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Rex Nutting
Dec. 8, 2010, 12:01 a.m. EST
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By Rex Nutting, MarketWatch
BRUSSELS (MarketWatch) "” Just about every day, we hear another argument that Europe's grand experiment with economic union will end in failure, if not this year, then very soon.
Despite desperate measures to rescue Greece and Ireland, the powerful forces pulling Europe apart will prevail, these critics say.
The euro and the European Union are dead in their current form, or so the theory goes. The common currency and the economic and political union cannot survive if some of its members are zombies.
Ireland's Finance Minister, Brian Lenihan, explains the dire necessity of budget cuts during an economic crisis that has hit the country and the European Union at large.
Official Europe begs to differ. The European Union, and its single currency, will come out of the crisis stronger than ever, Europe's leaders insist. Extensive discussions with mid- and top-level leaders in Brussels and Frankfurt indicate a strong commitment to a unified Europe. There is no turning back.
"We shall never surrender" is the motto they've adopted from Winston Churchill. Indeed, these leaders recognize that the current crisis is the most dangerous threat to a united Europe since World War II. Remember, the Cold War and the subsequent collapse of the Eastern Bloc, drove the European nations together; the sovereign debt crisis threatens to drive them apart.
But the markets sense weakness, vulnerabilities, divisions within Europe. The leaders of the 27 nations may want unification, but will the people of Europe be willing to pay the price of higher taxes, fewer services and reduced sovereignty? Unification may mean less freedom, the freedom to keep their culture, the freedom to use an appropriate fiscal policy for local circumstances, and also the freedom to be irresponsible.
No one knows what the public will do. There have been mass protests of proposed spending cuts throughout Europe, but governments have held firm. The Greeks are more or less going along. The Irish Parliament is voting on another austerity budget, designed to meet the demands of the EU and the International Monetary Fund. The government will likely fall after the vote. The opposition has rejected the demands of the outsiders, but things may look different when it is in power. Read more about the Irish vote.
Usually, if you owe more than you can possibly repay, you go through bankruptcy, negotiating with your creditors to restructure your loans, or if that doesn't work, defaulting on them. Sovereign governments that have their own currency can print their way out of the hole by inflating and devaluing. Those avenues have been blocked for those who belong to the euro zone.
Iceland took the path of bankruptcy. In Iceland, as in Ireland and Spain, it wasn't profligate government spending that created the problems; it was the credit bubble in the private sector and bad debts in the banking system. Unlike Dublin, Iceland's people refused to take on the banks' bad debts. Instead, the tiny nation devalued its currency after its banks failed, and it appears to be recovering faster than Ireland.
Why wouldn't the Irish gladly rid themselves of both the euro and their continental masters and return to a devalued Irish pound, following Iceland's example? "They have too many hooks in us," according to an Irish journalist I met at the European Central Bank in Frankfurt.
Officials in Brussels and Frankfurt are counting on those hooks to keep Europe together. After 60 years of increasingly tighter bonds, the core nations of Europe are tied together in a thousand ways. The costs of staying may be high, but the costs of leaving are far greater, as the Irish have discovered. In the longer run, the rewards of unification outweigh the burdens.
It is not only the periphery nations who must pay for further European integration. Germany's export machine could suffer if the euro gets its house in order.
In addition, Germany, France and all the others must also reduce their budget deficits under guidelines being established in Brussels by the European Union. Of course, such fiscal guidelines already exist, but they have no teeth. Brussels intends to provide the teeth and make sure that they bite automatically whenever the rules are broken. In the future, even Berlin must bow to Brussels.
The response by the EU and the European Central Bank to the sovereign debt crisis has often disappointed the markets, who look for bolder and quicker actions. Spreads between yields on Greek bonds and German bonds remain wide, signaling that investors still perceive an elevated risk of default. The same is true for Portuguese and Spanish debt.
European officials would like those spreads to narrow, but not too quickly. If the spreads were to come down suddenly, the crisis would be over and the outside pressures on the national governments to control their budgets would be lost. Leaders such as Jean-Claude Trichet of the European Central Bank pray the crisis will not ease until the new fiscal surveillance and enforcement structures are fully agreed to.
And once those measures are put in place, full economic and political integration would be inevitable.
Borrowing another adage, this time from America, official Europe thinks "you never want a serious crisis to go to waste."
Rex Nutting is international commentary editor and a Washington-based columnist for MarketWatch.
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