Effects of Eurozone Summit Agreement Will Depend on the Details

Last week saw two German defeats within 24 hours. On the football field, Mario Balotelli led Italy to a  2-1 victory over Germany in the UEFA Euro 2012 semifinals. In Brussels, it was another Mario that dealt Germany a defeat of sorts at the Eurozone summit. Italian prime minister, Mario Monti successfully pushed aside German objections and won agreements to create a single Eurozone banking regulator and to allow bailout funds to lend directly to struggling banks.

A common banking support system is good for Europe; however, it must be accompanied by two things to make it a successful treatment for Europe’s ills: labor-market reforms and fiscal-system reforms. Without reforms to the labor markets of many European nations, countries from Greece to France will find themselves rapidly becoming economically uncompetitive with the rest of the world. The fiscal-system reforms proposed by Germany will also go a long way to making sure that the euro of the future looks less like the old lire than the deutschmark.

The news provides a short-term boost, but could store up more trouble for the future. Luckily, the announcement was vague on details, so the optimist would hope that the final arrangements incorporate sustainable plans for Europe’s budgets with measures for enhanced labor and fiscal competitiveness. For the banks that are at the center of the storm, more liquidity is probably fine, but liquidity can’t solve their issues when the real problem is one of solvency.