Uncertainty Over the Horizon

SLOVAKIA / POLAND - Zakopane, 2011
The border between Slovakia and Poland, near Zakopane, 2011. Valerio Vincenzo

If the Nobel Prize committee really believed that 2012 was the ideal time to award the peace prize to the European Union, the judges must either be deaf and blind or possessed of a wicked sense of humor.

With each new fix that fails to withstand closer inspection, it becomes less clear that the euro can be saved—and clearer that the effort to save it is beginning to rip Europe apart. Never have tempers in European capitals been more frayed than now, nearly three years after Greece’s de facto bankruptcy triggered the crisis that has spread from the Aegean peninsula to engulf the entire 17-member euro zone. Never has there been greater discord among the European Union’s 27 governments. Since François Hollande replaced Nicolas Sarkozy as France’s president, even the supposedly indissoluble Franco-German “couple” has been at loggerheads.

Never has Brussels—the seat of the EU’s power—been more unloved by Europeans. In Spain, furious demonstrators denounce the EU as the “Fourth Reich.” With some justification, people blame Brussels for designing an unworkable regime for the single currency and then demanding that they pay the exorbitant bill for sorting out the resulting mess.

From Athens via Rome and Madrid to Paris and on to Dublin, voters in revolt against austerity have been giving politicians the boot. Mainstream political parties are cracking under the strain. Radical movements are on the rise, not only on the right: young voters are fl ocking to the quasi-Marxist Syriza party in Greece and the comedian Beppe Grillo’s Movimento 5 Stelle in Italy as they call down brimstone on bankers, austerity, Brussels, and the entire political class. Catalonia, Spain’s wealthiest region (and yet currently €42 billion in the red) is in full revolt against Madrid, voting en masse for secessionist parties in recent elections. Most ominously, with demonstrators painting swastikas on effigies of the faultlessly democratic German Chancellor Angela Merkel, German power is again feared and resented—the very thing that the EU was supposed to end for all time.

About the only thing that unites European leaders as 2012 ends is extreme irritation with the British. The deadlock over the EU’s new seven-year budget is only one of many. The virtue of the proposed new European Banking Union (EBU) for the euro zone is that it would empower the European Central Bank (ECB) to sort out the mess in the continental banking sector. But the risk for Britain is that the City of London, which dominates European financial services, could be badly damaged—for instance, of concern is the ECB proposal that would require clearinghouses for euro-denominated business to be located inside the euro zone. If the euro-zone countries reject Britain’s reasonable demand for safeguards against the imposition of euro-zone rules on the wider European Union, a British veto of the EBU is certain. Th is issue alone puts Britain’s always uneasy relationship with the rest of Europe under strain as never before.

Additionally, never forgiven for the original sin of refusing to give up the pound sterling, London has added insult to injury by demanding that the euro zone get its act together—and that the European Commission do its bit for austerity by freezing its own budget and tightening the belts of its pampered functionaries. Chancellor Merkel retorts that euro-zone leaders are doing the right things, despite and not because of Britain’s sermonizing. She insists that reports of the euro’s demise were not only premature but downright false, essentially because she is simply not going to let it happen. That may prove true if politics can indeed triumph over economics, but in the increasingly parlous state of the euro zone, the pledge sounds hardly credible.

The euro-zone outlook continues to worsen. The harder governments try to bring runaway budgets and debts under control, the more unemployment rises, already averaging 11.6 percent in the euro zone. That squeezes tax revenues, even as steeper taxes bite hard on companies and on those still employed. According to the November forecast of the Organization for Economic Cooperation and Development (OECD), this deadly combination of rising debt and negative growth in Europe presents an even bigger threat to the world economy—and to social stability—than the U.S. “fiscal cliff.”

The longer Europe takes to adjust, the harder the task becomes. Much has been done to cut budget deficits, albeit with too little emphasis on cutting state spending. Labor costs are being driven down, prompting waves of strikes but increasing competitiveness. Exports are up in Ireland, which has run a current account surplus since 2010, as well as in Portugal and Spain. But much else is still required of the governments, consumers, and banks in the so-called PIIGS (Portugal, Ireland, Italy, Greece, and Spain)—not to mention France: tougher measures to shrink state bureaucracies and dismantle regulatory barriers to growth; the courage to tackle restrictive union and professional practices; and aggressive restructuring of European banks, particularly in Spain.

The viability of the euro itself is still in question, not least because the immediate effect of austerity measures has been to drive the euro-zone economies further apart. There is a chasm between the north and south regarding the cost and availability of business loans, growth rates, and, most explosively, with unemployment, which is nearly five times higher in Spain than in Germany. And there is no relief in sight. In 2012 euro-zone economies shrank by an estimated 0.4 percent, and in 2013 Greece’s economy is expected to shrink by 3.8 percent—on top of the nearly 20 percent fall in GDP that country has suffered since 2008. Without a revival of growth, budget cutting will not solve the debt crisis.

