No wonder a colleague of mine asked this morning: Why doesn’t Europe work like it did twenty years ago? How come it seems to be in constant crisis these days? The short answer is that, back then, the E.U. was a lot smaller than it is now, and it didn’t have a single currency. In 1993, there were just twelve members of what was then called the European Community, and, except for Greece, all of them were in Western Europe. Today, the E.U. stretches from the Atlantic to the Black Sea, and it contains twenty-seven countries, many of them very different from one another. Seventeen nations share the same currency, the euro, and one of them, unfortunately, is Cyprus.
While there are lots of causes of Europe’s debt crisis—irresponsible lending, inadequate regulation, a big real-estate bubble that eventually popped—the underlying one is that attempting to combine seventeen heterogeneous nations within one currency zone is an inherently challenging and dangerous venture. It creates problems for individual countries, which can no longer determine their own economic policies, and it ties the fate of the entire zone to what happens in small, peripheral places, such as Greece, Ireland, and, now, Cyprus.
If the E.U. hadn’t allowed Cyprus to adopt the euro in 2008, nobody except Cypriots and some rich Russians, who use the island as an offshore financial haven, would care much about the fate of its rickety banks. With a population of less than a million (there’s another three hundred thousand people living in Northern Cyprus, a Turkish enclave that considers itself an independent state), and an economy that accounts for less than half of one per cent of overall E.U. output, Cyprus is a mere speck in the Mediterranean. But because it’s part of the euro zone, what happens there could spill over into much larger and more significant countries, such as Spain and Italy, which are already struggling to overcome serious problems.
The Cyprus bailout, which was worked out in hastily-arranged talks in Brussels late last week, is necessary because many of the island’s banks are in terrible shape, and its economy has suffered badly from the troubles of neighboring Greece, its largest export market. Before the rescue was announced, there was legitimate concern that allowing the Cypriot banks to collapse might cause a run on troubled banks in Rome, Milan, and Madrid, as depositors and lenders in these places fretted that their institutions, too, would be allowed to fail. After the terms of the bailout were announced, the fears of contagion didn’t go away: they intensified. For the first time since the crisis began, back in 2010, the European authorities (together with the International Monetary Fund) had forced individual bank depositors to bear some of the costs of cleaning up the mess. While this sounded like a good idea to politicians in places like Holland and Germany, which have borne much of the cost of the bailouts, it appeared to raise the prospect of depositors in Spain and Italy being forced to swallow similar losses, thus giving them an incentive to get their money out now. On such logic, bank runs are constructed.
Most observers now agree that the E.U. and the I.M.F. made a disastrous error. Still, the idea of asking bank depositors to contribute something to the ten-billion-euro bailout wasn’t wholly insane. Most of the rescue money was being directed at Cypriot banks. In Europe, as in the United States, there is now widespread public opposition to bailing out financial institutions without asking their stakeholders—shareholders and bondholders—to take a hit. The problem facing the designers of the bailout was that Cypriot banks don’t issue many bonds—almost all the money they lend comes from deposits, many of which originate overseas. As a result, hitting up the depositors was the only way to raise a decent-sized financial contribution from the banks and those associated with them.
Ultimately, though, as a columnist at the Economist pointed out, the terms of the bailout were “unfair, short-sighted, and self-defeating.” In punishing middle-income Cypriots as well as rich foreigners, the bailout inspired a political backlash that risks re-igniting the euro crisis at a moment when the greatest danger appeared to have passed. Since early last year, when Mario Draghi, the Italian-born chairman of the European Central Bank, pledged to do whatever was necessary to save the euro, fears of all-out collapse have receded. Under Draghi’s leadership, and over the objections of Germany’s central bank, the E.C.B. has lent money to troubled commercial banks hand over fist (just like the Fed did during the U.S. financial crisis) and it has pledged to make unlimited purchases of sovereign debt from countries like Spain and Italy should such actions prove necessary. As a result of these measures, the yields on Spanish and Italian bonds have fallen substantially. But in the past couple of days, they’ve risen again, and local stock markets have fallen sharply—a sell-off that is likely to intensify on Wednesday morning.
After all Europe has been through in the past three years, I doubt very much that its leaders will allow tiny Cyprus to bring the whole thing crashing down. By rejecting the terms of the bailout, the Cypriot parliamentarians have effectively called the bluff of Germany, Europe’s dominant power, which insisted on imposing harsh terms. Now, Angela Merkel, the German chancellor, needs to step in. During the coming days, she or her representatives will have to broker a compromise that prevents the banks in Cyprus from collapsing, reduces the levies on deposits (particularly for small savers), and elicits contributions toward the cost of the bailout in other ways—quite likely ones that punish offshore depositors, the Russians included, even more. In the meantime, there may well be more drama, and more turbulence in the markets.
In Europe, as in the United States, that’s how things work these days. Absent a blow-up in the markets, nothing much gets done. When the markets are calm, as they have been this year, the politicians slip off the leash and respond to their own constituencies. In Germany in particular, that means balking at handing over more money to southern Europeans, whom many Germans consider shiftless, and to countries that have turned their banks into parking garages for the capital of rich Russians, whom Germans see as tax evaders. Cypriot protestors are holding up signs calling Merkel a bank robber. To many residents of Bavaria and Rhineland-Westphalia, she is merely being responsible.
As I said, I think they’ll eventually sort it out; they usually do. Ever since the euro was created, in 1999, skeptics in the United States and Britain have been predicting its demise. For all Europe’s troubles, the currency is still going strong. (On Tuesday, it was worth about $1.29, about twenty per cent more than its value ten years ago.) But that doesn’t mean Europe is working well. It isn’t. For more than four years now, its economy has been languishing badly. In the fourth quarter of 2012, the output of the euro zone fell at an annual rate of 0.6 per cent, and it might well drop again in the first quarter of this year.
With some countries, such as Italy, Portugal, and Spain, trapped in depression-style slumps, the entire continent is calling out for a stimulus package of the sort the Obama Administration introduced in 2009. Without an injection of demand, there is no prospect of the most stricken regions rebounding of their own accord. But despite the fact that even the mighty German economy is now contracting, Merkel is still refusing to countenance a stimulus. With a parliamentary election scheduled for September, she’s more interested in portraying herself as a prudent Prussian housewife than a Keynesian savior.
That complicates things. The euro zone won’t survive an indefinite economic malaise—no political settlement could. Assuming it scrapes through the current crisis, and there’s really no reason it shouldn’t, its fate hinges much more on events in Germany than on what happens in places like Cyprus and Greece. In such an unwieldy multi-national structure, strong leadership is desperately needed. In the past couple of years, Draghi has shown some, and so, on occasion, has Merkel. But she needs to do more—a lot more.
Original Article
Source: newyorker.com
Author: John Cassidy
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