Euro bonds? French President Nicolas Sarkozy apparently isn't familiar with the term. He talks and talks, but he never mentions euro bonds. And then it's Italian Prime Minister Mario Monti's turn. Euro bonds? Never heard of them. Or at least he says nothing about them in his speech. The next speaker is German Chancellor Angela Merkel, who wouldn't dream of mentioning euro bonds.
It is last Thursday, and the three European leaders have just had lunch together in Strasbourg and are giving a press conference on the subject of the euro. It must have been an amazing lunch, full of unity, harmony and understanding.
Or at least that's the way they describe it. And when something is that pleasant, it makes complete sense not to talk about euro bonds, even though they are now the central issue in the debate over the euro crisis. Merkel is opposed to the idea and Sarkozy and Monti are in favor, but they don't want to say as much.
Of course, there is, as always, a journalist around who is leery of the harmonious mood, which is why he asks about the bonds that everyone knows about but isn't mentioning. Merkel says that she hasn't changed her opinion on the issue, but without actually uttering the distasteful words. Sarkozy mentions the Rhine River, tells a joke about a hypochondriac, talks and talks and finally says that he and his counterparts will certainly come to an agreement. But he doesn't mention euro bonds by name.
And then it's Monti's turn again, and what does he do? He does use the word euro bonds, but then he quickly switches to a new, more attractive synonym, noting that he would not be overly opposed to "stability bonds." His words reveal that there is indeed a serious conflict within the euro zone.
Nothing works in Europe without Merkel. And the German chancellor isn't just opposed to euro bonds. She also refuses to accept a move by the European Central Bank (ECB), backed by the French in particular, to buy up the bonds of ailing euro-zone countries on a much larger scale than it has done to date, in order to bring down the yields on those bonds. But that was not an official topic in Strasbourg, where Sarkozy assured his fellow leaders that France respected the independence of the ECB.
The staged harmonious mood stands in sharp contrast with reality. In the middle of its biggest crisis, Europe is hopelessly divided. One summit follows the next, and they all end with conciliatory statements and avowals, but not with any shared plan for how to save the euro.
The situation could hardly be any more dramatic. The European monetary union threatens to implode unless something happens soon. The ambitious project that was supposed to permanently unify the continent will have failed, with dramatic consequences for Europe and the rest of the world. Countries would go bankrupt, banks would have to be rescued once again, and the economy would sink into a recession that would last for years.
The moment of truth is approaching, now that the end game for the euro has begun. But what will happen now? In the coming weeks, but particularly in the first quarter of 2012, the ailing European countries will have to raise massive amounts of money. In Italy alone, more than 110 billion ($145 billion) in old debt is set to expire, which will have to be refinanced (see graphic). But who is going to give these countries fresh capital at the moment?
Investors have lost confidence in the euro-zone countries and in their ability to rescue the common currency. Not even the recent changes of government in Italy, Greece and Spain have been enough to persuade them otherwise.
There is a growing sense of fear, both in the financial markets and in government offices. Even serious bankers who exude confidence in public admit privately that the monetary union could soon fall apart.
The previous bailout attempts have been worthless, they say, noting that Europe must finally reach for the only weapon whose firepower is endless, the European Central Bank. The ECB must finance the debtor nations, even if its own constitution bars it from doing so. The central bank has enough money, and it can also print money if necessary.
Most European leaders share this realization by now -- all except Merkel. She remains resistant, concerned about the central bank's independence and monetary stability. She is also staunchly opposed to all attempts to pool the debts of euro nations through jointly issued debt known as euro bonds.
The German chancellor is increasingly isolated. At home, she must defend any concessions to save the euro against her coalition partners, the business-friendly Free Democratic Party and the conservative Christian Social Union (the Bavarian sister party to Merkel's Christian Democratic Union). She must convince members of parliament from her own party and abide by the rules set by Germany's Constitutional Court in its far-reaching decisions on the euro crisis. The FDP is creating alarm by polling its members on the party's position on the crisis. In other countries, Merkel is seen as a stubborn defender of German interests who hasn't recognized how serious the situation is -- and is therefore jeopardizing the entire monetary union.
