The Reckoning

For Europe, It Ain’t Over ‘til La Gordita Sings

The more ensconced in the world of macroeconomics I become, the less pleasure I take in what otherwise would be a columnist’s most cherished goal: saying I told you so. But I will say again what I have been saying for two years now: you cannot run an economy the size of Spain’s on credit card interest rates. Yet that is precisely where Spain finds itself once again.

Today, just three weeks have passed since the EU’s last effort to declare victory over the sovereign debt crisis. On March 26, after much hemming and hawing over the cost to her constituents, German Chancellor Angela Merkel agreed to allow an increase in the EZ bailout fund to roughly $666 billion. This followed a March 13 disbursement of another 130 billion ($169 billion) to bailout the insolvent Greeks.

For some reason, members of the Angela Merkel fan club choose that moment to declare victory on her behalf. Typical was Michael Shulman, a formerly sober critic, all but ran up the white flag earlier this month, declaring that the policy was working, (though adding “One former TIME editor is bombarding me with emails saying that my continued gloom about Europe’s future is more and more misplaced).”

Yet the problem in Europe is blindingly clear to anyone who can add: by the European Commission’s own reckoning, the potential exposure to sovereign defaults by Portugal, Ireland or Spain (not even including the wobbly Italians) would be approximately $1.2 trillion. That’s twice, roughly, what is contained in the EZ’s bailout fund.

Meanwhile, Merkel’s insistence on austerity at all costs has guaranteed that Spain, Greece and Portugal are plummeting back into recession (and the larger Eurozone will follow if this continues too much longer).

The result of this political gamesmanship has once again elevated Europe’s economic dysfunctions from a regional annoyance to a global threat to economic growth. On Monday, Spain found itself paying over 6 percent to borrow money to fund its budget deficit. As global markets reawakened to this fact, debts costs rose across the board – most ominously, pushing the cost of debt for an Italian 10 year bond up near 6 percent, too.

Should this not be halted soon, the world’s 8th largest economy will default, even if EZ leaders decide to call it something else. And if that happens, we’re right back to the Lehman moment, watching as the loss of trust in basic tenets of the global financial system spread Europe’s crisis far and wide.

Spain’s new prime minister, Manuel Rajoy, has worked hard to reign in his government’s deficit – a figure notoriously difficult to control due to the autonomy enjoyed by Spain’s regional governments. Previous Eurozone support for Spain had demanded that the country’s current accounts gap fall to 4.4 percent this year, but after taking office earlier this year, Rajoy found he had been left in worse shape that the previous government had conceded. As a result, Spain will run a 5.8 percent deficit this year instead.

Merkel’s stubborn insistence that growth need not be part of the solution has now run its course. Spain is not Greece – it has a vibrant financial sector and can feasibly become a competitive economy again. But in delivering her particular prescription for saving the euro, Merkel may in fact be destroying it.

Given the depths that the EU’s weaker economies have fallen to, it’s now hard to imagine any of them recovering soon without resorting to a drastic measure: withdrawal from the euro, reintroduction of their own national currencies and devaluing them to bring competitiveness back to their economies.

The austerity crowd – and their right-wing cheering section in the US – will have none of it. Those Mediterranean types just need to work harder. Peter Schiff, the right-wing hedge fund titan, echoes these ideas in America. Late last year, he chided the United States for not being more like Angela, proof that the suicidal strain of economic fundamentalism that drove the global economy to the brink of depression in 2008 is alive and well.

And so the danger that Europe poses to US growth is not just “contagion” in the event of a major default; there’s a psychological deviance afoot, too.