spain eventually requests assistance it will be in a crisis and the cost of assistance will be greater. It is penny-wise but dollar foolish. By failing to to find a preventative salve, officials are not maximizing the breathing space that the ECB has created (intentionally or otherwise)
We have long argued a Greek exit was unlikely, but have been in a minority until recently. Hollande's election in France coincided with the realization of the destructive effects of the discussion of a Greek exit on the official level. France has taken the lead in insisting that a Greek exit be ruled out.
Merkel is visiting Greece today for the first time since the crisis began. Press reports have hinted that her position has shifted and she now recognizes that a Greek exit is not desirable. Her visit implicitly sends that message, especially as it appears likely to be accompanied by supportive comments from the EU and IMF about progress in the talks with Greece.
Merkel, however, is the consummate politician and her visit to Greece must also be understood in terms of domestic German politics. It serves a couple of purposes. It steals some of the thunder of her challenger in next year's elections, SPD's Steinbruck. Steinbruck, who had served as the finance minister in the previous grand coalition government Merkel led, has seen his public support rise since he became the SPD's candidate.
Steinbruck has taken a position that is more in line with France. While the German public appears to prefer a tougher stance toward Greece (after all Bavaria does not even want to subsidize the poor regions of Germany any more), by Steinbruck tacking left, allows Merkel to move toward the center. The demonstrations and anti-German effigies that will likely greet the Chancellor seem likely, perhaps ironically, to strengthen her image back in Germany.
Merkel's visit is also important for Greek politics. Prime Minister Samaras is wrestling with uncooperative coalition partners and the political center as been weakened by depression that is set to continue next year and austerity that appears to being forced upon them by foreigners (but in reality economic catastrophe would be even worse outside of the monetary union). Merkel's visit may help strengthen the political center in Greece.
In regards to Spain, the German position has carried the day. In regards to Greece, Germany has accepted the French position for their own reasons. Yet this does not mean that the pillars of Europe are back. Our key interpretative point is that the new and significant divide in Europe is between creditors and debtors and France's interest are more aligned with the debtors than creditors.
And so it goes.