The window of opportunity to save the euro is rapidly closing, as the sovereign debt crisis erodes the solvency of Europe’s banks and drives up borrowing rates for even once rock-solid countries like France.
On Saturday, the crisis swept away another leader, when Prime Minister Silvio Berlusconi resigned after 17 years of dominance in Italian politics to the jeers and cheers of crowds in Rome.
Both there and in Greece, jumbled parliaments came together with urgency to install more technocratic governments that are committed to delivering the difficult reforms and austerity measures demanded by the European Union, the European Central Bank , and the International Monetary Fund .
Despite those drastic and tangible steps, though, there is a host of problems that could quickly overwhelm Europe’s progress.
Looming over all the discussions of reform and financing mechanisms is the slowdown in the Continent’s already anemic growth rate, to 0.5 percent in 2012, and even the threat of a double-dip recession , the European Commission said in a forecast for the euro zone last week.
That calls into doubt the adequacy of the euro zone’s latest attempt to placate the markets, the lagging effort to bolster the $605 billion European Financial Stability Facility to $1.4 trillion or to find other funding. The task will become that much harder in a recessionary environment, especially as France’s credibility with investors begins to decline.
“I think we’re in very dangerous territory, and the euro zone has to act soon,” said Simon Tilford, chief economist for the Center for European Reform in London. “There isn’t really a muddle-through option right now. And those who argue that it’s possible for the south and Italy to default or deflate into competitiveness are fanciful and flying in the face of evidence.”
The damage that can result, he said, is potentially severe “to their economies, debt burdens, social and political stability, democratic accountability, and their belief in their European allies and in the European Union itself.”
At the center of it all sits Germany, leading the bloc of Northern European countries, which also includes the Netherlands and Finland, steadfastly maintaining that austerity and fiscal rectitude on the part of the debtors, no matter how painful, represent the only path to resolving the crisis. Any proposals to share the burden with the heavily indebted countries by collectivizing European sovereign debt — even though they may have contributed to the prosperity of the northern countries by consuming their exports — are rejected out of hand, largely for fear of a political backlash.
When Germany’s council of independent economic advisers proposed to Chancellor Angela Merkel last week a way to share European debt to protect Italy and Spain, she dismissed the idea as impossible without changes to European Union treaties. She has also opposed any expansion in the European Central Bank’s role in buying up the bonds of the indebted countries, which could hold down interest rates on their debts, let alone allowing the bank to guarantee Italian debt.
But critics say there is no time for the treaty changes Merkel is talking about; those could take years to put in place.
“The crisis must be solved right now, and it simply will not wait for these instruments to fix it,” said Bernhard Rapkay, chairman of Germany’s Social Democrats in the European Parliament.
The vulnerability of Italy — the third-largest economy in the euro zone and the fourth-largest debtor nation in the world — brought the crisis into the core of the euro zone. For all the speculation over weaker countries eventually choosing to leave the euro, there is really no euro without Italy, certainly not a euro that can be considered a common European currency.
And if borrowing becomes so expensive for Italy that it is priced out of the markets, which seemed a real possibility last week, there is no so-called wall of money big enough to bail it out or to guarantee its $2.6 trillion debt.
“We’ve entered a make-or-break scenario,” said Thomas Klau, a German who heads the Paris office of the European Council on Foreign Relations. “The present situation with Italy now is sustainable for days, perhaps weeks, but not months. This new chapter either writes the endgame of the euro zone, or it precedes a much bigger leap into political and economic integration than all those made so far.”
With each bout of uncertainty, speculative attacks come closer to the core of the European Union. Greece teeters, Italy wobbles, and France begins to tremble. The precariousness of the situation was on full view Thursday when a leading ratings agency, Standard & Poor’s, mistakenly suggested on its website that it had downgraded France’s prized AAA rating, prompting a sell-off in French government bonds.
The mistake was quickly corrected and the French, enraged, opened a formal investigation. The episode showed how little margin for error remained even for France, which is already suffering from a drop in industrial production and has watched the gap between its bonds’ rates and those of Germany widen to record levels, an ominous development in this environment.
And it may get worse, with a recession looming. Unless, of course, the crisis has concentrated minds sufficiently, especially in Berlin. One of the first and most effective ways to combat the crisis and the potential downturn, experts say, would be to enable the European Central Bank, or ECB, to act as a lender of last resort, or to at least let it print some more money, to try a little inflation as a recipe for growth and debt reduction.
“I understand the German fetish with inflation , but that’s increasingly wearing thin,” said Jan Techau, a German who is the director of Carnegie Europe in Brussels. “The reluctance to use the ECB as the lender of last resort when Italy is solvent is something I don’t understand.”
In part, it is a result of the German economy’s unusual strength throughout the crisis. In the last few years, it has grown stronger — with higher exports, rising employment, an unexpected burst of tax revenue, even a windfall from an accounting error — while others in Europe have struggled.
German trade groups have pressed Merkel to do what it takes to save the euro, which has been a boon for exporters, allowing them to sell products in a currency depressed by the troubles of its weaker members.
“The German people don’t understand really what’s going on and are really skeptical the measures will be helpful,” said Anton Börner, president of the Federation of German Wholesale, Foreign Trade and Services.
Germany has drawn lines in the sand before over the euro — about the impossibility of a Greek default or the use of the ECB to buy sovereign bonds — and has backtracked when faced with disaster. The impending slowdown is expected to cool German growth as well.
The outlook is not entirely bleak. Upon taking the reins at the ECB this month, Mario Draghi cut interest rates by a quarter percentage point, which may help growth rates. And Germans have lately seemed open to expanding debt guarantees in exchange for the promise of stability.
“The conviction of the seriousness of the crisis has reached a new level, and that is positive,” said Janis A. Emmanouilidis, senior policy analyst at the European Policy Center. “Whenever you hit the wall, you come up with something.”
Either the ECB will have to play a more active role in propping up the most indebted euro-zone nations, or countries will have to commit to a more federal system, with something like a Treasury Department and a real central bank. If not, a breakup of the euro zone, with some countries dropping the currency or being forced to do so, may be inevitable.
These discussions are causing anxiety inside the European Union, especially among the 10 member countries that do not use the euro, who fear a two-speed Europe — the European Union divided into different blocs with different rules — that hurts their interests. Some countries inside the euro zone fear such changes, too, because they will require more rigor and discipline.
The options are politically difficult, said Mr. Klau of the European Council on Foreign Relations. “But the alternative is potentially so devastating that the cost of action, however large, is much smaller than the cost of inaction, because inaction can trigger a chain of events that European leaders will no longer be able to control.”