The European Debt Crisis is a Problem of Political Will

Back in the summer, as U.S. politicians seemed on the verge of failing to agree a debt limit extension to avoid default on America's obligations, Europeans looked on in scornful amazement at an apparent failure of leadership.  Now the shoe is very much on the other foot.  Speaking on November 16, President Barack Obama accused the Eurozone of suffering from "a problem of political will" that put the future of the single currency at risk.  America's leaders succeeded in averting a default crisis when common sense finally prevailed (though the Democrats paid a higher political price for reason than the Republicans).  Whether Europe's leaders can pull off their own great escape is much more open to doubt, because in their case their sovereign debt problem is much graver than America's debt limitation problem and the solution to it is far less readily apparent.

Signifying the sense that there is a problem of political will, the current leaders of the single currency project—Angela Merkel and Nicolas Sarkozy—are widely compared unfavorably in the media with their predecessors who built the foundations of the European project in the 1950s —Konrad Adenauer and Charles de Gaulle.  Such yardsticks obscure understanding of the current crisis more than they enlighten.  There is really nothing in modern history that allows for appropriate comparison with their forbears to judge today's  leaders because the single-currency issue lends a unique dimension to Europe's debt crisis.

That said, the fetters of history still bind the most important actor in the unfolding debt crisis.  Germany has to decide whether to drop its visceral  opposition to the European Central Bank [ECB], throwing inflationary caution aside to act like a lender of last resort, or risk being blamed for the destruction of the euro.  This is a tough call for a nation whose thinking on political economy continues to be shaped by horror of the hyper-inflation it suffered under the Weimar regime in 1923.  In private, Angela Merkel is said to be in favor of allowing the ECB to print money to buy up enormous quantities of Italian and Spanish debt, but is unprepared to take the political risk of saying so in public.  As a result, the unity of Germany and France, which has been at the heart of the European project since its inception and through its evolution into the single currency, is now fraying.

If nothing else, the current crisis shows that unity in the face of economic and financial crisis is far more difficult for a 17-member club of nations than for a union of fifty states under one government.  Europe's pre-crisis hubris about its glorious economic future now looks sadly laughable.  Back in 1988, Paul Kennedy's The Rise and Decline of the Great Powers predicted that the U.S. was about to enter a period of decline because the fiscal costs of Cold War victory would sap its economic vitality.  The best that may be said about that forecast was that it was premature, but best-selling sales at least provided the consolation of profit in doom.  Far less well-known was another much more fanciful declinist tract by Jacques Attali, a key aide to President Mitterand of France and director of the new multilateral bank established to assist the post-communist economic reconstruction of Eastern Europe.  In Lignes d'Horizon (1990), he predicted that global economic predominance would soon pass from the United States to a European bloc and a Japanese-led Pacific bloc!  

Such inaccurate forecasts should counsel caution about predicting the outcome of the current crisis, but it is difficult to see the Eurozone surviving in its present form.  The problem of leadership has arguably less to do with ensuring the survival of the single currency as presently constituted and more to do with saving parts of the project.  If the Germans cannot bring themselves to agree to an ECB printing-press solution to bail out the worst national debtors—which anyway may just prove a sticking-plaster solution that temporarily stems the problem without actually resolving its deep-seated roots—then the only apparent alternative to save the euro is to create a smaller union of Northern European countries—about eight of the current members—and leave the Southern European nations to form their own satellite zone.

Having invested so much political capital in creating the monetary union, the Northern members are unlikely to ditch it entirely.  However, things will have to get much worse—as they probably will—before the European political class gears up for radical action.  In the meantime, doing something to stave off the current crisis is a short-term necessity and the imperative for action becomes daily more pressing.

The dimensions of the problem are huge.  France has now slumped to 13th place in a Eurozone league table of financial security, just one place above Italy and below two troubled debtors—Spain and Ireland.  Its government has huge debts, which pushed up yield on its 10-year government bonds to 3.69%—the highest level since the formation of the Eurozone, and its banks are massively exposed to bad debts in Italy, Spain, and Greece, in particular.  If one of the two nations at the heart of the Eurozone is sucked into the financial contagion, the resultant crisis will put the entire project at risk.

The fact that Europe is now the epicenter of the crisis whose roots are traceable to the American financial crisis of 2007-2008 can be no comfort to the United States and the rest of the world.  The uncertainty besetting the Eurozone is a drag on global economic recovery in an interdependent world.  The reality is that two-thirds of all lending in the Eurozone is between its 7,000 banks and institutions in the U.S., Asia, and the Middle East.  In total Eurozone banks hold 55 trillion euros in assets, much of them loans to sovereign countries and other banks, only some of which are in the Eurozone.  If the current crisis produces a string of bank failures in Europe, the effects will ripple outwards to every part of the world, not least the United States.