Paris – With markets still volatile, and politicians only marginally closer to a solution of the euro’s troubles than they were two years ago, the future for the euro zone remains uncertain at best.
Economists and financial analysts point to a series of land mines that lie ahead.
Growth is slowing, even in Germany, where exports are down and imports are stagnant. A team of experts stalked out of Greece last week to force Athens to live up to its debt-cutting promises as its bills continue to mount. The Italian government is applying fiscal Band-Aids to its deficit instead of surgery, while there is new budgetary pressure on Rome and Madrid, considered too big to bail out.
On Thursday, the Organization for Economic Cooperation and Development provided only the latest gloomy assessment of the prospects for a new recession and a European banking crisis. “The sovereign debt crisis in the euro area could intensify again,” the group said, urging the recapitalization of some European banks and better financial management in the 17-nation euro zone.
And the German finance minister, Wolfgang Schäuble, scolded Athens, warning that European aid would be provided only “if Greece actually does what it agreed to do.”
“The situation is extremely grave,” said Julian Callow, chief European economist for Barclays Capital. “Despite a sharp slowdown in economic activity, especially on the export side, you still have to push governments with large deficits to cut them to levels that are sustainable. That’s the key challenge, and the economic environment is much less favorable now for fiscal consolidation in the euro zone. And the Greek situation is like a ticking bomb.”
But Europe works in incremental steps, driven by crisis and the domestic politics of its nations. Any sweeping solution to the problems of the euro — like an “economic government,” or a pan-European Treasury or Finance Ministry, or collective “euro bonds” — is many months, if not years, away.
Still, most experts agree that Europe’s crisis will persist until it adopts a far tighter fiscal and monetary union, expels weaker economies or divides into two, with different currencies.
“You either go forward to more European economic governance or backward,” said Edwin M. Truman of the Peterson Institute for International Economics. “And if you go backward, you go backward pretty far, to the fragmentation of Europe.”
Mr. Callow said that the mood among European central bankers and German officials, too, was “centralize or die.”
For now, Europe is working on ratifying the changes made to its economic system at a meeting on July 21. To go into effect, even those limited changes must be approved by all euro-zone countries and their parliaments, which may take until mid-October, further unnerving markets.
The hope among experts and economists is that the changes, if carried out with skill, may allow Europe to further isolate Greece and its unsustainable debts from other countries, reducing the risk of contagion and buying time for other countries to fix their budgets and work on how to better centralize control of fiscal policy. Though abstract on the surface, the changes will provide more flexibility to bail out or further restructure Greek debt, to aid Italy and Spain with their bond sales and even to recapitalize some European banks, weakened by their exposure to sovereign debt in the form of Greek, Portuguese, Spanish and Italian bonds.
Changes in the European Financial Stability Facility, which will be expanded to $610 billion of collective financing from the 17 euro-zone states, should also allow it to act as a kind of bank. That would help relieve the European Central Bank from its current role as the buyer of last resort for Italian and Spanish bonds, a decision it reluctantly made to keep down the borrowing costs of those governments and prevent Greece’s problems from infecting the rest of Europe.
The facility itself is already a form of stealth euro bond, in that its obligations are shared by all euro-zone members.
If everything goes well — a big if — that could buy time for the euro-zone nations, under the leadership of the European Union president, Herman Van Rompuy, to draft a new set of institutions, with more oversight and power over national budgets and tax regimes, which would probably be embodied in a new treaty that would need to be ratified only by the 17 members of the euro zone — not by all 27 member states of the European Union.
Such a treaty would probably take years to write, ratify and carry out. Because it would involve a serious ceding of economic sovereignty to a central authority, democratic governments would have to seek the approval of their voters.
Jacob Funk Kirkegaard, a Danish economist also at the Peterson Institute, has been skeptical about Europe’s weak political leadership to handle the euro crisis. But once the stability facility is ratified, he said, he sees the possibility of using it to finally undertake a serious restructuring of unsustainable levels of Greek debt by the end of the year.
The July 21 decisions already sanctioned a partial, if inadequate, restructuring of Greece’s debt despite vows never to do so.
Greece is still running a deficit, even without its huge debt payments, which is one reason why the pressure on Athens has not let up. The problem is not simply that countries like Finland would like collateral before providing any more loans to Greece, but that the Greeks have not fully followed through on their promises.
Their spending cuts have already thrown the economy deeper into recession, leaving Greece even more enmeshed in a so-called debt trap. But if Athens can fix its finances enough to run a notional budget surplus without debt payments, then economists can calculate how much debt it can actually afford to pay, and restructure the rest.
By contrast to Greece, Portugal and Ireland have made significant strides to fix their deficits, Mr. Kirkegaard said, and they have “a fighting chance to make it with the subsidized lending” from the stability facility.
In the past two weeks, under fierce market and European pressure, the Greek, Italian, French and Spanish governments have all moved to cut their budget deficits further, and Spain has passed a “balanced budget” law, as Germany has done and France vows to do.
But the pressure is considerable, especially as anxiety rises about the health of European banks, since they carry so much sovereign debt. The problem is circular: if faith in the solidity and creditworthiness of the sovereigns themselves crumbles, in part because of the need to raise more money to help the banks, then the banks are in real trouble.
And if anxious banks stop lending to one another, that could set off a Lehman-style global crisis, which has caused unease in Washington about the exposure of the American financial system to European debt. While that has not happened, there are plenty of hidden land mines ready to explode at any moment, including a political meltdown in any of the vulnerable countries.
Inaction to fix the banking sector also troubles markets, said Simon Tilford, an economist with the Center for European Reform in London, because it “highlights a willful refusal to recognize the core of the crisis, which is the collapse of economic activity and low economic growth.”
Without growth, he said, there is no easy way forward; growth cannot be produced by austerity or by structural reforms, even if those may help later.