Twice in the twentieth century, Europe plunged the world into massive wars that cost millions of lives to fight and billions of dollars to wage. Now, eleven years into the twenty-first century, another major conflict in the Continent threatens to wreak untold carnage upon the globe. This time the financial cost might well run into the trillions.
In an op-ed piece in The New York Times, titled “An Impeccable Disaster,” Paul Krugman warns that the euro, the common currency of all of Europe, except for Great Britain, is at risk of collapse.
Financial turmoil in Europe is no longer a problem of small, peripheral economies like Greece. What’s under way right now is a full-scale market run on the much larger economies of Spain and Italy. At this point countries in crisis account for about a third of the euro area’s G.D.P., so the common European currency itself is under existential threat.
And all indications are that European leaders are unwilling even to acknowledge the nature of that threat, let alone deal with it effectively.
Listen to many European leaders — especially, but by no means only, the Germans — and you’d think that their continent’s troubles are a simple morality tale of debt and punishment: Governments borrowed too much, now they’re paying the price, and fiscal austerity is the only answer.
Yet this story applies, if at all, to Greece and nobody else. Spain in particular had a budget surplus and low debt before the 2008 financial crisis; its fiscal record, one might say, was impeccable. And while it was hit hard by the collapse of its housing boom, it’s still a relatively low-debt country, and it’s hard to make the case that the underlying fiscal condition of Spain’s government is worse than that of, say, Britain’s government.
So why is Spain — along with Italy, which has higher debt but smaller deficits — in so much trouble? The answer is that these countries are facing something very much like a bank run, except that the run is on their governments rather than, or more accurately as well as, their financial institutions.
Now, a country with its own currency, like Britain, can short-circuit this process: if necessary, the Bank of England can step in to buy government debt with newly created money. This might lead to inflation (although even that is doubtful when the economy is depressed), but inflation poses a much smaller threat to investors than outright default. Spain and Italy, however, have adopted the euro and no longer have their own currencies. As a result, the threat of a self-fulfilling crisis is very real — and interest rates on Spanish and Italian debt are more than twice the rate on British debt.
Adding to the problem is the E.C.B.’s obsession with maintaining its “impeccable” record on price stability: at a time when Europe desperately needs a strong recovery, and modest inflation would actually be helpful, the bank has instead been tightening money, trying to head off inflation risks that exist only in its imagination.
And now it’s all coming to a head. We’re not talking about a crisis that will unfold over a year or two; this thing could come apart in a matter of days. And if it does, the whole world will suffer. So will the E.C.B. do what needs to be done — lend freely and cut rates? Or will European leaders remain too focused on punishing debtors to save themselves? The whole world is watching.
Why should the U.S. be concerned about the threat of a euro collapse? Because U.S. banks and corporations are heavily vested in Europe to the tune of approximately one third, that’s why. If the European economy goes south, many U.S. firms and banks will follow suit. The domino effect could conceivably be worse than the ’08 run after the Lehman Brothers’ collapse.
The crisis is so ominous and imminent that U.S. Treasury Secretary Timothy Geithner virtually pleaded with European policy makers to step up their efforts to avoid a calamity.
“The threat of cascading default, bank runs, and catastrophic risk must be taken off the table, as otherwise it will undermine all other efforts, both within Europe and globally,” Geithner said. “Decisions as to how to conclusively address the region's problems cannot wait until the crisis gets more severe.” He also urged governments to unite with the European Central Bank to immediately “create a firewall against further contagion.”
There are some indications that European leaders are finally starting to heed the warning signs and take action, but some believe it might be too little too late. While a $500 billion euro war chest will be made available to ward off any run, Bank of Canada Governor, Mark Carney, believes that number is too inadequate and is calling for $1 trillion euros to “overwhelm” the crisis.
Most observers now concede that a Greek default is inevitable and that the real test will be whether Europe can stop the hemorrhaging from progressing further. The protagonist, however, is Germany – the Continent’s most powerful nation – which has been reluctant to break from its hard-line stance of “responsibility” and “monetary stability” in order to play the unusual role of savior.
And while Germany’s government begins to shore up its banks in anticipation of a Greek default, the rest of the Continent – and the world – holds its breath. The last time Germany played the lead in a European conflict an awful lot of people got killed and an awful lot of damage was inflicted. Wouldn’t it be ironic – not to mention poetic justice – if this time Germany rode in on a white horse instead of a gray tank?