Days of euro reckoning loom in 2011
WASHINGTON--2011 promises to be the year when the European sovereign debt crisis finally comes to a head. Cascading political and financial deadlines in the first third of the year threaten to dramatically accelerate what had heretofore been a slow-motion train wreck. This rapidly unfolding euro calamity is likely to force Germany to assume significantly greater responsibility for Europe’s economic future. And it may require the United States to become more involved with failing European states. Faced with this prospect, both Berlin and Washington should be proactive, not reactive. Europe’s economic woes are profound, deeply seated, and highly contagious. In the 16-member eurozone the government debt-to-GDP ratio rose from 69.8% in 2008 to 79.2% at the end of 2009. (The euro zone now has 17 members, Estonia joined on January 1, 2011.) And, among the 27 members of the European Union, debt increased even more, from 61.8% to 74%. And it is projected to balloon further in years to come. Many economists believe that indebtedness over 60% spells trouble. In 2009, 12 EU member governments had debt ratios higher than 60 percent of GDP, including Greece (126.8 percent), Italy (116.0 percent), Belgium (96.2 percent), and Hungary (78.4 percent). These persistent and growing debt levels have spooked financial markets, which have begun to charge some European governments onerous interest rates to borrow new money or to rollover existing debt. Higher servicing costs have only compounded Europe’s debt problems, forcing first Greece ($146 billion) and then Ireland ($112 billion) to seek bailouts from their fellow EU members and the International Monetary Fund. So far, other governments have been willing to pony up bailout money because their banks hold massive amounts of debt issued by some of Europe’s most vulnerable economies. French banks hold $2 trillion in debt issued by other Europeans and German banks hold $1.8 trillion--amounts equal to about the size of the French economy and nearly two-thirds of the German economy. With German and French banks undercapitalized, they could not stand the shock of a sovereign default or debt restructuring. This dire situation threatens to worsen in early 2011. Both Portugal and Spain need to rollover tens of billions of euros in government debt in the first quarter of this year. In late December, Lisbon was paying 3.5 percentage points more to borrow than was Berlin. And Madrid was paying 2.5 percentage points more. Ominously, Portugal’s borrowing costs have quadrupled in the last year and Spain’s have doubled. Compounding the problem, Portugal has a presidential election in January 23, which is likely to freeze government decision-making until the vote. Soon thereafter, however, Lisbon is likely to face pressure from other EU members to accept a bailout, if only to build a firewall to keep the euro crisis from spreading to Spain. Spanish banks hold $78 billion in Portuguese debt. Ireland then holds a parliamentary election in February or March. Heated rhetoric in the run-up to that vote is likely to raise new doubts about Dublin’s willingness to go through with promised belt-tightening. The opposition Fine Gael and Labor parties are likely to promise voters to renegotiate terms of Ireland’s bailout if they win, forcing the holders of Irish bonds to share the burden of adjustment. Market jitters are almost inevitable. New European bank stress tests could trigger market perturbations as early as February, when the methodology for such examination of the banks’ books is expected to be announced. The new inquiries need to be tough to be credible. But if they are tough, they are likely to paint a bleak picture of many European institutions, creating new anxiety among investors. With the day of reckoning at hand, Germany, the biggest of Europe’s rich countries, will be under pressure to ride to the rescue, much to Germans’ dismay. So far, Berlin has resisted building a larger European bailout war chest or backing issuance of eurobonds that could absorb those issued by beleaguered European governments. But German taxpayers have to realize that they can either pay to help bailout Portugal and Spain or they will pay to bailout their own banks. And it will be cheaper to do so early in 2011, before the crisis spreads to Italy and costs explode. The United States must also accept that its stake in the euro crisis dictates a more active American engagement. Europe is the second largest U.S. trading partner, a significant portion of American corporations’ profits are earned in Europe, and U.S. banks hold $1.4 trillion in European debt. Washington needs to support more IMF involvement in future European bailouts, with more money and more intrusive oversight, back additional swap arrangements between the European Central Bank and the U.S. Federal Reserve, and generally pressure Europe to stem the current crisis before it spreads further by bulking up the European bank bailout fund, by creating eurobonds, and by moving rapidly toward a common European fiscal policy. The euro crisis is entering a new and dangerous phase. 2011 could prove to be annus horribilis if Germany and the United States do not step up to the plate and accept greater responsibility for resolving a crisis that could yet wreak havoc with the transatlantic economy.
Bruce Stokes is a Senior Transatlantic Fellow at the German Marshall Fund in Washington.
The views expressed in GMF publications and commentary are the views of the author alone.