Europe is trying to deal with the euro crisis one problem at a time. That approach is doomed to fail.
A SYSTEM is only as strong as its weakest point. Reinforcing one link in the chain exposes the vulnerability of the next. The euro zone is now so fragile in so many places that if the single currency is not to break apart, Europe must set about redesigning the system as a whole. The European summit on June 28th and 29th is a test of whether the euro zone's leaders will be capable of that (see Charlemagne). Even though some of the wiser ones are now hatching plans for a banking union and for intervening directly in government-debt markets, the evidence so far is that the task is still, alas, beyond them.
The futility of treating the euro crisis as a series of separate national emergencies was plain for the world to see this week?first in Greece, then in Spain, and finally at the G20. On June 17th Greek voters chose parties that say they will broadly stick by the bail-out agreement (see article). The new government, a coalition of the three parties, headed by Antonis Samaras of New Democracy, vowed that Greece's place in Europe would "not be put in doubt".
It was a rare victory for the euro, but investors' relief lasted only a few hours. That was partly because Greece has so many more weaknesses to overcome. To accomplish anything at all, Mr Samaras will have to put aside a lifetime of rivalry and rise above the politics of patronage. He must persuade ordinary Greeks, battered by austerity, to accept cuts to the minimum wage, pensions and spending, as well as a programme of structural reform that has no parallel in modern Greek history. If he fails, Greece will not qualify for further tranches of rescue money. Even if Greece's official creditors give some leeway, by slightly lowering interest rates or rescheduling debt payments, the threat will remain that Greece will have to leave the euro.
Greece, thus, is trapped. As long as the country is in danger of leaving the euro, growth will continue to shrink, bail-out targets will be missed and politics will drift to extremes. But as long as Greece lacks growth, misses targets and fails in its politics, it will be in danger of leaving the euro.
Spain is now in a similar bind. Earlier this month it secured a pledge of up to ?100 billion ($127 billion) from the euro zone to shore up its banks. But this did nothing to restore confidence. Bad loans in Spain are at an 18-year high: as The Economist went to press, rumours swirled that the latest assessment of the banks' dodgy assets would be well above ?100 billion. And the bill for shoring up the banks is supposed to be paid by the Spanish government, which may not be able to afford it. On June 19th Spain sold 12-month bills with a coupon of over 5%, more than two percentage points higher than a month ago (and, again, not sustainable).
To solve this problem, another fix is proposed. At the G20 summit in Mexico some countries suggested that the euro zone's rescue funds should be used to buy the bonds of governments which, like Spain's, are under attack. The European Stability Mechanism and its forerunner, the European Financial Stability Facility, can exploit a special contingency to spend hundreds of billions of euros trying to put a ceiling on borrowing costs.
Yet again, a new wheeze sparked a market rally. But for how long? Germany, the euro-zone economy that counts, has not signed up to the plan. Even if it does, the funds would be barely enough to save Spain, to say nothing of Italy, which has ?2 trillion of sovereign debt. The inadequacy of the funds available risks being seen as a signal that there are limits to the euro zone's commitments?in other words, an invitation for investors to flee.
Only if the rescue funds were free to borrow unlimited money from the European Central Bank could they credibly stand behind national debts?and there is not yet any sign of that (see article). And even if they had such firepower, the rescue funds' intervention might prove counterproductive if bondholders fear that big purchases by the funds are merely pushing other investors back in the queue of creditors. For the euro zone to find its way through this crisis, intervention in bond markets needs to be combined with a bolder overhaul of the system itself. As we have argued, that means a detailed plan to build a banking union and to mutualise some debt.
That sinking feeling
The reassurances from Berlin are that, at the last hour, Germany will do what it takes. But by sticking to half-measures and emphasising the limits to Germany's ability to help, Chancellor Angela Merkel is sowing doubt and deepening the economic pain. Each quick fix that is hailed as a victory before being swept aside saps the credibility which will be necessary to push through real reforms. This lets politics drift. France's new president, François Hollande, is calling for cross-border help, even as he pursues policies (see article) guaranteed to scare Mrs Merkel's electorate into thinking that Germany is being tricked into paying for other countries' laxity. In Italy Mario Monti is meeting ever more public resistance to his reforms.
In theory all this is manageable. In practice it is hard to see how the euro zone's leaders can reconcile the months of political wrangling ahead with investors' tendency to flight.
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