Covering the European sovereign debt and banking crises is an exercise in frustration.
EU leaders know what needs to be done to “fix” the crisis, the problem is that Germany and other countries of the European core refuse to accept that they will be the losers in this scenario. Thus, this is a political game that just keeps going and going.
EU leaders have been more or less successful in kicking the can, and even a grumbling Germany and Finland finally resign themselves to increasing bailout funding or modifications to the EU treaties when it’s clear that existing measures are not enough.
The problem is not that the European core will finally face reality and relent to measures to prevent all-out disaster. The real concern is that by the time they get there, problems festering beneath the surface will have escalated so far that the less painful options will no longer be available.
For example, pressures on Portugal will likely increase over the next year, and most economists agree that it could ultimately have to restructure. Meanwhile, Spain’s economy continues to contract, austerity measures exacerbate the problem, and pressures on Spain’s financial sector multiply as more and more businesses and individuals are unable to pay back their loans.
Spain’s banks would find themselves at the front line of a Portuguese debt restructuring. Without a proper firewall, illiquidity issues will collapse the Spanish financial sector if insolvency doesn’t. Investors will be so concerned that Spanish banks will not be able to stay afloat that they will certainly render them thus.
If Europe could bail out Spain, then this wouldn’t be much of a problem. It may be able to bail out the financial sector, but then concerns are likely to spread to the Italian financial sector, and on to the French financial sector, and so forth. Ultimately, the eurozone will run out of funding to address these problems, and the effects of this crisis would be far worse for Germany, the Netherlands, and Finland than would some inflation or more bailout spending.
And this doesn’t even consider growing social opposition to austerity and recession.
EU leaders have the ability to nip these problems in the bud. But as they drag their feet, the most painless options available to them rapidly disappear. Should they fail to take more activist measures now, they will be forced to accept much more devastating consequences later.