The global financial system is currently being roiled by one thing and one thing only: the fate of Europe. This past weekend, high-level meetings of both the International Monetary Fund and the G20 nations took place in Washington, and the predominant focus was on Europe and whether the nations of the European Union and the euro zone would be able to stave off what increasingly appears to be a make-or-break crisis over banks, the sovereign debt of Greece, and the stability of the international financial system.
The markets—save for a rally on Monday—have been placing their bet, and it is a decisive no. For a change, this isn’t about the United States, or the size of the American national debt, or for that matter about Obama and the Tea Party. It is about Europe (and for all those who believe that the entire global financial system hinges on America, sorry, this one really is about Europe and its implications for the cost of mortgages in Eureka and small-business loans in Athens, Ohio).
The assumption in finance land is that Greece will default on its debts, and that will then trigger a financial crisis to rival, if not surpass, what happened three years ago. Mavens such as George Soros have predicted as much. But while the risk is undeniable, it is just that—a risk. It would be foolish to ignore, but as the panic spreads, it is increasingly clear that it is just as foolish to assume that all this is a done deal and that incalculable pain lies ahead. Contrary to what many are now predicting, Europe—reeling though it is—will not implode.
The fear is that the European Union as constituted doesn’t have the ability to move quickly enough. It isn’t the size of Greek debt per se, but the fear that the hundreds of billions of dollars potentially exposed will so undermine European banks that the whole system—and that means the entire global banking system—might be imperiled. With so many actions dependent on each of the legislative branches of the 17 euro-zone countries, there is a viable concern that real-world events will move far more rapidly than the political institutions can respond. A Greek default on debts would then trigger various runs on French and German banks, which would then lead to massive selling of any liquid assets anywhere—and stocks above all—which would then cascade around the globe in a fashion not unlike what happened after Lehman Brothers collapsed three years ago this month.
The same constraints against rapid joint action existed three years ago, of course, but then the European Central Bank as well as Germany, France, and the United Kingdom (not a part of the euro zone, but vital nonetheless) reacted aggressively in the wake of the collapse of financial markets. Today, the fear is not so much that these countries separately and jointly couldn’t respond to a major meltdown than that they can’t respond to anything less than a major meltdown—thereby making the odds of a major meltdown uncomfortably greater.
Memory plays its own tricks, and comparing sentiment across the years is devilishly difficult. Yet in the insular world of finance, the sense of dread and negativity certainly rivals the worst days of three years ago. The widely shared belief is that the United States is either in or on the verge of a recession; that China is slowing precipitously based on weakening exports, imploding urban real-estate bubbles and slack consumer demand; and that Europe is on the verge of an unraveling as historic as the forces that brought it together 20 years ago when the European Union was formed.
So the question is, will Europe implode? Contrary to the widespread assumption, I think not.
It isn’t just that Angela Merkel, Germany’s answer to Margaret Thatcher, has drawn what for her is an unequivocal line that Greece will not leave the European Union or the euro zone. It’s that slowly, sloppily, the governments of Europe are awakening to the realization that since they have tethered their collective economic fate to each other, the costs of unraveling are so immense as to be untenable. No government feels comfortable demanding more funds to bail out Greece or shore up banks or create a backstop for the tenuous finances of Italy. But each government understands at some animalistic level that no electorate will celebrate the consequences of doing too little. Even those supposedly dour, disapproving burghers of Düsseldorf who are tired of bailing out what they see as profligate Greeks would blanch at the market consequences of the end of the euro. Germany doesn’t just pay to maintain that union; it benefits mightily as well.
There is no way to prove that the officials of the EU will access their better angels at the last moment (however auspiciously named the German chancellor is). But this crisis is shaping up as the European version of the American debt-ceiling debate: messy, disheartening, but when pushed to stare at the alternatives, deeply clarifying.
Hence the lurch in the past days toward a more explicit, aggressive response, ranging from a more robust stabilization fund, to plans and statements from German Finance Minister Wolfgang Schaeuble to new IMF head Christine Lagarde that suggest at the least a recognition that this won’t magically resolve itself. Yes, the German minister has to speak cautiously, ahead of an important vote on bailout money on Thursday, and yes, Lagarde has been a study in rhetorical excess, but still, no one is in denial and most now recognize what is at stake.
The sense of dread and negativity certainly rivals the worst days of three years ago.
The European Union remains a bold experiment: can multiple nations cede increasing degrees of sovereignty to a new entity in return for more security—both economic and political? The answer until a few years ago was a resounding yes, but that was in the absence of crisis. To expect the resolution to be easy is foolish, but to assume that dissolution is the inevitable outcome after generations have fought and striven—that, too, is foolish. The formation of the union was never widely or easily digested, but neither was the carving together of the United States in the early to mid-19th century.
The risk remains that globally, because of Europe, we are on a precipice and will fall. That needs to be factored into any near-term decision about money, business, and economic outlook. But the costs of dissolution are prohibitive, for Europe and for the world. China, Brazil, India, the new creditor nations of the world, have begun the unthinkable conversation about bailing out Europe if Europe will not bail out itself: an unlikely event but indicative of how serious this is. In the end, it is those costs for Germany, for France, and for the entire euro zone that should act as a bulwark against the worst-case scenario.