It wasn't long ago that Mario Draghi was spreading confidence and good cheer. "The worst is over," the head of the European Central Bank (ECB) told Germany's Bild newspaper only a few weeks ago. The situation in the euro zone had "stabilized," Draghi said, and "investor confidence was returning." And because everything seemed to be on track, Draghi even accepted a Prussian spiked helmet from the reporters. Hurrah.
Last week, however, Europe's chief monetary watchdog wasn't looking nearly as happy in photos taken in front of a circle of blue-and-yellow stars inside the Euro Tower, the ECB's Frankfurt headquarters, where he was congratulating the winners of an international student contest. He smiled, shook hands and handed out certificates. But what he had to tell his listeners no longer sounded optimistic. Instead, Draghi sounded deeply concerned and even displayed a touch of resignation. "You are the first generation that has grown up with the euro and is no longer familiar with the old currencies," he said. "I hope we won't experience them again."
The fact that Europe's top central banker is no longer willing to rule out a return to the old national currencies shows how serious the situation is. Until recently, it was seen as a sign of political correctness to not even consider the possibility of a euro collapse. But now that the currency dispute has escalated in Europe, the inconceivable is becoming conceivable, at all levels of politics and the economy.
Collapse of Currency a 'Very Likely Scenario'
Investment experts at Deutsche Bank now feel that a collapse of the common currency is "a very likely scenario." German companies are preparing themselves for the possibility that their business contacts in Madrid and Barcelona could soon be paying with pesetas again. And in Italy, former Prime Minister Silvio Berlusconi is thinking of running a new election campaign, possibly this year, on a return-to-the-lira platform.
Nothing seems impossible anymore, not even a scenario in which all members of the currency zone dust off their old coins and bills -- bidding farewell to the euro, and instead welcoming back the guilder, deutsche mark and drachma.
It would be a dream for nationalist politicians, and a nightmare for the economy. Everything that has grown together in two decades of euro history would have to be painstakingly torn apart. Millions of contracts, business relationships and partnerships would have to be reassessed, while thousands of companies would need protection from bankruptcy. All of Europe would plunge into a deep recession. Governments, which would be forced to borrow additional billions to meet their needs, would face the choice between two unattractive options: either to drastically increase taxes or to impose significant financial burdens on their citizens in the form of higher inflation.
A horrific scenario would become a reality, a prospect so frightening that it ought to convince every European leader to seek a consensus as quickly as possible. But there can be no talk of consensus today. On the contrary, as the economic crisis worsens in southern Europe, the fronts between governments are only becoming more rigid.
The Italians and Spaniards want Germany to issue stronger guarantees for their debts. But the Germans are only willing to do so if all euro countries transfer more power to Brussels -- steps the southern member states, for their part, don't want to take.
The Patient Is Getting Worse
The discussion has been going in circles for months, which is why the continent's debtor countries continue to squander confidence, among both the international financial markets and their citizens. No matter what medicine European politicians prescribe, the patient isn't getting any better. In fact, it's only getting worse.
For weeks, investors and experts demanded a solution to the Spanish banking crisis, preferably in the form of a cash infusion from the two Luxembourg-based European bailout funds, the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM). When Madrid finally decided to request what could ultimately amount to almost 100 billion ($125 billion), the experts realized that this would suddenly send Spain's government debt shooting up from 70 to 80 percent. As a result, interest rates started rising instead of falling.
The experience of the last few days describes the entire dilemma faced by European politicians trying to rescue the euro: A step that was intended to provide relief only exacerbated the problem.
The same thing happened with the next proposal, which made the rounds last week. Italian Prime Minister Mario Monti wanted the European bailout funds to intervene on behalf of Spain and Italy to bring down their borrowing costs.
But that would have required the affected countries to submit to a program of reforms, a path Monti and his Spanish counterpart, Mariano Rajoy, want to avoid. They would prefer to have the money without conditions. But the German government is unwilling to accept this, which puts Europe at its next impasse. Furthermore, the rescue strategists' resources are limited. Although the Luxembourg bailout funds still have more than 600 billion in uncommitted resources, it is already clear that the money would be used up quickly if what many experts now believe is unavoidable came to pass, namely that not just the Spanish banking industry but in fact the entire country required a bailout. The bailout funds would be completely overtaxed if Italy also needed help.
Even ECB Has Largely Exhausted Resources
Until now, the defenders of the euro have been able to resort to the massive funds of the ECB, if necessary. If things got tight, the monetary watchdogs could inject new money into the market.
But now even the ECB has largely exhausted its resources. It has already bought up so much of the sovereign debt of ailing countries that any additional shopping spree threatens to backfire, causing interest rates to explode instead of fall. At the same time, the conflict between Northern and Southern Europe in the ECB Governing Council is heating up. Last week, the head of Spain's central bank managed to convince the ECB to ease its rules to allow Spanish banks to use even weaker collateral than before in exchange for borrowing money from the ECB. This could set off a tiff with the central bankers from the donor countries, who are loath to look on as the risks in the central bank's balance sheet continue to grow.
Indeed, the European leaders seeking to save the euro are in a race against the clock. The question is whether the economy in Southern Europe will recover before the euro rescuers' tools are exhausted, or whether it will be too late by the time the recovery arrives. It's a question of growth and the economy, but also of character. How willing are the Spaniards and Italians to accept reforms and hardship, and how willing, on the other hand, are the donor countries of the north to provide assistance and make sacrifices?
Not willing enough, say many experts. As a result, the world is imagining the unthinkable: the withdrawal of several Southern European countries from the monetary union, or possibly even the general collapse of the euro zone. It isn't easy to predict how such a tornado would affect the global economy, but it's clear that the damage would be immense.