If the euro looks slightly more likely to endure (at least in the short term) than it did a year ago, that improvement is based on a benign confidence trick. On July 26 Mario Draghi, president of the European Central Bank, stared down the financial markets—and sharply reduced Spanish and Italian borrowing costs—by uttering two sentences: “The ECB is ready to do whatever it takes to preserve the euro.And believe me, it will be enough.”

In September—sweeping aside the objections of the German Bundesbank and implicitly shredding the “no bail-out” clause in the Maastricht treaty, which originally established the euro—the ECB board duly confirmed that it stood ready to buy virtually unlimited short-term bonds of debt-distressed euro-zone governments, provided they requested help and pledged, as “collateral,” to undertake deeper fiscal and structural reforms. The euro zone thus acquired, by the back door, the lender of last resort it had desperately lacked. Without the ECB commitment to “outright monetary transactions” (OMT), the bond markets would have demanded such stiff premiums that Spain and even Italy could have been unable to service their debts by the new year.

But there are costs, to Germany above all: not only might OMT translate for German taxpayers as “on my tab,” but Merkel has, whatever she may say to the contrary, put the commitment to preserving the euro ahead of sound monetary policy. The ECB has only treated the symptoms, yet it has brought real relief by enabling governments to finance debt more cheaply. Not for the first time, Draghi had bought the politicians more time. But, as before, the moment pressure eased, they again dragged their feet.

Reluctant to request a greater bailout than the €100 billion already on offer to restructure Spain’s property-bubble-laden banks, Prime Minister Mariano Rajoy reacted to lower borrowing costs by acting as though Spain had mysteriously ceased to need ECB help at all. For Greece, talks on the next €44 billion installment of bailout money dragged on for weeks after its government braved riots in Athens and cut spending for 2013 by a further €9.4 billion—cuts that are proportionally steeper than those mandated in the U.S. fiscal cliff.

The delay was caused by wrangling between euro-zone ministers and the International Monetary Fund’s redoubtable president, Christine Lagarde, who refused to disburse another cent of IMF money unless governments agreed to restructure Greece’s official debt to bring it down from 190 percent of GDP to a “sustainable” 120 percent by 2020: a level that, lest it be forgot, is still double the maximum allowed under euro-zone rules.

The IMF won the argument but lost this battle. The deal finally thrashed out in late November gave Greece just enough cash to ease pressure on its banks and to stumble into next year, but no more. Beyond that, ministers cobbled together a debt-reduction package that, with luck, should reduce Greece’s debt load to 126.6 percent of output by 2020. It was an overdue first step toward acknowledging that Greece is broke; but, critically, it stopped short of conceding that official as well as private creditors will have to take losses. Almost all Greek debt is now owed to governments and the ECB, and, at least until after next year’s German elections, there is no way Merkel is going to tell German taxpayers they will not be getting all their money back. Even after spending €200 billion, and counting, on the Greek rescue, a “Grexit” is still a possibility.

Merkel intends to go down in history as the German who “saved Europe”—on German terms. Th ose terms go far beyond the stability and growth pact that proved insufficient to prevent free riding on the back of a common interest rate: this time Germany will insist on deeper financial integration, secured by centralized economic control over euro-zone national finances. That loss of sovereignty will be hard enough to sell to euro-zone governments, let alone their voters. But, if they really want to keep the euro, they may conclude that they have no choice.

It will be harder still to sell to the British, for whom this further massive accretion of power by the European Commission would clearly constitute another step toward the “United States of Europe” that Britain opposes. Not only will Britain demand guarantees that it cannot be compelled to sign up to, and will not be bound by, the new rules, London will say that if the euro-zone core wants “more Europe,” it must make allowances for Britain’s desire for “less Europe” for itself, thus formalizing the concept of a two-tier European Union. Absent such guarantees, Britain would veto any new treaty. If Brussels tried to press ahead without treaty revision, a British government of whatever party would find itself under irresistible public pressure to leave the EU altogether.

Prime Minister David Cameron’s coalition is already committed to holding a referendum before any further powers are transferred to Brussels. He is further pledged to seek the repatriation of powers from Brussels in a whole range of areas: restrictions on working hours, health and safety, education, regional spending, and agricultural policy—where Britain has long argued that decisions are better taken at the national level. He is under intense pressure to hold a referendum on whatever deal he secures. But he may not get a deal at all: it is holy writ in the EU that integration is a one-way street and repatriation of powers from Brussels is unthinkable. That could lead to a British withdrawal.

Yet Europe would be much the poorer without Britain, not just in terms of the EU’s international infl uence. Britain is Europe’s oldest democracy, its most forceful champion of free trade, its only source (with France) of military power, and champion of its most valuable asset: a single EU-wide market. That is understood in Berlin and other northern capitals, yet even Britain’s natural allies insist that the U.K. cannot have Europe à la carte. The Europeans may wake up to find that they have torn up the rule book to keep Greece in the euro, but, by refusing to alter a line or two, they have propelled Britain out the door of the European Union—a matter a thousand times more important to the future of the continent. The risk is not yet great. But the risk is there.

Join the Discussion