Mario Draghi didn’t quite coin a new phrase two weeks ago. But the European Central Bank president certainly popularised the expression “positive contagion”. After years in which the eurozone has been suffering from plain old contagion—which doesn’t even need the qualifier “negative”—Draghi now thinks a positive dynamic is in play.
The term “contagion” has tended to be used in financial markets to refer to the way that problems in one country (such as Greece) can so unnerve investors that they cause difficulties in other countries (for example, Portugal, Spain and Italy). Draghi, though, seems to be using the word more broadly to cover the whole panoply of vicious cycles that had been sucking the eurozone into a whirlpool.
The ECB president is right that the vicious cycle in financial markets has given way to a virtuous one. The best measure of this is how peripheral bond yields have dropped since he said last July that the ECB would do whatever it took to preserve the euro—“and believe me, it will be enough”. Spanish 10-year yields have fallen from 7.4% to 4.9%, while Italian ones are down from 6.4% to 4.1%. The Stoxx 50 equity index, meanwhile, is up 12%.
But vicious cycles don’t just apply to financial markets. They also affect the real economy and politics—and flip back then into the world of finance. Until Italy and Spain stop shrinking, the risk of tipping back into negative contagion remains.
Remember, too, how financial markets can be fickle. Only a year ago, confidence was buoyed by the ECB’s decision to lend struggling banks 1 trillion euros of cheap three-year money. But then Greece’s indecisive first election and Spain’s dithering over its banking reforms triggered the most dangerous episode yet in the euro crisis.
Still, before looking at the remaining risks, it is important to acknowledge the progress in both the underlying situation and confidence. The fundamental causes of the crisis were uncompetitive economies, excessive government borrowing and weak banks. All three problems have been partly remedied. For example, labour costs in Spain and Greece have been falling, improving their industries’ competitiveness—so much so that Spain has had a current account surplus for the past three months. Meanwhile, fiscal deficits across the periphery of the eurozone have been cut although they are still too high. Finally, Irish, Greek and Spanish banks have been stuffed with capital.
Confidence, too, is returning. It’s not just the sovereign debt yields that