I have been examining and re-examining the situation, trying to find the potential happy ending. It isn’t there. The euro zone is in a death spiral. Markets are abandoning the periphery, including Italy, which is the world’s eighth largest economy and third largest bond market. This is triggering margin calls and leading banks to pull credit from the European market. This, in turn, is damaging the European economy, which is already being squeezed by the austerity programmes adopted in every large euro-zone economy. A weakening economy will damage revenues, undermining efforts at fiscal consolidation, further driving away investors and potentially triggering more austerity. The cycle will continue until something breaks. Eventually, one economy or another will face a true bank run and severe capital flight and will be forced to adopt capital controls. At that point, it will effectively be out of the euro area. What happens next isn’t clear, but it’s unlikely to be pretty.
It is depressing that politicians around the world have put so much effort (and money) into trying to stabilize the global economy all through the complex aftermath of the subprime crisis, and that they have not managed to do so yet. Certainly, Europe’s problems have additional causes, over and above those linked to the previous credit crunch. These include the domestic politics of countries like Greece, as well as the political and monetary design of the European Union and the Euro.
It’s impossible to predict exactly what will happen, but I very much hope the European Union is able to keep together. While there are many practical challenges associated with the project of European integration, it seems like a very positive undertaking from a human perspective. The European Union embodies the recognition that nation-states are too small to deal with the world’s problems and they need to find ambitious and effective ways of working together. That is especially true now, when economic factors threaten to undermine the whole enterprise.
Previously: Sovereign debt crises in the EU