Recently I went to get some churros con chocolate with a friend studying at Universidad Complutense. He is an educated guy, very sharp, a real “pícaro” who does not hesitate to poke fun at something he finds ridiculous. We began to talk politics, specifically Europe’s sovereign debt crisis, and at one point I noted with amazement and some sympathy that the Germans would be inevitably responsible for bailing out the rest of Europe. My friend looked at me squarely in the eye and said, “They tried to conquer Europe twice in less than a century, without mercy, and left us with Franco. Que se jodan.”
You do not have to agree with my friend to see his point. Europe is in serious trouble, and though the Spaniards continue to party until the sun rises, they are increasingly angry and disillusioned. After having experienced one of the great economic miracles of the twentieth century, Spain’s future looks decidedly grim. The Spanish youth will likely suffer a lower quality of life than that of their parents, and so far there appears to be little they can do about it.
In this post, I will attempt to explain Europe’s economic situation, tying in Spain where relevant. A follow-up post will elaborate on Spain’s current circumstances, focusing on what I have been able to observe in person.
The Debt Contagion – Too Little, Too Late
Why is Europe’s economic crisis so scary? The European Union (EU) is the world’s largest economy, with approximately 308 million people. If it goes bust and the 17-nation euro zone dissolves, an economic tsunami would hit the U.S. and the rest of the world. Stocks markets would tank, people’s savings would disappear, banks would stop lending and likely suffer a run on their accounts, and political chaos would follow.
This sounds like a drastic, impossible scenario, until you look at the numbers. Europe’s biggest debtors are facing unprecedented yields on their sovereign debt, with both Italy and Spain above 6% on ten-year bonds. Such levels necessitated European-sponsored bailouts in Ireland and Portugal over the past year. But Italy is the world’s eighth largest economy and third largest bond market. It is too big to be “bailed out.” Without investors buying its bonds, Italy’s government will simply run out of money and default on its debts. The EU’s situation is so tenuous that any number of events, from the failure of a big bank (read: France, whose banks are heavily exposed to Greek debt) to the collapse of a government to more unsuccessful bond auctions could cause its demise. Then there are the political pressures, which are already reaching a boiling point. Both Greece’s and Italy’s governments succumbed to the crisis this fall, and Spanish voters just gave Spain’s conservative opposition party, Partido Popular, an enormous victory on November 20.
Yet hasn’t the Old World been in “crisis” for the past two years, ever since Greece began to look insolvent? Yes, but only according to some. The problem lies in what David Wessel of the WSJ calls a policy of “delay, deny, and disguise.” European governments have been roundly accused of not taking action fast enough, of refusing to acknowledge reality, and of being dishonest with their people. Instead of putting out the Greek fire when the first signs emerged, Europe’s leadership (particularly Germany’s Angela Merkel) did not acknowledge that Greece had borrowed too much, turning what might have been a tough but manageable problem into a death spiral.
One huge reason for the delay was deciding who would pay for Greece’s sins. German taxpayers? French-bank shareholders? Foreign bondholders? Merkel still has not explained fully to her people why the Germans must pick up the tab. And here in Spain, I can’t tell you how many election posters for Spain’s ruling party were covered in graffiti that said “MENTIROSO” (liar), referring to the outgoing President Zapatero’s persistent denial through May 2010 that Europe’s sovereign crisis was serious and that Spain was directly in its path. The political costs of acting decisively now are enormous. But there is no other choice.
The End Game
This is where IR junkies like me get excited. Ultimately, the big issue at stake is sovereignty, the bread and butter of international politics. There is no way for the euro currency to be saved without greater European fiscal unity. This means that Germany, Europe’s biggest and richest nation, will have to bear the biggest burden in bailing out the so-called “periphery nations” like Greece, and Germany in turn will have greater political sovereignty because of its direct influence in another nation’s economy. See the problem here? Picture the headlines: “Greece, the cradle of democracy, reels under second German occupation.” Sounds outlandish, but that is exactly how my Spanish friend and many of his fellow Europeans feel about ceding sovereignty to Germany.
Yet if Germany does not lead soon and pledge to bolster Europe’s main rescue fund, the European Financial Stability Facility (which aptly sounds like a mental institution!), then the game is over. Italy and Spain, whose budget deficits and debt-laden economies have made investors flee to refuges like U.S. Treasuries, would default and the euro zone would disintegrate. The best solution available is the one to which European leaders are coming to embrace with agonizing slowness: the restoration of growth and competitiveness through aggressive monetary easing (read: bailouts), a weaker euro and stimulatory policies in the core (Germany, France, etc.), while the periphery undertakes austerity and reform. The only institution capable of doing this is the European Central Bank (ECB), whose fate lies in Germany’s hands, specifically those of its Constitutional Court. However, the ECB does not support such an expansion of its mandate because of the moral hazard that could result: i.e., in giving struggling but essentially solvent economies like Italy and Spain a “Get out of Jail Free” card without guaranteed accompanying reforms. If this mess is not thick enough, then there is the fact that German voters are not going to want to be bailing out parts of their weaker neighbors’ debt for the next 25 years, as one plan by Germany’s Council of Economic Experts proposes.
Suppose Merkel and her Europeans colleagues decide to face political suicide and support this plan. What exactly would these “reforms” entail? One buzzword is “austerity,” but that hardly touches on how much could get chopped. All of the social achievements that Europeans hold sacred would be up for grabs, including free education, universal healthcare, welfare, even retirement pensions. A related key concept is structural reform. In the case of Spain, the autonomous communities would have to make serious concessions in sovereignty to streamline the public sector, since now there is tremendous duplication in the country’s bureaucracy between regional and national government. The unions would lose much of their collective bargaining power, because the protections they have won have made almost impossible to fire anyone in Spain who is not a temporary worker (and most of those workers are under 30, which helps to explain youth unemployment).
All of this austerity and reform would have to happen under the assumption that these economies can grow and increase their competitiveness at the same time, a controversial notion that makes economists like Paul Krugman scream with indignation. The truth is doubtless more nuanced. The best route to improved competitiveness is to streamline the public sector and overhaul the markets for labor and services, but doing so entails rewriting Europe’s social contract. Remember what happened last time Europe had to endure an extended age of austerity in the 1930s? Not a comforting thought.
Thus, if the European Union manages to save itself from dissolution, it will have to construct a humane set of rules and policies that will avert a potential revolution by crisis-weary citizens. The hard work has not even started yet.