A growing sense of anxiety has begun to simmer in the eurozone as the year’s dramatic events put the single currency in an increasingly precarious position. Earlier this month, Silvio Berlusconi’s announcement that he would step down and allow technocrats to try to salvage the Italian economy seemed extraordinary. Now, however, pundits are looking fondly at the days when they could bite their nails over the collapse of individual countries as the euro itself appears to be in mortal danger.
Many are predicting that massive defaults, disintegration, recession, and austerity willcause economic havoc in Europe if dramatic action is not undertaken quickly. Growing fears of catastrophe have caused a run on beleaguered banks and governments, raising Spanish and Italian bond prices to unsustainable levels and even beginning to affect once-invincible German bonds. The OECD now forecasts the eurozone entering recession, shrinking by as much as a full percentage point in the fourth quarter. This has the potential to cause a devastating, self-reinforcing cycle. As investors dump European bonds, governments have to impose strict austerity measures to remain solvent. Making its fiscal situation worse and spooking investors, these measures exacerbate economic contraction at a time when the eurozone is already entering recession, only to start the cycle all over again.
Dramatic action by the European Central Bank (ECB) and Germany is necessary if disaster is to be avoided. The ECB needs not only to severely loosen monetary policy, but also abandon its conservative demeanor and accept its role as one of the only institutions capable of taking dramatic action to save the euro.
Germany likewise needs to buck up. Although it is the only country with the resources to support troubled-but-solvent neighbors and save the euro, Germany has been squeamish at the prospect of infinitely supporting weaker EU members. This attitude needs to change. Germany, after all, needs its neighbors as much as they need Germany. Germany’s robust, export-driven economy depends on being able to sell exports for euros rather than Deutsche Marks, which would be much stronger, and therefore make German exports relatively more expensive and less competitive. UBS recently estimated that Germany breaking away from the euro would cost some 20 to 25 percent of its GDP, far greater than the cost of supporting the rest. Unless Germany bites the bullet and takes dramatic action soon, Europe and the world may be stuck in an economic quagmire for decades to come.Tweet