Issue of the week: Crackup in the eurozone

last updated 8 January 2015

“Something, somewhere has to give,” said Gavyn Davies in FT.com. The eurozone—the alliance of 16 nations whose common currency is the euro—is in deep crisis this week, with its weakest members “forced to choose between a massive fiscal retrenchment and leaving the monetary union.” The crisis began last May, when Greece agreed to draconian budget cuts in return for a $106 billion bailout from the European Central Bank, supplemented by $39 billion from the International Monetary Fund. But a flashpoint was reached last weekend when Ireland accepted an $89 billion bailout to avoid defaulting on its bonds. That bailout was intended to stabilize the euro and shore up the bonds of struggling Portugal and Spain as well as Ireland. Instead, the euro plunged and interest rates on suspect bonds skyrocketed, as investors concluded that, yes, a European government really might default.

Blame Germany, said Ambrose Evans-Pritchard in the London Telegraph. German Chancellor Angela Merkel, whose government exerts enormous influence as the biggest contributor to the ECB, insisted that in return for a bailout, Ireland must endure “hair-shirt austerity” in the form of sharp budget cuts and tax hikes. The result? Ireland’s “tax revenues have collapsed,” and now its economy can’t generate sufficient growth to service its debt. Germany’s actions were “shallow, paltry, and mean-spirited,” said Roger Cohen in NYTimes.com. This week, amid mounting worries about Ireland, Merkel announced that come 2013, investors holding bonds of ailing eurozone countries will have to accept a “haircut”—a loss of principal—in the event of future bailouts. Investors immediately dumped the bonds of Spain, which borrows heavily to cover its budget deficits. It’s ironic: Twenty years ago, in forming the eurozone, Germany acknowledged its stake in Europe’s “united future.” Now, Germany appears all too eager to help the alliance unravel.

“It’s as if Germany had decided that southern Europe was a burden” it wanted to escape, said José-Ignacio Torreblanca in the Financial Times. What a change from the alliance’s early days, when Germany encouraged Spain, Portugal, Greece, and others at the periphery of the zone to grow faster than the countries at the core—Germany and France. That “virtuous circle of growth” hastened Europe’s economic integration. Now, though, Germany is courting China and Russia as trading partners, and turning its back on Europe. Big mistake. “In a century dominated by Asia, no European country will be able to make it on its own.” A “weaker Europe” will also mean “a weaker Germany.”