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The euro on the brink

Published: 20 Nov. 2011, 22:07

The most dreaded scenario may actually come true. The sovereign debt crisis in the periphery of the euro zone is spreading to the core economies. Greece’s credit woes have caught up to Italy and Spain and now threatens France. The yield on Spain’s 10-year government bonds shot up to 6.75 percent, which is close to the Maginot Line of 7 percent.

That volatility has sent the troubled southern European countries seeking bailouts to avert bankruptcy. France’s government bond yields have also neared 3 percent, raising concerns that a core economic power in Europe may have its credit rating downgraded from the sterling AAA level, making it difficult for France to stabilize its fiscal health.

If the contagion and investor jitters are not contained, the European Union may end up as a league of indebted economies staying afloat on rescue programs. European banks have cross-purchased sovereign debt and one country’s default could translate into a chain reaction of insolvencies across the euro zone.

Italy, Spain and France are the core founding members of the euro. European leaders must act fast to quarantine the weaker economies so that the credit and fiscal crises do not spread to the heart of the euro zone. For now, an enhanced role - and very aggressive bond purchases - by the European Central Bank may be the only option.

But Germany and other stronger European economies oppose a larger role for the central bank in resolving the debt crisis. Some propose a split of the euro zone or the kicking out of troubled economies to stave off contagion risks. But there is no time to lose debating the options. Italy must come up with 40 billion ($54.5 billion) to 60 billion euros every month as its bonds mature starting early next year.

But Italy and Spain cannot afford raising new funds with government debt yields hovering above 7 percent. If they seek bailout money, the economies of France and Germany would be jeopardized. It’s now more obvious than ever: A European crisis spells trouble for the entire global economy.

Individual states must heed the fiscal terms agreed to during the EU summit last month. They must overhaul public finances and the European Financial Stability Facility should be recapitalized to purchase more bonds of troubled members. The entire euro zone will come under jeopardy if other countries emulate Greece’s political mess and its dilly-dallying over reform measures.