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Europe's monetary union forever altered by crisis

BRUSSELS — Europe and the euro will never be the same.

The debt crisis is forcing governments to rewrite some of the eurozone's most fundamental rules. While some see the current turmoil as the slow-motion wreckage of the common currency bloc, others maintain Europe will have the political resolve to keep it together and even bring it closer together.

Either way, one thing is clear: Thanks to new debt and bailout rules being agreed to among the 16 eurozone nations, Europe's monetary union will be forever altered, even if it survives the crisis.

Next week European finance ministers will work on fleshing out a so-called European Stability Mechanism. The new rules will rearrange the eurozone's power structure to protect stronger economies such as Germany from paying for the profligacy of "peripheral" countries such as Greece or Portugal, threatening to create a two-tier Europe.

But the prospect of such a growing divide, unexpectedly, raises the question of closer fiscal union — money flowing from rich countries to weaker ones — even though there is huge political resistance to such a scenario.

"The debt crisis is uncovering deeper problems within Europe, calling into question the EU's future development," Monument Securities analyst Stephen Lewis wrote in a note this week. "Without political union of eurozone member states, the hopelessness of the euro's situation is likely to appear overwhelming. The search is on for the magic bullet that will cure the euro's malaise."

At the heart of the stability mechanism — chiefly sought by Germany, Europe's paymaster — is forcing investors to take part of the losses in debt crises. Bondholders — including banks and hedge funds — were protected in both the bailouts of Greece and Ireland. Now, politicians say that starting in 2013, they will have to become liable for the risks they agree to take as part of their profession.

The most direct consequence, however, has been that investors are asking for higher premiums on fiscally weak governments' debt. That, in turn, risks pulling Europe in two different directions — that of economically strong countries that will keep paying low borrowing rates and those that will pay more because of the perceived risk surrounding their debt.

Greece, Ireland, Portugal, and even Spain and Italy have to spend more money to refinance their debt, burning up cash that could otherwise have built schools, roads and hospitals, and boosted growth and jobs. No longer will they be able to borrow at interest rates close to those paid by fiscally solid Germany — as they did for years after the euro's launch in 1999.

Whatever finance ministers eventually make of the new stability mechanism, the debt crisis has already called into doubt the assumptions underpinning Europe's monetary union.

Until last year, the eurozone stuck to two seemingly contradictory mantras: No government could ever default, and no country could ever be bailed out. The no-bailout idea fell in May, with Greece. The no-default premise was stamped with a 2013 expiration date Sunday, when European Union finance ministers agreed to force losses on private creditors if a country's debt pile is deemed too big to bear.

Many economists argue that the debt loads of Greece, Ireland and Portugal are already unsustainable, since the harsh austerity measures they have been forced to take are killing off desperately needed economic growth.

At some point, a support system for the eurozone's weaker members might be necessary, since the low borrowing costs they enjoyed in the healthy days of the currency union are likely gone forever.

But such measures — the direct flow of cash throughout the eurozone — would imply a level of political union that countries have so far been very reluctant to accept for fear of losing sovereignty.

Europe's monetary union forever altered by crisis 12/03/10 [Last modified: Monday, November 7, 2011 1:26pm]
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