GIVING UP MORE SOVEREIGNTY
The stakes are huge. The euro zone encompasses 17 nations and collectively makes up the world's second largest economy, with a gross domestic product of more than $12 trillion. Its fate in the coming months will probably be the single biggest factor in determining the health of the U.S. economy through the 2012 presidential election. Global markets are waiting on a solution. U.S. Treasury Secretary Timothy Geithner has spent the last few weeks pushing for more activism.
Twice in the previous century, Europe drew the rest of the world into its political problems in the most dramatic way: two world wars. The danger now is different, but Europe once again seems to be turning into the global center of gravity--though in a far more negative way than the designers of the European Monetary Union imagined. "This is not what we had in mind," Antonio Borges, head of the European department of the International Monetary Fund, remarked in understated fashion last week. Besides the economic issues, Europeans must grapple once again with the political one: Can these nations give up another giant chunk of their sovereignty?
The major players know that it is probably too late for partial fixes. European banks face a potential "Lehman Brothers moment" much bigger than what happened to Wall Street in September 2008: If Greece defaults or drops out of the euro zone, and the markets attack other weaker economies as is their wont, then insolvency fears could spread to every major European bank that holds debt in these countries. Credit markets could freeze up.
"German leaders, no matter how unhappy about having to rescue Greece, are not about to let the euro collapse."
That danger is real. And while European leaders bicker over euro-zone changes that could take months or years to achieve, the markets are counting in weeks. European ministers are aiming to announce plans at the G-20 meeting in Cannes, France, in November to beef up their two-year-old emergency fund--the $595 billion European Financial Stability Facility--for dealing with the debts of Greece, Ireland, and Portugal. Finance ministers are mulling ideas to let the giant fund leverage its power by borrowing against its assets. Yet even now, leaders disagree about the EFSF's future. Schaüble, still the hard-liner, declared last week that "we do not have the intention" of boosting the total amount in the emergency fund.
No outside cavalry can come riding to the rescue--not even China with its trillions of dollars in Western debt. Gao Xiqing, the worldly head of the China Investment Corp. (he went to Duke University Law School and speaks perfect English) bluntly declared at the IMF forum last Sunday that an overheating China has all it can handle with its own problems. "We have to save ourselves," he said, shrugging off the effects of a euro breakup. Gao acknowledged that the prospect of a euro-zone breakup terrified almost everybody, but he said that didn't guarantee that leaders would keep it from happening. "I still think there is a possibility," Gao said, disputing Soros's assertion. "The fact that it's going to be the end of the world doesn't mean it's not going to happen." Asked by National Journal afterward if the Chinese government was preparing for a euro-zone breakup, Gao laughed and retorted: "I'm not the government" (although he runs its sovereign wealth fund). When the question was asked again, he walked away smiling without answering.
To be sure, rescuing indebted countries isn't popular in the rich countries. Northern Europeans such as the Germans may fear for their pensions and could rebel at the polls. Contingency plans to create separate northern and southern euro zones are already being discussed, at least informally, as a kind of nuclear option. Bill Murray, a spokesman for the International Monetary Fund--which has gone from a perceived interloper a year ago to a central player in the discussions--told NJ that IMF analysts are preparing for all possibilities and that "early-warning exercises" include "holy-shit possibilities" such as a euro-zone breakup.
THE COST OF FAILURE
Euro skeptics abound. "They need a long-term sketch of how they get to fiscal union," says Harold James of Princeton University, a historian who specializes in 20th-century Europe. "But what we've got at the moment is just a version of what's been happening the last year, which is just a muddle-through."
But European ministers will, in the end, have to save themselves. That is why the European Central Bank's unlikely transformation into a giant fiscal sugar daddy, unpalatable though that is to purists, may be necessary. If a member country runs into trouble, as Greece and Ireland did, the other member countries may have little choice but to become buyers of last resort for the debt through something like the emergency fund.
One much-debated solution--new euro bonds that would be sold by a common treasury and be backed by the joint credit of all member countries--might work well, Credit Suisse says in a much-cited new analysis. But, the bank cautioned, the idea "takes too long to set up, requires constitutional reform, and--in some countries--a referendum." Nor can the emergency fund be easily turned into a bank or insurance company. That would also require parliamentary approval and might violate the prohibition against ECB lending to European Union institutions. Instead, Credit Suisse said, the "silent solution" is to have the central bank continue to buy or repurchase the weaker European debt. Trichet himself said recently that, come what may, ECB would ensure sufficient liquidity for the European monetary system. All this has calmed the markets somewhat. "There is no one in denial in Europe right now," a U.S. Treasury official told National Journal.
Indeed, banks, hedge funds, and other market players who are betting against the survival of the euro zone are toying with elemental forces that they might not fully understand. Credit Suisse estimates that "the cost of not bailing out the peripheral countries is higher than the cost of bailing them out." The bank's analysts estimate that a breakup of the euro zone would lead to a recession that reduces its combined GDP by about 5 percent. Financial markets would seize up, just as they did during the U.S.'s financial crisis in 2008, and economic activity would collapse.
It's also worth remembering that Europe's bigger economies, particularly Germany, have prospered under the common currency, avoiding competitive devaluations that might occur otherwise in the weaker Mediterranean countries. It's no surprise that, under the euro system, Germany has reestablished itself as an export powerhouse and now has a (relatively) low 6.5 percent unemployment rate.
THE FORCE OF HISTORY
But the economics are not the most salient point about Europe's predicament today. Although markets are driving the news, the euro crisis is mainly about politics and history. And the bottom line is that feuding over debt, no matter how serious, is unlikely to trump history. However unpopular or painful it might be, the transformation of Europe into a deeper political unity is better than the alternative--a return to anomie and possibly even war down the line, most European officials say.