Foreign Policy: Europe Is Messier Than It Seems
David Gordon is head of research at Eurasia Group and former director of policy planning at the U.S. State Department.
Douglas Rediker is a senior fellow at the New America Foundation and a former member of the International Monetary Fund's executive board.
"The Euro Is Heading for a Crackup."
Don't bet on it. Sure, things look bad. The crisis, well into its third year, has forced Greece, Ireland, Portugal, Spain, and now Cyprus into various forms of international financial rescue programs, and it shows no signs of abating. After two years of denial and half-measures, market participants have little faith in the ability of Europe's policymakers to reach a solution. Spanish bond yields are frighteningly wide and those of Italy, the continent's most prolific borrower, are following closely behind. This summer's announcement a fuzzy-at-best plan to recapitalize Spanish banks and create new mechanisms to channel pan-European resources to Europe's stricken financial sector relieved market pressure for all of a few hours. Perhaps most alarmingly, no one seems to have a plan, with British Prime Minister David Cameron warning that the eurozone must either "make up or break up" — with the implicit threat that the latter is increasingly likely.
But before writing the euro's obituary, let's remember: The driving force behind a European currency union was never purely or even principally financial. It was political — and these binding forces remain strong. After centuries of bloodshed on the continent culminating in the last century's two world wars, the European Union (EU) and ultimately the euro arose from a deep-seated desire to abolish the risk of state-to-state conflict. A slide back to nationalism is a constant fear in the minds of European political leaders and peoples. And so, in spite of growing concerns about the benefits of sharing a single currency across 17 countries, member states and their publics remain highly supportive of the European project and the euro. While the crisis has caused this support to decline a bit, studies consistently show that Germans, French, and Spaniards favor remaining in the euro. Even upwards of 70 percent of Greeks, who are in their fifth year of recession and looking forward to a decade of grinding austerity, claim that they want to stay in the currency union. They may not get their wish (boundless hope can overcome an awful lot, but not the cold mathematics of Greece's debt burden) but their robust support illustrates the basic fact that the political will to maintain the euro remains strong.
It's true that Europe doesn't yet have a comprehensive plan to balance sensitive and increasingly difficult issues of national sovereignty, financial resources, and disparate economic models and strength among eurozone members. It's also true that this marks a decisive break from the post-World War II trajectory of European integration, which was built on grand visions both successful (the common market and common currency) and less so (the Lisbon Treaty that set the foundation for today's host of supranational European political institutions).
What Europe does have, though, beyond sheer will, is a process, however tortured and painful it may look to those on the outside, to ensure that the euro and the EU hold together. The political and economic costs of a eurozone implosion remain too high and the benefits of maintaining the common currency too real for the countries involved, as self-defeating as they appear at times, to allow a crack up. Europe will likely make steady, halting, and at times apparently counterproductive steps toward a banking union, limited fiscal federalism, and a path to political union. The path from here to there won't be smooth, just as the past two years haven't been — but it will likely be enough to keep the currency union.
To be clear: We could very well be heading for a deep crisis, and we might even see the exit of one or more member states, with Greece the most likely. But other peripherals won't see a Greek exit as a signal to leave themselves; in fact, measures taken as a consequence may well strengthen their own prospects within the currency union. The likelihood of the eurozone imploding and the reintroduction of national currencies across a broad swath of Europe thus remains exceptionally small.
"It's All Greece's Fault."
Nope. Greece definitely shares a great deal of blame for Europe's current predicament (and, of course, its own). Athens lied about its budget and finances to get into the euro back in 1999, lied about them to stay in the euro in the decade since, and continues to bob and weave as it pretends to comply with the terms of its bailouts, agreeing to absurdly high projections for anticipated growth rates, tax revenues, and privatization revenues. Greece took Europe for a ride, and now both are paying the price.
But Greece's seemingly miraculous overnight transformation from profligate to responsible required willful blindness from European authorities. And the reason that dissimulation was even available to Greece in the first place lay in the faulty construction of the euro itself, in which all eurozone sovereign risk was made to be a thing of the past.
In the pre-euro 1990s, markets widely and correctly assessed Greece as a poor credit risk. As a result, Athens was able to borrow only infrequently, and had to pay high rates to do so. Over the years, when Greece had problems paying back its highly priced debt, it defaulted, devalued, borrowed more, and the cycle continued.
Joining the common currency was assumed to eliminate both Greece's credit risk (that it wouldn't pay back its creditors) and currency risk (that it would pay them back in a different currency worth far less than the one in which they borrowed). These may have been noble aims, but the economic logic rested on assumptions that were faulty at best. Milton Friedman cited these flaws, among others, when he predicted that the euro would be lucky to survive the decade. As he and others warned at the time and is all too apparent now, adopting the euro didn't magically transform countries like Greece into paragons of financial probity. Yet European banks took the elimination of sovereign credit risk at face value and lent Greece huge sums at historically low interest rates, comfortable in the knowledge that the European Central Bank (ECB) would provide virtually instant liquidity for newly issued Greek bonds, so that the lenders could start the whole process again shortly thereafter. And not only did the process continue, but it grew over a decade until the amounts involved became unsustainable, and the crisis as we now know it hit.
The flow of cheap funds was supposed to lead to investment and commerce in Greece and other "peripheral" European countries, which would eventually lead to an economic convergence with the eurozone core. When Greece borrowed money by the truckload, it was doing precisely what the eurozone architects and the ECB intended. Greece undeniably spent its windfall poorly — taking few steps to fix systemic problems like tax evasion, corruption, and public sector bloat. But the only reason it had money to spend so poorly was due to the overly optimistic (and at times inherently delusional) assumptions that underlay the common currency system. Polonius had it right: "neither a borrower nor a lender be." In Europe, both parties share the blame for ignoring that advice.
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