Europe nominally has a public debt crisis. But the Continent’s real crisis is of central political and social planning, done not through overt decree but stealthily, through the supposedly free global financial markets. Americans shouldn’t look on with too much smugness, because our policymakers are creating the same slow-motion disaster at home.
Starting last fall, global investors provoked the gradually unfolding emergency. They stopped funding Greece’s attempts to paper over its unsustainable deficits with more debt. Since Greece had joined the euro common currency a decade before, bondholders had financed the Mediterranean nation’s debt at interest rates only slightly above the rates at which Germany could borrow.
If investors had priced Greece’s debt based on economic or market fundamentals, they would have demanded a bigger return as compensation for higher risk. After all, Greece, with much higher debt levels, a lower credit rating, and an inefficient labor market, was never Germany.
But investors disregarded these factors in favor of a cruder political truth. They gambled that the stronger euro nations would never let a member of the 16-nation euro zone default on its sovereign debt, because allowing such a default, in the eyes of Germany and France, would risk the future of the euro and of European integration.
So far, the world’s investors have proven correct. In late 2009 and early 2010, Europe tried to wish the problem away. The European Central Bank continued to accept Greek debt as collateral from the Continent’s banks, hoping this artificial liquidity would keep banks lending to the strapped country. But Greece’s crisis seeped across borders to Portugal, Spain, and Italy, as investors demanded a stronger sign that Europe would save them if needed.
In May, Europe gave investors what they wanted. The Continent’s leaders, chiefly French President Nicolas Sarkozy and German Chancellor Angela Merkel, announced, in addition to a EUR250 billion ($305 billion) International Monetary Fund package, a new, EUR440 billion ($537 billion) “European Financial Stability Facility” (EFSF). Over a three-year period, the EFSF is supposed to lend money to European nations that can’t borrow cheaply in the capital markets. France and Germany hope that because the EFSF will boast national guarantees, it will garner its own AAA rating and thus be able to raise its own funds cheaply.
To American observers, it may seem like Europe is going through contortions to delay the obvious: Greece is insolvent. As NYU professor Nouriel Roubini, author of Crisis Economics, wrote in June, Europe’s rescue will leave Greece “with a public-debt-to-GDP ratio of 148 percent by 2016,” a level of indebtedness that, even if “stable” by then, is still “unsustainable.”
Europe, then, rather than face up to its problems, is delaying their resolution and making the inevitable day of reckoning even more painful. With a rescue package in place, for example, European nations lose some leverage that they could use with intractable labor unions, keeping their job markets hobbled. As European economies remain stagnant, Greece and other weak nations will continue to pile on debt that they can’t reasonably repay at artificially cheap rates, with bond buyers comfortable that Germany will be there to rescue them on demand.
Moreover, the weak only bring down the strong, as investors in German and French debt must consider not only the two nations’ own prospects for growth, but the likelihood that the two will have to assume hundreds of billions of dollars’ worth of their neighbors’ debt.
Meanwhile at Home
America could use Europe’s blunder to its great advantage. As Europe tries to avoid dealing with its economic reality, we could be facing up to ours. Washington could admit, for example, that Americans have borrowed and spent too much for years, based on unrealistic bubble-era housing values; that government policies have long directed too much scarce investment capital to the housing and finance industries; that our financial sector is too big relative to the rest of the economy, thanks to a quarter century of “too big to fail” policy coming from Washington; that public-employee salaries and benefits are too high and were based on unrealistic bubble-era tax revenues; and that we’ve severely neglected our physical infrastructure for decades now, meaning that we don’t even have much in tangible results to show for all of our bubble-era profligacy.