Splitting Up The Eurozone Will Trigger The One Thing Merkel And Sarkozy Want To Avoid

Sarkozy Merkel

Photo: AP

Two preposterous ideas are gaining strength in Europe.The first is that the EU could end up splitting into two directions.

Merkel and Sarkozy should already be aware that such a situation would provoke exactly what they want to avoid: two bond markets.

The Franco-German market would attract most investors, like the German market is doing now, and investors would flee from the remaining national markets.

Soon, losses would be reflected on bank balance sheets and constricted credit would translate into a drop in activity and German and French exports.

That is to say, a continent-wide debacle. Either Europe stays like it is or it splits, something that Merkel herself has pointed out.

The second idea is that popular in some schools of thought, particularly the socialist point of view, is that adjustments can be postponed. Proponents argue that growth alone can pay back debt, and with excessive cutbacks this would be difficult.

Still, if debt financing strategies are not put into place, investors could notice that there is no willingness to pay down debt such that they would continue to flee and a dearth of financing opportunities would ruin them.

This route is now untenable. Thank goodness that the new governments shaping up in Greece, Italy and Spain have this point clear.

Whether they can command authority is another matter altogether. The biggest challenge is whether the principal economies will contract while reforms are happening.

That could feed the downward spiral of liquidity shortages. In that case, it would be necessary that someone help these countries. Yet the EU and IMF do not have enough money to lead the bailout.

This post originally appeared at El Economista.

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