Another recession to ruin Europe

The initial hard-line posturing on both sides of the Greek debt stand-off is already moderating. This latest European crisis can be resolved and, as I recently explained, most likely will be. Yet don’t be overly optimistic about the euro area’s longer-term chances of survival. The hash that the European Union has made of this latest Greek emergency, a small and relatively tractable issue, tells you those chances aren’t good.

Imagine another bad recession. The euro area in its present form couldn’t hope to survive. Even now, after all that’s happened, the EU’s leaders can’t bring themselves to think about this. Perhaps they’re assuming that another bad recession won’t ever happen. That’s the kind of foresight that built the single currency.

Greece is not the problem - or shouldn’t be, anyway. It can be managed because it’s a small country and because no other euro member country is in nearly so much trouble. The resources necessary to restore its prospects are relatively small; and a new debt settlement for Greece needn’t serve as a template for other debt-relief supplicants. Greece can plausibly be presented as a one-off.

There’s good justification for that, in fact. The country’s previous debt restructuring was bungled. It wasn’t big enough to restore solvency - Greece’s government debt is still more than 170 percent of GDP - and the relief, such as it was, came with draconian fiscal conditions that stomped on an economy already on its back. The coming Greek settlement should be thought of as correcting those errors, a second chance to get things right, not as a precedent-setting innovation.

Once Europe’s leaders have muddled their way through the Greek problem, the short-term prospect for the euro area is more sub-par growth, dangerously low inflation and high unemployment. The European Central Bank’s adoption of quantitative easing was a good step (if absurdly overdue), but QE won’t be as effective in the euro area as it was in the United States. And fiscal policy remains tight, especially in Europe’s weaker economies, as governments try to bring down their debt burdens by running fiscal surpluses. That’s at least partly self-defeating, of course, because austerity holds back growth.

Now suppose, as I say, that another severe downturn imposes itself on this trend of stagnation. It’s entirely possible. Europe’s financial system remains fragile, and its projects to create a banking union and a properly integrated capital market are moving, respectively, slowly and not at all. That exposes the EU to bigger-than-normal risks of financial accidents.

As things stand, the policy options would be limited. Interest rates are already at zero. Notwithstanding QE, the ECB is a more inhibited central bank than, say, the U.S. Federal Reserve. It’s forbidden to undertake direct monetary financing of governments. On QE, it finally decided to test the limits of that prohibition, but more effective forms of monetary-base expansion - such as so-called helicopter money - are seen as expressly forbidden.

Fiscal stimulus, on the other hand, is ruled out by the sinister combination of institutional incapacity and mutual animosity. To be sure, the euro area as a whole isn’t lacking in fiscal capacity. Euro-area government debt is less than U.S. public debt. There’s no economic reason why Europe shouldn’t borrow (at extremely low interest rates) and spend the money on, say, large-scale infrastructure investments. But when Europe designed its monetary union it forgot to design even the rudimentary fiscal union that, as we’ve learned, the larger enterprise needs.

Then why not start building such a union? Partly because it would require a new European treaty, which in turn would demand a measure of popular consent. With the union and its works so unpopular, governments dread embarking on that process. More fundamentally, the commitment to European solidarity, invoked down the years to motivate the whole project, has all but vanished. Far from thinking “we’re in this thing together,” Germany sees Greece as a nation of scroungers and thieves, and Greece sees Germany as a nation of atavistic oppressors.

Unless this failing union is reshaped in far-reaching ways, the optimistic scenario is protracted stagnation. The pessimistic scenario is political collapse, followed by who knows what. Where are the European leaders willing to rise to this challenge? Name me any who’ve even begun to think about it.

*The author is a Bloomberg View columnist and a member of the Bloomberg View editorial board.

by Clive Crook