Jacques Attali, who used to be an adviser to former French President François Mitterrand, paints the concerns of partner countries in a particularly drastic light. After the two world wars, says Attali, it is "now Germany, once again, that holds the weapons for the entire continent's suicide in its hands." If Germany doesn't change its position, says Attali, "there will be a catastrophe."
Europe's Failed Attempts to Save the Euro
From the foreign perspective, the situation is clear: Rescuing the euro depends on Germany, which merely has to abandon its resistance to pooling debt. But this sort of "liability union" would not only contradict the so-called no-bailout clause of the European treaties, under which no euro-zone country can be held liable for the debts of another, but it would also be particularly dangerous for the Germans. As Europe's largest economy, Germany would shoulder the biggest burden and, in the end, could even be plunged into ruin with the rest of the euro zone.
Merkel is also concerned that the debt-stricken nations would immediately revert to their old bad habits if they felt that their rescue was certain. For this reason, the Germans only want to approve aid in return for strict conditions.
The chancellor has behaved very cautiously from the start. She has made an incrementalist approach the cornerstone of her crisis management, and has always insisted there would be no bold stroke that would slice through the Gordian knot. She wants to think about solutions in terms of an end result. But what if this end result remains so nebulous that tiny steps are in fact the only alternative?
As a result, the efforts to manage the crisis have hobbled along from one summit meeting to the next, without any evidence of lasting success. International investors have set their sights on more and more ailing countries, which in turn have been forced to pay higher rates on their sovereign bonds.
The instruments and programs with which Merkel and her counterparts have sought to control the crisis have proved to be too timid. Because the first bailout package for Greece was inadequate, it was followed by a second one. The European bailout fund was also enlarged. But because the fund still isn't fully functional, the ECB is constantly intervening in the bond markets, buying up Italian and Spanish sovereign debt to stabilize yields.
But the chronic stopgap measures have failed to reestablish confidence in the monetary union. There have also been glaring inadequacies in crisis management, as a result of infighting over competencies as well as jealousies between the European Commission and national governments, the ECB and the politicians, and among the central banks of individual countries.
There is also no love lost among the senior-most representatives of the European Union and the euro zone. European Commission President José Manuel Barroso envies European Council President Herman Van Rompuy for his prominent position, while Van Rompuy in turn challenges Euro Group President Jean-Claude Juncker's authority. All of this infighting leads to strife, ambiguities and a cacophony of voices.
Barroso's hapless actions are a case in point. Less than two weeks after the crisis summit in late July, he settled his scores with the European heads of state and government, saying that their resolutions were not far-reaching enough, and that their implementation was deficient. The intervention did not exactly build confidence in Europe's ability to get its act together, and the risk premiums on some European government bonds rose significantly as a result.
Even worse than the disharmony is the fact that the euro zone's backstop fund, the European Financial Stability Facility (EFSF), is not functioning correctly. It was originally set up for crisis-ridden peripheral euro-zone members, but it was soon clear that it was too small even for that. The member states had to add additional guarantees so that the EFSF's effective lending capacity could actually reach 440 billion as originally planned.
But even that amount was quickly stretched to its limits. The markets were not in the least bit impressed by the Europeans' commitment. A few weeks ago they targeted two countries, Italy and Spain, which would overburden the EFSF if they had to be bailed out.
In the future, the EFSF's remaining funds of 250 billion are to be leveraged, or increased, to between four and five times their current value, using complex financial constructs involving the participation of private investors. The reasoning is that this could also protect countries like Italy or Spain, in the event that they are faced with liquidity problems due to turbulence in the euro zone. If necessary, the funds could also be used to prevent banks from collapsing.
But the euro rescuers did not take investors into account when they were doing their calculations. During his recent promotional tour of state-owned funds in China and investors in Japan, EFSF chief executive Klaus Regling, who had hoped to persuade Asian investors to put their money into the bailout fund, encountered noticeable reticence. The managers of the large investment funds apparently no longer trust the Europeans to get their problems under control.
To make the new instruments more attractive, the EFSF itself must become more heavily involved than planned. This would reduce the necessary leverage considerably. At a meeting of euro- zone finance ministers this week, Regling intends to present solutions that amount to only a doubling or, at most, a tripling of the EFSF funds.
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