Protesters demonstrate against spending cuts in Madrid: Spain's economy, the EU's fourth largest, is in increasingly dire straits.

REUTERS/Andrea Comas

he European Union might soon find itself in the hairiest stretch of its seemingly endless debt crisis. Spain's borrowing costs are shooting up to heights that are dangerously close to bailout levels, and as the continent's fourth-largest economy, it is "too big to fail — or to rescue," says Robert Zoellick, the outgoing head of the World Bank. Many critics are wondering how EU officials, led by German Chancellor Angela Merkel, allowed the crisis to reach this point, particularly after the European Central Bank (ECB) gave policymakers ample breathing room late last year by flooding the market with more than $1 trillion in loans. Are Europe's leaders — alternately attacked both for their aggressiveness and timidity — only making things worse?

Yes. Europe is destroying itself: EU leaders seem determined "to commit economic suicide for the continent as a whole," says Paul Krugman at The New York Times. Spain's borrowing costs are climbing because it's in a deep depression, and yet the political class continues to demand harsh austerity measures to cut deficits, which will only make the depression worse. "This is, not to mince words, just insane." The ECB must be allowed more freedom to intervene in markets, and countries must be allowed to spend their way out of economic slowdowns. Otherwise, Europe will go "off a cliff. And the whole world will pay the price."
"Europe's economic suicide"

The central bank will act if politicians don't: "The idea that the ECB can now sit back and let the politicians do the rest is surely deluded," says Jeremy Warner at Britain's The Telegraph. Eventually the ECB will be forced to follow the U.S. Federal Reserve in implementing "full scale quantitative easing," in which the central bank buys up government bonds directly to keep their yields down. Germany will resist because it's paranoid about inflation, but "monetary policy has to be run for the benefit of Europe in aggregate, not just the Rhineland and her dominions."
"Only a matter of time before ECB is forced into massive quantitative easing"

But the central bank might make things worse: Further intervention by the ECB "could lay the foundations for the next crisis," says Francesco Guerrera at The Wall Street Journal. The ECB's $1 trillion in loans was meant to encourage private banks to buy Spanish bonds, and the plan succeeded. But now those banks are saddled with bonds that could soon plunge in value, leaving Europe vulnerable to a "devastating domino effect." The risk of any government intervention in financial markets is the spread of "largely undetected and unknown risks within the system."
"Sowing seeds of the next major crisis"