Have we all been underestimating the gravity of the European crisis? That deeply unsettling question threatens to wreck the world’s peace of mind in what could just be a much more turbulent fall than people expect. The American election and much else could be wrenched out of shape by new and much more dangerous developments in the world’s worst man-made policy disaster of the last generation.
Summer was lovely in Europe, and the markets were quiet. But all that is now likely to change. The French call this time of the year the Re-Entry. In August, everybody leaves for the beach or the country. But summer ends quickly in Europe; on the first Monday of September it is 66 degrees (Fahrenheit) in Paris, 73 in Berlin, 64 (and raining) in Milan and 75 in Madrid. And everywhere in Europe, the forecast is for stormy weather ahead.
Basic decisions about Europe’s future were put off during the summer, but there is a sense in many quarters that Europe’s can-kicking days may be coming to an end. American companies are quite openly preparing for an imminent Grexit, as the crisis mavens are calling the potential Greek exit from the euro; as the NYT reports big US companies are developing contingency plans to open drachma-denominated accounts, demanding payment in advance from Greek counterparts and making plans to ship physical cash into the country to pay employees if the banking system crashes. Those fears are heightened by polls showing that only one fourth of Germans support more aid to Greece; the French are no more enthusiastic.
Meanwhile, Spain’s situation continues to deteriorate, with the country visibly spiraling toward some kind of bailout. Any new funding from the ECB will come with much tougher conditions than the easy funding that got Spain (and Europe) through the summer without a meltdown, but Prime Minister Mariano Rajoy is insisting that Spain won’t accept a lot of conditions. Rajoy has big problems at home; not only Spain’s banks but its powerful regional governments look to be seriously in hock. Arguments over regional funding are radioactive in Spain. Powerful independence movements in provinces like Catalonia are ready to use budget tussles to build support for secession. Rajoy must worry that if on the one hand the Spanish government looks to have lost its independence and been forced to obey orders from Brussels and on the other it is squeezing the regions, support for the idea of Spain itself will collapse in significant chunks of the country.
Meanwhile the Italians haven’t really made serious labor market reforms despite solemn promises to do so (surprise, surprise), and former Prime Minister Berlusconi is threatening to blackmail the technocratic government of Mario Monti—a government that depends on Berlusconi allies for parliamentary support. Berlusconi was the only politicians since Mussolini who gave Italy a long period of governmental stability; it’s far from clear that Italy’s fractious political clans and tribes can put together a stable government following Monti’s impending departure. (Elections have to be held by spring as Barbie Latza Nadeau writes in a useful Daily Beast update, and Monti—currently with a 30 percent approval rating in the polls—has said that he won’t try to field a slate of candidates.) The big success story in Italian politics lately is the anti-euro, anti-establishment party headed by comedian Beppe Grillo which surprised everyone with success in local elections earlier this year. Italy is Europe’s third largest economy and the smart money has to be betting that the country is going to be increasingly rudderless for a while and the kind of strong leadership that could push labor market reforms through in the teeth of public opinion looks impossible. Italy won’t reform enough to meet minimum German standards, and it’s going to need money. Lots of it.
But without any doubt, the worst news is coming from France. It’s not that France is headed down the tubes like the PIIGS. Yet. But with a major French bank (Credit Immobilier de France) needing a bailout, unemployment rising above the psychologically crucial 3 million mark, and a stubbornly high budget deficit despite a round of tax hikes and spending cuts, things are not looking good. And as Businessweek reports, bond investors are showing early signs of skittishness. French debt currently earns only about a two percent interest rate; it wouldn’t take much for investors to push those yields above 4 or even 5 percent if perceptions of Europe and France continue to deteriorate. France has benefited from a “safe haven” perception, but that perception looks vulnerable to the autumn storms that now seem to be sweeping toward the EU.
The bad feeling across Europe continues to grow. The north is frustrated with the south; the south thinks the north is hypocritical and unrealistic. The east is disillusioned with the westerners who seemed to be such know it alls back in 1990. The west increasingly thinks expansion was, in some cases at least (Bulgaria, Romania, you know who we are talking about) premature. Most leaders agree that Europe’s problems can’t be solved without some big institutional changes, but that will require some referendums. Nobody wants to take European questions to the voters right now because fed up voters in many countries are itching for a chance to say no.
In other words, Europe can’t work without changes it can’t make.
The ECB so far has papered over the gaps in European unity by printing money. That has prevented the growing problems of sovereign debt and private debt from turning into the kind of financial crisis that rips whole countries apart. But this is a band aid not a cure, and the band aid is getting more expensive. Europe is trading strength for time: it is weakening the institutions and credibility of those who will have to solve the crisis in order to postpone the day of reckoning. This cannot go on forever, and it won’t.
All eyes turn to Berlin under these circumstances, but no solutions seem to be forthcoming. Germany increasingly emphasizes its idea that a true European bailout needs to be accompanied by a serious advance toward European political union. It wants EU organizations to have the ability to veto national budgets and control spending. This seems unrealistic for three reasons. First, there is no sign that public opinion in countries like France supports it. Second, even Germans now tell pollsters they don’t want “more Europe.” Third, if France joins Italy and Spain on the sick list, Germany can’t bail them all out. It’s questionable whether Germany’s own credit ratings and finances could handle a bailout of both Italy and Spain. Add France, the second largest eurozone economy into the mix, and we are way past the tipping point.
In early days, the European crisis looked like something that the Europeans could fix if only they could stop their squabbling and get their act together. This year, as summer turns to fall and the businessmen and journalists of Europe go back to their offices, we may be facing something else: a crisis that Europe cannot solve no matter what it does.
The key indicator: French bond rates. As long as investors aren’t running away from French debt, Europe’s problems look ugly but there is no need to call in a priest for last rites. But a debt panic in France puts us in a new situation. Any little uptick in French interest rates is a cause for worry; any sign of a sustained rise in those rates and it’s time to start edging toward the storm cellar. If France falls, it’s curtains for business as usual.