The European crisis gets quietly worse

By Felix Salmon
September 28, 2010
Edward Hugh has a must-read overview of the euro crisis as it stands right now: not nearly as panicked as when everybody was concentrated on Greece back in May, yet in many ways worse than that.

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Edward Hugh has a must-read overview of the euro crisis as it stands right now: not nearly as panicked as when everybody was concentrated on Greece back in May, yet in many ways worse than that.

Greece still seems certain to default sooner or later, and its bonds are trading at levels very near to those seen in May. Spain has improved a bit — but that tiny improvement seems to have been accompanied by a significant rise in complacency on the part of the government, so it’s unlikely to last long. And both Ireland and Portugal have deteriorated significantly.

Ireland’s debt is trading at worse levels than ever before, its economy is still in recession, and its banking system is a mess; in Portugal, the public deficit is likely to reach 9% of GDP this year, and the country’s debt spreads are also looking distressingly similar to Greece circa April 2010.

Writes Hugh:

Like former US Treasury Secretary Hank Paulson before them, Europe’s leaders, having armed their bazooka may soon need to fire it…

The EuroArea countries could be likened to a group of 16 Alpine climbers scaling the Matterhorn who find themselves tightly roped together in appalling weather conditions. One of the climbers – Greece – has lost his footing and slipped over the edge of a dangerous precipice. As things stand, the other 15 can easily take the strain of holding him dangling there, however uncomfortable it may be for them, but they cannot quite manage to pull their colleague back up again. So, as the day advances, others, wearied by all the effort required, start themselves to slide.

What’s certain is that if you’re going to fire your bazooka anyway, it’s better to fire it earlier rather than later: the cost of a bailout always rises the longer it’s delayed. So why are the ECB’s bond purchases dwindling, and why is the much-vaunted European Financial Stability Facility still surrounded by so many questions? Yves Smith quotes the FT’s Wolfgang Munchau with some worrying math on that front: essentially, the EFSF won’t be able to lend cheap money to struggling countries at all.

In other words, the Eurozone’s bazooka might turn out to be even less effective than Paulson’s was. And if that’s the case, there’s no point in throwing good money after bad at all: it might be easier and cheaper just to slice that Alpine rope at a strategic point and sacrifice a weaker member or two for the sake of keeping everybody else safe.

Of course, slicing the rope would be easier if and when one of the peripheral countries actually wanted to do so — to attempt their own competitive devaluation in the global currency war. The stricter that the Germans are about the conditionality attached to new funds, the likelier that’s going to become.

In any crisis, there comes a point where it’s easier to let things fall apart than it is to keep things together. Given how fractious the European project has always been, and given that the generation of politicians who staked their careers on the European Union has now completely retired from the scene, a breakup would seem to be an inevitability at this point. The only question is when it will happen, and who will go first.

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