May 17, 2012
Suddenly, it has become easy to see how the euro
— that grand, flawed experiment in monetary union without political
union — could come apart at the seams. We’re not
talking about a distant prospect, either. Things could fall apart with stunning
speed, in a matter of months, not years. And the costs — both economic and, arguably even more important, political — could be huge.
This doesn’t have
to happen; the euro (or at least most of it) could still be saved. But this
will require that European leaders, especially in Germany and at the European
Central Bank, start acting very differently from the way they’ve acted these past few years. They need to stop moralizing and deal
with reality; they need to stop temporizing and, for once, get ahead of the
curve.
I wish I could say that I was optimistic.
The story so far: When the euro came into
existence, there was a great wave of optimism in Europe — and that, it turned out, was the worst thing that could have
happened. Money poured into Spain and other nations, which were now seen as
safe investments; this flood of capital fueled huge housing bubbles and huge
trade deficits. Then, with the financial crisis of 2008, the flood dried up,
causing severe slumps in the very nations that had boomed before.
At that point, Europe’s lack of political union became a severe liability. Florida and Spain
both had housing bubbles, but when Florida’s
bubble burst, retirees could still count on getting their Social Security and
Medicare checks from Washington. Spain receives no comparable support. So the
burst bubble turned into a fiscal crisis, too.
Europe’s
answer has been austerity: savage spending cuts in an attempt to reassure bond
markets. Yet as any sensible economist could have told you (and we did, we
did), these cuts deepened the depression in Europe’s troubled economies, which both further undermined investor
confidence and led to growing political instability.
And now comes the moment of truth.
Greece is, for the moment, the focal point.
Voters who are understandably angry at policies that have produced 22 percent
unemployment — more than 50 percent among the young —
turned on the parties enforcing those policies. And because the entire Greek
political establishment was, in effect, bullied into endorsing a doomed economic
orthodoxy, the result of voter revulsion has been rising power for extremists.
Even if the polls are wrong and the governing coalition somehow ekes out a
majority in the next round of voting, this game is basically up: Greece won’t, can’t pursue the policies that Germany and the European Central Bank are
demanding.
So now what? Right now, Greece is experiencing
what’s being called a “bank jog” — a somewhat slow-motion bank run, as more and more depositors pull out
their cash in anticipation of a possible Greek exit from the euro. Europe’s central bank is, in effect, financing this bank run by lending
Greece the necessary euros; if and (probably) when the central bank decides it
can lend no more, Greece will be forced to abandon the euro and issue its own
currency again.
This demonstration that the euro is, in fact,
reversible would lead, in turn, to runs on Spanish and Italian banks. Once
again the European Central Bank would have to choose whether to provide
open-ended financing; if it were to say no, the euro as a whole would blow up.
Yet financing isn’t
enough. Italy and, in particular, Spain must be offered hope — an economic environment in which they have some reasonable prospect
of emerging from austerity and depression. Realistically, the only way to
provide such an environment would be for the central bank to drop its obsession
with price stability, to accept and indeed encourage several years of 3 percent
or 4 percent inflation in Europe (and more than that in Germany).
Both the central bankers and the Germans hate
this idea, but it’s the only plausible way the euro might be
saved. For the past two-and-a-half years, European leaders have responded to
crisis with half-measures that buy time, yet they have made no use of that
time. Now time has run out.
So will Europe finally rise to the occasion? Let’s hope so — and not just because a euro breakup would have
negative ripple effects throughout the world. For the biggest costs of European
policy failure would probably be political.
Think of it this way: Failure of the euro would
amount to a huge defeat for the broader European project, the attempt to bring
peace, prosperity and democracy to a continent with a terrible history. It
would also have much the same effect that the failure of austerity is having in
Greece, discrediting the political mainstream and empowering extremists.
