By Simon Johnson
Most experienced watchers of the eurozone are expecting another serious crisis to break out in early 2011. This projected crisis is tied to the rollover funding needs of weaker eurozone governments, i.e., debts falling due in March through May, and therefore seems much more predictable than what happened to Greece or Ireland in 2010. The investment bankers who fell over themselves to lend to these countries on the way up, now lead the way in talking up the prospects for a serious crisis.
This crisis is not more preventable for being predictable because its resolution will involve politically costly steps – which, given how Europe works, can only be taken under duress. And don’t smile as you read this, because this same logic points directly to a deep and morally disturbing crisis heading directly at the United States.
The eurozone needs to – and will eventually – take three steps:
1. Agree on greater fiscal integration for a core set of countries. This will not be full fiscal union, but it will comprise some greater sharing of responsibilities for each other’s debts. There is much room for ambiguity in government accounting and great guile at the top of the European political elite, so do not expect something completely clear to emerge. But Germany will end up underwriting more of the liabilities for the European core – the opposition Social Democratic Party and the Greens are very much pushing Chancellor Angela Merkel in this direction by calling her “unEuropean”.
2. For the core countries, the European central bank (ECB) will receive greater authority to buy up government bonds as needed. Speculators in these securities will be badly burned as necessary. The wild card here is whether Bundesbank president Axel Weber will get to take over the ECB in fall 2011 – as expected and as apparently required by Ms. Merkel. Mr. Weber has been vociferously opposed to exactly this bond-buying course of action. The immovable Weber will meet the unstoppable logic of economic events. Good luck, Mr. Weber.
3. One or more weaker countries will drop out of the eurozone, probably becoming rather like Montenegro – which uses the euro as its currency but does not have access to the ECB-run credit system. Greece is probably the flashpoint; when it misses a payment on government debt, why should the ECB continue to accept Greek banks’ bonds, backed at that point effectively by a sovereign entity in default? The maelstrom will probably sweep aside Portugal and perhaps even Ireland; the chaos will threaten Spain and Italy.
It would be so easy to set up preemptive programs with the IMF for Portugal and Spain, but this will not happen. The political stigma attached to borrowing from the IMF is just too great.
The unfortunate truth is that despite its much vaunted supposed return to preeminence and the renewed swagger of senior officials, the IMF remains weak and of limited value. It is an effective lender to small European countries under intense pressure – Latvia, Iceland, Greece, etc. But the Fund does not have the resources or the legitimacy to save the bigger countries.
At the end of the day, the Europeans will save themselves, with the measures outlined above – only because there will be no other way to avoid wasting 60 years of political unification. But this action won’t “save” everyone; one or more countries will be forced out of full eurozone membership (although they will likely keep the euro as the means of exchange). And the costs to everyone involved will be large and largely unnecessary.
And remember, when the financial markets are done with Europe, they will come to test our fiscal resolve. All the indications so far are that our politicians will also struggle to get ahead of financial market pressure.
There are plenty of places in Europe where you can find an easy political consensus is to cut taxes and increase budget deficits. Sadly, this no longer pacifies markets. The American political elite – right and left – believes that we are different from the Europeans because we issue the dollar and therefore have some special privileges for ever.
But this is not the 1950s. Asia has risen. Europe will sort itself out and become more fiscally Germanic. The Age of American Predominance is over.
Our leading bankers looted the state, plunged the world into deep recession, and cost us 8 million jobs. And now many of them stand by with sharpened knives and enhanced bonuses – also most willing to suggest how the salaries and jobs of others can be further cut. Think about the morality of that one.
Will no one think hard about what this means for our budget and our political system until it is too late?
An edited version of this post appeared this morning on the NYT.com’s Economix blog; it is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.
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