Peterson Institute for International Economics
March 28, 2011
The euro area sovereign debt crisis is gradually turning into the best thing that has happened to European Union politics and European economies since the launch of the Single Market in the mid-1980s. The crisis has shattered the fake ten-year political and economic equilibrium between core and periphery countries that followed the initial shock of euro introduction. That sham equilibrium was based on the feel-good factor of illusory growth from real estate booms and credit financed consumption sprees. It was enabled both by incompetent financial market credit risk assessments that allowed Greece to borrow at German interest rates for a decade and also allowed European governments to believe the comforting, but erroneous signals from financial markets. After all, if Greece could borrow at German rates, who in Brussels could question it? It must have meant that the dream of European integration and economic convergence was really happening, that "Brussels" was competently steering Europe toward "ever closer union" and that all Europeans would enjoy Luxembourg’s standard of living.
Instead the tide that was supposed to lift all European boats has gone out. Euro membership has become a kind of prison shelter, protecting country inmates from the mean streets of global financial crises, but allowing unpleasant things to happen to the weak, unless they reform before entering or prepare to do politically heavy lifting on reform once inside.
The European political and institutional response to the latest crisis, had to navigate 27 national domestic political constituencies. Inevitably it limped behind. Yet the fact that it took only about 12 months from May of 2010 to negotiate the new permanent euro area crisis facility to be known as the European Stabilization Mechanism (ESM) is testimony to the innovative capacity of the European Union. The ESM is a permanent new EU institution built to last, and it was wise for leaders not to rush into it. The result has been a new political and economic equilibrium between the core and periphery of Europe. However unstable it is in the short run, this new equilibrium could ultimately help resolve the European sovereign debt and banking crisis.
Most financial market analysts and non-Europeans who have overlooked these accomplishments have committed two important fallacies.
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