Tuesday, January 11, 2011

Euro Zone on a Slippery Slope

After taking a break for the holidays, the Euro zone's debt crisis is back in full swing. Portugal is now under pressure to take a bailout. As previously choreographed for Greece and Ireland, the Portuguese government is strenuously resisting the idea, proclaiming that it has more than met its goal this year for deficit reduction. If things go according to script, the bond markets will smack Portugal around, and European leaders will pressure Lisbon to bite the bullet before other dominoes--think Spain and Belgium--being to teeter.

This time, China and Japan have joined the fun. Both nations committed to buy bonds to help shaky Euro bloc nations, Spanish debt in the case of China and special bailout bonds jointly issued by the Euro bloc nations in the case of Japan. This isn't altruism. Both Asian nations are export-driven, and already hold significant amounts of Euro-denominated investments. They have plenty to gain if the Euro zone stabilizes and much to lose if it doesn't.

Europeans may welcome the Asian infusion. But it changes the landscape. The more China and Japan help Europe, the more they would want the EU to remain intact. Germany and other wealthy EU members may find themselves increasingly constrained to support their profligate neighbors, even as their citizens become more restive over the costs. The political dialogue in Europe could deteriorate, particularly if EU leaders appear to pay heed to China and Japan while their citizens pay more taxes.

The Euro zone is on a slippery slope. That China and Japan would openly acknowledge their support for Euro zone debt highlights Europe's inability to finance itself. The more Europe needs outside help, the fewer options the Euro zone will have. Unity will be its only rational option. The need to pay back Revolutionary War debt was one of the major reasons why the 13 rebellious British colonies in North America remained united after attaining independence--ultimately, the United States assumed responsibility for this debt as part of the price of ratification of the Constitution. Europe will have to move toward greater political union in order to establish greater fiscal control and restraint.

But people aren't always rational. In the preceding century, Europe was the principal battleground for two world wars that killed tens of millions. Why? Historians still debate that question, but there's no rational explanation. Although the Euro's problems won't lead to war (the Europeans learned from WWII not to be trigger happy), precipitous secessions by wealthier Euro bloc members can't be excluded. Electorates have a limited tolerance for bailouts, as the American mid-term elections last year illustrate.

There's no to know for certain how things in Europe will end up. But the continent cannot maintain the status quo. It's on a slippery slope, and time will tell which way it slips.

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