Opinion / Editorial Opinion

Europe’s economic crisis is going global


Margaret Scott illustration

Margaret Scott / NewsArt

Margaret Scott illustration

Losing a long war is always hard to accept. Hemmed in by the western allies and the Russians in the final days of World War II, Hitler convinced himself that he had two armies in reserve to mount a counterattack and win the war. Meanwhile, having lost the entire Pacific, Japan’s imperial cabinet believed that no enemy could set foot upon the country’s sacred soil. When the truth is unimaginable, human psychology finds an alternative reality in which to dwell.

That describes the global situation today. The entire planet seems to be in denial about what is about to occur in the eurozone. Pundits keep expecting Germany to pull a rabbit out of the hat and flood the continent with eurobonds, or that Mario Draghi will mount a coup at the European Central Bank and buy up every deadbeat country’s bonds.

Either could happen, but both are extremely unlikely. Germany cannot guarantee the eurozone’s debt without control over the eurozone, which no one has offered, and northern Europe will not permit the ECB to be hijacked by “Club Med” and turned into a charity organization. It is not just a matter of politics; it is also — as the Germans keep pointing out — a matter of law.


Greece’s recent election has put it in the anti-austerity vanguard. Italy and Spain (which does not have enough money to bail out its banking system), have similarly called for an end to austerity. All have lost access to the bond market, and Portugal is so far beyond hope that its sovereign debt is trading for cents on the euro.

There is no well-thought-out plan for the orderly exit of the eurozone’s insolvent countries. There are no safeguards, no plans, no road map — nothing. The Maastricht Treaty, like the United States Constitution, did not provide for an exit mechanism. So, instead of realism and emergency planning, we get denial and more happy talk. But, just because something is “unthinkable” doesn’t mean that it can’t happen.




The U.S. banks most likely to be affected by such a scenario would be the globalists: Citigroup, Bank of America, JPMorgan Chase, Goldman Sachs and Morgan Stanley. They would require a rescue package similar to the U.S. Troubled Asset Relief Program, created after Lehman Brothers’ collapse in 2008. The U.S. can afford a second TARP, but it would require congressional legislation, which is not guaranteed.

Massive wealth destruction, combined with global financial chaos, would pose a challenge to monetary policy-makers worldwide. Central banks would be tasked with preventing deflation, implying a major round of quantitative easing. But since banks are the transmission mechanism for monetary stimulus, this presupposes functioning banking systems. Each country would need to restore confidence in its banks’ solvency, which would most likely require a blanket bank guarantee and a recapitalization scheme (such as TARP).

The U.S. financial system can withstand any shock, because the U.S. can print the money that it needs. The Fed can maintain nominal prices, nominal wages and growth if it acts heroically, as it did in 2008.

The stock market will react negatively to the level of uncertainty caused by the collapse of the European financial system (as it did in 1931), and the dollar, yen, and gold should benefit. The fate of the British pound and Swiss franc is impossible to predict; they could benefit as safe havens, but their banks are highly exposed to the eurozone.


Christopher T. Mahoney is a former vice chairman of Moody’s.