At about the time the American presidential election is in full swing in September, the euro zone may finally have to face the music about Greece, Spain, and the emergency mechanism the EU has developed to deal with governments nearing default.
The German Constitutional Court is expected to rule on September 12 regarding the legality of the European Stability Mechanism (ESM), the emergency bail out fund tapped by Greece and other countries. Most of the funds are supplied by Germany, but if the court rules that the ESM is unconstitutional, it will likely fall apart just at a time when it will be most needed.
Also on that day, elections in the Netherlands will be held and anti-bailout forces are expected to do very well. If they come to power, it will only complicate the situation with Greece.
Also around September 12, a decision will have to be made about Greece. Athens wants to renegotiate a part of the bailout agreement to give it more time to reach deficit and debt targets. This means the Greeks will need an additional infusion of cash — something no European country is eager to do. At that point, some of Greece’s $160 billion dollar debt will have to be written off, which would hit taxpayers not private businesses. Since there is little enthusiasm to keep Greece’s head above water, it is possible that Greece will be forced to leave the euro — with unknown consequences for Spain.
“In nearly 20 years of dealing with EU issues, I’ve never known a state of affairs like we are in now,” one euro zone diplomat said this week. Here’s where things get really dicey, as this Reuters analysis makes clear:
A bailout of Spain would probably be double those of Greece, Ireland and Portugal combined, while Italy’s economy is twice as large as Spain’s again.
The European Union has already agreed to lend up to 100 billion euros to rescue Spanish banks. One euro zone official said Madrid has now conceded that it might need a full bailout worth 300 billion euros from the EU and IMF if its borrowing costs remain unaffordable.
The euro zone does not seem to have enough cash in the current setup to deal with a scenario of Spain and Italy needing a rescue, and a sense of doom is growing among some policymakers. Fighting the crisis, said the euro zone diplomat, is like trying to keep a life raft above water.
“For two years we’ve been pumping up the life raft, taking decisions that fill it with just enough air to keep it afloat even though it has a leak,” the diplomat said. “But now the leak has got so big that we can’t pump air into the raft quickly enough to keep it afloat.”
Compounding the problems, Greece is far behind with reforms to improve its finances and economy so it may need more time, more money and a debt reduction from euro zone governments.
If Greek debt cannot be made sustainable, the country may have to leave the euro zone, sending a shockwave across financial markets and the European economy.
That shockwave probably won’t be as devastating for the United States as the financial meltdown of 2008 that ultimately doomed the McCain campaign. US banks and the Federal Reserve have been preparing for just such a euro crisis for months.
But there is no way to prepare if, in addition to Greece leaving the euro, the dominoes of Spain and Italy fall. Those economies are just too massive not to cause significant problems for the US economy if they default.
It should be noted, as Reuters points out, that the EU, the European Central Bank, and the IMF have been able to muddle through these kinds of crisis over the past two years — not solving any of the problems with the euro and debt but pumping “just enough air” to keep it [the lifeboat] afloat even though it has a leak.” There’s no reason to believe there isn’t some kind of solution that kicks the can down the road some more, delaying the day of reckoning and hoping that something will turn up to save the euro.
But September appears to be a month of crisis and decision for Europe as well as a month that could make or break the Obama campaign.