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07.21.11

Why Europe’s Crisis Matters

European leaders are gathering for an emergency summit in Brussels today to deal with their financial crisis. Stefan Theil writes that the situation could affect the U.S.

First there was the subprime meltdown. Then the crisis infected banks and housing. Now it’s threatening to break apart the most powerful economic bloc in the world: the European Union, home to 500 million people. Because of the global shock waves, America’s feeble recovery depends on whether European presidents and prime ministers meeting in Brussels today get their escalating crisis under control.

For more than a year now, little Greece has been insolvent after its politicians recklessly piled up $467 billion in debt. Instead of letting Greece go bust, the rest of Europe bailed it out—and with it Europe’s banks, which had just as recklessly stuffed their books with Greek government bonds. But the problem didn’t go away. Since then, similar bailouts of Ireland and Portugal have followed. Over the last two weeks, things took a drastic turn for the worse when Italy and Spain, much larger but similar high-debt economies, started shaking too. Despite bailouts totaling some $2.1 trillion so far, there is no end to this crisis in sight.

Here’s why it matters:

For one thing, part of the bill for Europe’s bailout might come due to American taxpayers, adding to America’s own debt problem. That’s because $398 billion of the total European bailout came from the Washington-based International Monetary Fund, where the U.S. is a member and usually contributes 17 percent of the funds. If the IMF can’t recover its loans, the taxpayer is stuck with the bill.

Second, if vacillating European leaders can’t keep the crisis from spreading—and so far, they’ve let it get successively worse—they’ll risk another freeze in the financial markets, comparable to what the world saw during the 2008 financial crisis. Just as that crisis quickly turned global, a crisis hitting Europe’s biggest banks will hardly leave America unaffected, for the simple reason that American banks and financial companies are deeply invested in Europe.

Third, the last thing a debt-addicted America needs is fresh proof from Europe of how incapable Western countries are of curbing their addiction to debt. Never in economic history have debt levels—public and private—in the Western world been anywhere near this high, as a Deutsche Bank report warned again last week. We are in uncharted territory, which makes it doubly frightening if Europe doesn’t get its crisis under control.

Fourth, a weak and imploding Europe now would mean you can kiss America’s feeble recovery goodbye. A prosperous Europe is good for everybody, including America, whose companies can sell more of their products to Europe.

A weak and imploding Europe now would mean you can kiss America’s feeble recovery goodbye.

But don’t expect the crisis to end any time soon. German Chancellor Angela Merkel went into the summit warning not to expect any “silver bullet.” Last year, the crisis might have been resolved by letting Greece default on some of its debt and shoring up those Greek, French, and German banks most affected. That might sound bad, but writing off debt that can never be repaid ultimately costs less money than dragging a crisis along and letting it fester. The primary example is Japan, where dithering bankers and politicians tried to cover up a debt crisis in the 1990s, plunging the country into almost two decades of deflation and recession.

Now, with the crisis fast spreading to other countries, it’s gotten much more complicated. Even if the debt crisis were to magically disappear overnight, the chances for uncompetitive countries like Greece to survive without the messy process of exiting the euro zone are getting smaller. The danger is that things are now moving too fast for Europe’s slow-moving leaders.