„Europe is difficult to understand for the markets,” says Christine Lagarde, French finance minister.
Investors understand that Greece, its debt scheduled to reach 160% of GDP in 2013, is in a hole from which it will not emerge until it restructures its sovereign debt. Its banks, their profits plummeting in part because of windfall taxes, are shut out of international capital markets. Ireland is a victim of a decision by its government to make its taxpayers bear the cost of the bankers’ folly in lending to mad property developers. Spain is in a trap: the more it cuts spending, the more its economy declines, the higher its 20.7% jobless rate soars, and the more likely it is that the deficit will stick at around 10% of GDP. Portugal’s people are the poorest in the European periphery, its economy hasn’t grown in years and it cannot compete in world markets. Italy’s mostly family-owned businesses— over 80% of all workers are employed by firms with fewer than 250 employees —cannot get credit or compete with overseas rivals unless Italy devalues its currency, which its membership in the euro bloc makes impossible. The word of the existing governments in these countries means little, since all are likely to be turfed out in the next elections.
Sitting atop this volcano is a bureaucracy that is fractured, indecisive, incoherent and without sufficient resources to contain what it likes to call „the contagion.” Euro-zone bureaucrats alternately proclaim an existential threat to their common currency, and attempt to reassure the markets by promising that no nation is too big to bail.
The International Monetary Fund worries that austerity will produce a downward spiral of spending cuts, reduced economic growth and therefore lower revenues to the treasury, followed by more spending cuts to shore up the treasuries’ take, in a cycle that can only be arrested by more spending, now. The European Central Bank opposes such a stimulus, and argues that the path out of this mess is more austerity, which it argues will restore confidence and spur growth.
The peripheral countries will have to borrow huge sums in 2011, at growth-stifling interest rates if unaided. Italy, already Europe’s largest bond borrower, will tap the markets for €340 billion ($455 billion), Spain will have to sell €160 billion to €180 billion of IOUs, Portugal is estimated to need €40 billion to €60 billion cash. Banks and companies in the euro zone will have to roll over billions more. But the support institutions may not have the resources to help Spain, with an economy twice the size of those of Greece, Portugal and Ireland combined, or Italy, an economy half again as large as Spain’s.
Finally, there is the dangerous interconnection of the financial system. One-third of Portuguese banks’ foreign lending has been to Greece, Ireland and Spain; German banks have over a $400 billion exposure to peripheral-nation banks, $550 billion if exposure to Italian banks is included. Evolution Securities reckons that German, French and British banks have a €1.2 trillion exposure to banks in the peripheral countries (including Italy).