The European Muddle

Like many great issues of the day, the euro mess is difficult to conceptualize.  Why not take a stab at it, though, since it’s something that could cause the US economy to collapse?

Here are links to a few graphics encapsulating different aspects of the European problem.  A few insights can be gained by interpreting them with our own 2008 financial crisis as a point of comparison.

The European Union faces at least two complex interrelated problems.  The first has to do with the condition of banks; the second has to do with the indebtedness of member countries.  There is also a third problem, which is more political.  It has to do with the structure of the EU itself and the poor tools it has for redressing “state-level” problems (critical weaknesses within member-nations like Greece and Spain) that threaten the euro’s value and stability.

Credit imbalances within the euro zone
The integration of nations within the eurozone encouraged capital flows within the community, while creating imbalances that threaten it, should the banks within one of the weaker countries fail.

This wonderful set of graphs published by the New York Times shows the interrelation among creditors and borrowers by country.  Done in late 2011, the graphs offer a general idea of how the stronger European economies—France’s in particular—would be affected if the banks of Greece and Italy were to go down.  French banks have many loans outstanding there and would incur grave losses, possibly fatal ones, were their weaker counterparts to fold.

Unlike in the US, the euro-zone lacks a mechanism like the Federal Reserve, which capably intervenes to stabilize and close or sell ailing US banks if necessary.  In 2008, the Treasury and Federal Reserve averted a general financial meltdown in the US this way.  They intervened directly in the affairs of troubled banks in the interest of keeping the whole banking system operating.  The panic of failing banks was mitigated;  otherwise, it would have spread like a contagion.  Our banking system was supported, and the problem was treated as a matter quite separate from that of the federal government’s own indebtedness or patterns of borrowing.

Until recently, the European Union could not behave similarly: it could not act to help banks, it could only give money to sovereignties.  On June 28th, however, the EU’s member-nations agreed to begin lending money to banks directly, a measure that untethers these two problems and allows a more flexible approach aimed specifically helping banks that might fail.  Nonetheless, it remains to be seen whether this will be much help, as the level of capital needed to stabilize the banks is very large.

Rising sovereign debt
Which leaves the other big problem: the rampant government spending in many EU countries, illustrated in this set of maps, also published by the New York Times.  The maps indicate the significant variation in the spending habits of the governments that make up the European Union.  In many of the EU countries, however, including some of the strongest—such as France and Germany—sovereign debt as a portion of GDP has been growing dramatically.  The difficulty of reining in spending and bringing the most profligate governments in line has led to popular unrest as well as political conflict over austerity measures and proposals for stringent fiscal reform.

It’s not clear, though, whether these disproportionately high debt burdens pose a threat to the long-term health of many of the stronger EU countries.  The more that the elements of the crisis can be differentiated and handled pragmatically on a case-by-case basis, the better the prospects for amelioration will be.  This is definitely a case where what’s good for the goose is NOT good for the gander–or in this case, more fitly, for the PIIGS (the acronym for Portugal, Italy, Ireland, Greece, and Spain).  Helping the most distressed banks may at least buy the EU time to address the more politically fractious issue of how to restore fiscal balance—a very different proposition in Greece than it is in France or Germany, and a more sensitive issue still for the euro zone as a whole.

The Sovereign Debt Exposure of the EU’s 10 Strongest Banks
, Forbes.
Paul Taylor, Euro Zone Fragmenting Faster Than the EU Can Act, The Independent (Dublin).