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European Debt Crisis Reaches “the End of the Beginning”: Martin Wolf

Aaron Task
·Editor in Chief

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Stocks rallied Wednesday on (among other things) new, new hopes for a solution to Europe's dual sovereign debt and banking crises after EU Commissioner Jose Manuel Barroso unveiled a plan to force big European banks to raise capital. Meanwhile Slovakia's parliament -- on its second go-round -- approved plans to expand the European Financial Stability Fund, becoming the 17th and final EU member to ratify the plan.

In reaction, the euro hit a three-week high vs. the dollar, spurring another rally in global risk assets, notably equities and commodities such as copper, and a corresponding sell-off in "safe havens" such as U.S. Treasuries. Following a big overnight gain in Chinese equities and 2%-plus gains in Germany and France, U.S. stocks resumed their recent rally. Heading into the final hour of trading, the Dow was up 175 points, or 1.5%, to 11,590. (Update: The Dow closed up 0.9% at 11,519, about 100 points below its intraday high but enough to put the index back in positive territory for the year. The Dow has now risen 8% since Oct. 3; the S&P 500 is up 12% since it's intraday low on Oct. 4 after its largest seven-day rally since March 2009. See: "Fall Melt-Up" to Follow "Summer Swoon" Ed Dempsey Says)

After months of being "behind the curve," European policymakers are "finally aware" of the acute nature of the crisis, says Martin Wolf, chief economics commentator at The Financial Times. "They are coming under enormous pressure...to do something big."

Generally speaking, traders seem to believe European policymakers have gotten the message from German Chancellor Angela Merkel and French President Nicolas Sarkozy, who last week pledged "to deliver a response that is sustainable and comprehensive" by the G20 meeting in early November.

This "could conceivably be the end of the beginning" of the European crisis, Wolf says, borrowing from Winston Churchill.

Still, the longtime EU skeptic remains "a little pessimistic" about the long-term viability of Europe's so-called great experiment with a single currency and monetary unity.

Europe: 'First Aid Is No Cure'

In the end, Wolf believes EU policymakers may lack the will (political or otherwise) to move from band-aids to a cure for Europe. His prescription as detailed in a recent column includes: "Divide countries in difficulties into the insolvent and the illiquid; restructure the debts of the former and provide unlimited, but temporary, support for the latter; and recapitalise banks, after stress tests that allow for losses on sovereign debt, either from national treasuries or from the European financial stability facility, in accordance with the flexibility given by the decisions taken in July 2011."

In addition, Wolf is beginning to question his longstanding view that Germany will do "whatever it takes" to keep the EU together.

"As long as the Germans and German elite believe it doesn't threaten in a profound way their own solvency...they will keep supporting it," he says in the accompanying video. "But I think they're getting to the point where some are beginning to wonder whether it doesn't threaten them."

Specifically, Wolf thinks Germans are starting to wonder about whether they'll have to bail out Italy, which with over 2 trillion euros (about $2.8 trillion) of sovereign debt, he describes as both "too big to fail and too big to save."

Wolf admits an Italian default is not an imminent danger and, clearly, financial markets are not terribly worried about that potential threat -- or just about anything else -- right now.

Aaron Task is the host of The Daily Ticker. You can follow him on Twitter at @atask or email him at altask@yahoo.com