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.
Originally published at The Baseline Scenario and reproduced here with permission.