December 11, 2011
The European Union's leaders promised to stop Europe's spiral into economic oblivion. They needed to immediately restore confidence in the solvency of Spain and Italy, urgently take steps to kickstart growth and then credibly commit to changes addressing the institutional weaknesses of the euro area. They failed on all three fronts. Now they are almost out of time.
Given the inability of Europe's leaders to tackle the problems of Greece – a small economy – investors have been losing faith in their ability to support the much larger economies of Spain and Italy, which also face serious economic problems. This has driven up borrowing costs to unsustainable levels.
Unless policymakers can demonstrate how troubled EU economies can meet their borrowing needs at non-penal interest rates, the crisis will continue to deepen.
Worsening doubts about the solvency of sovereigns has also eroded confidence in the creditworthiness of EU banks that hold substantial amounts of sovereign bonds. To make matters worse, endemic weaknesses in the financial system, brushed under the carpet when the narrative prematurely changed to one of "fiscal crisis", have come back to haunt us with a vengeance. The need to provide public support to troubled banks is casting a dark shadow on sovereigns. Weak banks and troubled economies are now locked in a dance of death.
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