Two years of gross mismanagement of the euro-zone debt crisis have all too predictably produced a wider crisis of market confidence that now threatens the entire 17-nation euro zone. This week’s formation of new technocrat-led governments in Greece and Italy has not calmed fears. Practically every euro zone country is paying the price in higher interest costs and ebbing economic growth.
The only country that isn’t suffering — yet — is Germany, whose competitive export-driven economy feeds on foreign demand and an exchange rate held down by its neighbors’ troubles. But all European countries cannot be Germany and run net surpluses, especially if Berlin insists on policies that keep factories shuttered and workers unemployed.
And German leaders are wrong if they think their country will remain unscathed as its major trading partners and neighbors unravel.
Chancellor Angela Merkel of Germany has been talking a more pro-European line. But she is still insisting on growth-killing austerity as the price for European bailouts and still blocking the European Central Bank from printing more euros and acting as a lender of last resort.
Mrs. Merkel’s advisers insist that she is doing what the German people want. That is not leadership. She needs to challenge her voters’ simplistic stereotypes of southern European sloth and tell them the truth: The real threat to Germany isn’t inflation; it is an economic collapse across Europe. And Germany has a huge amount to lose from a fracturing of the European Union.
European stock and bond markets are already treating that as an ever-more-realistic possibility, shunning even moderate levels of risk and pushing interest rates to unsustainable levels. As far as they can see, Mrs. Merkel and her fellow euro-zone leaders haven’t come up with an adequate plan, sufficient political will or sufficient cash to halt the contagion. As far as we can see, they are right.
The political changes at the top of Greece and Italy are promising. Greece’s new prime minister, Lucas Papademos, and Mario Monti of Italy are internationally credible economists, committed to making painful but much needed reforms, including liberalizing labor markets, shrinking overgrown bureaucracies, shedding state properties and rooting out corruption.
Given their training, they surely understand that their economies are not now strong enough to absorb more austerity, including broad new taxes or further sweeping service cuts. Mr. Papademos and Mr. Monti should press their fellow European leaders for a new and better deal. Even with the best leadership, neither Greece nor Italy will be able, on their own, to restore their fiscal health and help slow the spreading financial contagion. That will require substantial and immediate help from their euro-zone partners, starting with Mrs. Merkel.
An all-out effort by the European Central Bank to buy bonds, lower interest rates and inject new liquidity into the markets may still calm the contagion if it begins in the next few days. The bank’s new president, Mario Draghi, may be willing to play this role, if Germany stops standing in the way.
Mrs. Merkel must make clear that she will support the central bank taking on this expanded role. And now that new, credible leaders are in office in Athens and Rome, she and other euro-zone leaders need to meet with them and negotiate more growth-friendly reform packages. There is very little time left to avoid financial catastrophe.