The European debt crisis has moved several stops closer to hitting the balance sheets of already fragile US banks. The contagion is spreading quickly and may soon make inevitable the double dip recession in America predicted by many.
The only way to slow down the pace is for President Obama to sharpen the warnings he gave today to force Europeans to show more mettle. For that, he will have to put much more pressure very quickly on Germany’s stubborn Chancellor Angela Merkel.
The crisis is one of European sovereign or government debt with the turmoil spreading from Greece and Ireland to Portugal, Spain, Italy and now France. These are the largest economies in the group of 23 countries using the euro currency. Britain, Denmark and Sweden have stayed out.
The central banks of euro zone countries can no longer print money to handle national financial problems. That power is delegated to the European Central Bank based in Frankfurt, Germany. Its job is to control inflation, which requires austerity and cost controls. But austerity can be like slow-spreading poison when economies are losing steam and unemployment is rising.
The indebted countries started collecting debt long before the euro’s birth in 2002. All have preferred to borrow rather than apply painful reforms to change structures pre-dating the euro. To borrow, they issue government bonds usually bought by the major European and American banks.
At the same time, banks borrow overnight from one another in dollars and euros to cover their positions at closing time. This interbank borrowing, which can also be for slightly longer terms, depends entirely on the trust each bank has in the borrower’s financial health.
Panic is spreading through the banks because euro zone governments have failed to agree on a plan to prevent sovereign debt defaults or restructure debt. So the prospect is emerging of a double whammy. A devastating credit freeze among banks similar to the one after Lehman Brothers collapsed, in tandem with a Greek default followed by financial tumult in the entire euro zone.
The contagion will be devastating for American banks because many are deeply exposed to debt from European banks, which are exposed to sovereign European debt. This is not a worst case scenario with ifs and buts. It is already on the way.
There is a remedy. It requires that Germany allow the ECB to be for Greece and others what a national central bank would be, namely, a provider of bank liquidity even at the cost of some inflation. But it cannot print euros, like the Federal Reserve does dollars, because that would affect all 17 members. Instead, it must issue ECB bonds backed by the prestige and reliability of its own reputation and all euro zone governments. The bonds would be a kind of European sovereign debt and, thus, more reliable than Greek or Spanish bonds.
Painfully, jerkily and with maddening lethargy, Germany is coming to this view. But will it allow the entire euro zone and the group’s central bank to quickly put a floor under this crisis? Or will it refuse to save Greeks, Spaniards and Italians because they work shorter hours, enjoy longer holidays and get bigger retirement benefits than hard working Germans?
The irony is that Spain and Italy were in reasonably good health and their budget deficits were lower than in Germany and France. Markets are hitting them hard because of wavering in Germany and the ECB about the moral hazards of saving Greece. That has raised doubts about commitment to the euro as a currency and weakened the entire euro zone.
If this causes America to plunge into another banking crisis and recession, the entire global economy could head into a vicious downward spiral. We would have upon us the global depression from which Obama saved the world in 2009.