Project Syndicate
October 21, 2011
Since the summer, the continuing installments of the Greek crisis have concealed a worrying process of fragmentation in the eurozone. Indeed, there are several grim indicators of this development.
First, the spread between banks’ borrowing rate and the zero-risk rate has been climbing since July. Financial institutions with liquidity increasingly prefer to deposit their cash with the European Central Bank, which has had to resume its lending to banks. The same thing occurred in the 2007-2008 crisis, though the shift is less acute this time, and is confined to the eurozone. In London and New York, the interbank market is still working; nevertheless, there is reason for concern.
Second, cross-border banks are charging higher interest rates to firms in southern Europe than they are to comparable firms in northern Europe, which is worsening the situation for crisis-hit economies. This fragments Europe’s supposedly unified market. And, instead of combating this trend, northern European regulators are amplifying it by limiting financial institutions’ exposure to southern European banks.
Third, international investors no longer view southern European government bonds as in the same asset class as northern European ones. This is not simply about the price of risk, which is easily reversible. It marks a deep change in attitude. If this lending approach to southern countries continues, their solvency and economic recovery will suffer.
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