Europe's Grim Choices

Βad ideas, once embraced, become entrenched

By Robert Samuelson

Europe is at the abyss -- again. Its turmoil is rattling global stock markets and stoking fear and bewilderment. The obvious question is, what's the solution? The answer is, there is no solution. Europe faces choices, some bad and others worse. Unfortunately, it's unclear which are which. The best that can be imagined is that Europe lurches from crisis to crisis and that its slumping economy weakens the already fragile global recovery. The worst is a massive flight from the euro and an economic free fall that resurrects the dark days of 2008 and 2009.

Can anyone doubt that the euro's creation in 1999 was a huge blunder? It aimed to promote European prosperity and unity, but it's doing just the opposite. The very belief in its early success reduced interest rates in Europe's periphery (Greece, Portugal, Spain, Ireland, Italy). Low rates fed credit booms and housing bubbles that, once burst, caused recessions and swollen budget deficits.

As for unity -- the political dividend of economic success -- the euro now sows rancor. Germans, Italians, Greeks and the others quarrel over who's to blame and who should bear the cost. The single currency actually hinders economic revival. One way countries cushion austerity -- the spending cuts and tax increases designed to cut budget deficits -- is currency depreciation. This makes their prices more competitive, boosting exports and tourism. But euro countries lack this choice, because they're yoked to the euro. The human costs are immense. Unemployment is 14.2 percent in Ireland, 21.7 percent in Greece and 24.3 percent in Spain. How much suffering can societies tolerate without profound upheaval?

Two events underlie the new euro fears.

The first is Greece's June 17 election, because it might result in the country's quitting the euro. One leading party -- Syriza -- promises to repudiate the austerity agreement with other eurozone countries, the International Monetary Fund and European Central Bank (ECB). If that happened, the loans contingent on austerity would probably stop. Lacking euros to pay its bills, Greece would adopt a national currency that, almost certainly, would lose value against the euro, perhaps 50 percent or more. (Note: Polls show Syriza trailing slightly.)

The second event involves Spain, whose government shored up Bankia, a major lender, with 19 billion euros ($24 billion) to offset loan losses. It's feared that other banks harbor more losses and that these, piled atop existing budget deficits, will so scare investors that Spain would face much higher interest rates. (On 10-year bonds, rates rose a percentage point last week to 6.7 percent.) Spain would need bailing out, a huge task. Its economy is five times larger than Greece's.

Broadly speaking, the 17-member eurozone faces two choices.

One is to defend the euro at all costs. The immediate consequences for Greece -- or other countries -- of leaving the euro would be dire. Some companies, unable to repay euro-denominated debts, would go bankrupt. Inflation would shoot up. Banks might suffer large withdrawals. Worse, if Greece dropped the euro, it might trigger a chain reaction. Depositors in Spain, Italy or Ireland might stage runs on their banks, trying to withdraw euros before they were replaced by less valuable national currencies.

Preserving the single currency could cost trillions of euros, says Douglas Elliott of the Brookings Institution. The ECB might have to guarantee bank deposits or provide vast advances to banks to offset withdrawals. Softening today's austerity would require more borrowing. Who would lend? The ECB? Historically, excessive lending by central banks risks high inflation, though many economists discount that now. What about "eurobonds" -- bonds issued for individual nations but backed by all? This would make Germany, with its strong credit rating, the ultimate guarantor. Naturally, the Germans resist.

The other possibility is to admit that defending the euro is self-defeating, argues economist Desmond Lachman of the American Enterprise Institute. Imposing big spending cuts and tax increases on economies in recession worsens the recessions. Spain is supposed to cut its deficit by more than 3 percent of its economy in 2012, even though retail sales are down 11 percent from year-earlier levels. Budget targets won't be met, he says. The only hope for these countries is to jettison the euro and benefit from a cheaper currency.

Aside from the initial economic costs, the blow to Europe's political cohesion would be enormous. Europeans would debate: Who killed the euro? Germany would be a big loser.

Europe is a fifth of the world economy. Its multinational firms span the globe. What happens in Europe does not stay in Europe but affects markets and confidence everywhere. Europe's slackening export demand already hurts other economies. The great lesson here is that bad ideas, once embraced, become entrenched. The euro was a monstrously bad idea from which there is no easy escape.