It's too early to call the end of the euro zone crisis, but signs are growing that Europe may have turned a corner in its struggle to restore financial stability.
French Economy Minister Christine Lagarde, mangling a treasured Winston Churchill quotation, said last week: “We are in the middle of the beginning of the end.”
More prudently, we may be seeing “the end of the beginning.”
The evidence comes partly from financial markets, which are calmer, partly from the real economy, which is perkier, and partly from policy, which is responding at last to at least some investor concerns.
There are still plenty of risks -- lack of faith in planned stress tests of European banks; low or no economic growth; more credit rating agency downgrades of sovereign debt; an eventual Greek default or debt restructuring; weaknesses in euro zone governance; and political resistance to painful reforms.
But on balance, things are starting to look up.
“The figures we have are not confirming this pessimism,” European Central Bank President Jean-Claude Trichet said last week, dismissing analyst predictions of stagnation or even an austerity-induced double-dip recession in the euro zone.
Let's try to define what would constitute a turning point.
The pivotal moment in the global financial crisis of 2007-2009 came when the US authorities conducted stress tests of banks' resilience to further shocks and recapitalized some.
Success was not instant. There were early suspicions that the tests were not tough enough, or had been rigged in cahoots with bankers to fit the amount of capital available.
But the tests ultimately satisfied investors that US banks were safe and that the government would not let another major financial institution collapse as it did with Lehman Brothers.
Europe is not quite there yet. But EU regulators have now agreed to conduct individual stress tests on 91 major banks representing 65% of the region's balance sheet against an agreed set of criteria, including some sovereign risk, and to publish the results on July 23.
Critics have been quick to scorn what is known of the criteria, which insiders say were a hard-fought compromise between regulators who wanted multiple risk scenarios, including a bigger sovereign default, and those who wanted no sovereign risk at all.
Unlike the longer-running US choreography, the Europeans may not have time to arrange the recapitalization of any banks found vulnerable before the results are published.
But there is a strong political commitment of governments to do so where necessary, possibly drawing on a newly established euro zone financial backstop, created in May originally to lend to states shut out of credit markets.
The existence of a €440 billion ($558 billion) European Financial Stability Facility guaranteed by euro zone states should reassure investors that any exposed banks won't be left twisting in the wind, even though it would require a unanimous political decision to use it.
So let's examine the case for a turning point.
The euro has recovered from lows around $1.19 to touch two-month highs above $1.27 on Friday, partly due to disappointing US economic data. Spain and Portugal have been able to sell their debt at auctions, albeit paying higher risk premiums.
The ECB withdrew €199 billion in crisis liquidity from the market smoothly at the end of June, and the central bank's emergency purchases of euro zone government bonds have steadily declined. Trichet felt confident enough to highlight that tapering-off last week.
European stock markets have begun to rebound, led by bank shares, on growing expectations that the stress tests will not uncover new horrors.
Governments across Europe are introducing austerity measures to bring down public deficits, and structural reforms designed to address longer-term problems of aging populations, rigid labor markets and soaring health costs.
Greece, under the whip of an EU/IMF bailout program, is pushing through unpopular reforms cutting pensions, raising the retirement age and reducing layoff payments and notice.
France is raising its retirement age and the contribution years needed for a full pension. Spain is easing hiring and firing laws to try to bring down 20% unemployment.
This will not be smooth or easy, given resistance from labor and interest groups, but the political climate is more permissive for such reforms than at any time in a generation.
At the EU policy level, the Greek bailout and the EFSF are on track and the stress tests are under way.
Governments are broadly agreed on strengthening enforcement of the bloc's battered budget discipline rules. The EFSF, created as a temporary expedient for three years, may be extended and morph into a permanent crisis resolution mechanism.
Longer-term worries, particularly about Greece's ability to pay its debts on time and in full, may continue to dog the euro zone, as well as pessimism about the economic growth prospects of aging and inflexible west European societies.
Protests against austerity and a shrinking welfare state may grow. Governments may fall over unpopular reforms.
But for now, it looks as if the worst of the euro zone crisis may just be over. (Reuters)