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At the stroke of midnight on Dec. 31, central Tallinn's Theatre Square erupted in more than the usual New Year's cheer as Estonia became the 17th country to join the euro zone. European Union Economic and Monetary Affairs Commissioner Olli Rehn were among the revelers, but will there be much reason to celebrate?
Policymakers strain to appear as if it's business as usual in euro-land, but behind the scenes one finds barely suppressed panic about how to preserve the 18-year-old monetary union. "If you want to liken the overall mood in Europe to the five stages of grief, then we are very much still in the first stage -- denial -- and getting closer to the second [anger]," says Daniel Gros, director of the Centre for European Policy Studies, a Brussels-based think tank.
EU leaders orchestrated international bailouts of Greece and Ireland to calm bond market jitters and prevent a sovereign debt collapse, but they did so only reluctantly and with considerable internal dissent. While investors may not be spooked, they're still skittish, with bond yields at painfully high levels in Spain, Portugal and Italy when compared with safe haven Germany.
In December, the EU ruled out immediate aid for Portugal or Spain and also opposed an increase in the bloc's overall €750 billion ($1 trillion) crisis fund. The European Central Bank, under Jean-Claude Trichet, has been pumping billions into sovereign debt -- $69 billion since the May bailout of Greece -- as well as into some troubled banks, but the ECB often seems just one small step ahead of the market. More radical moves -- taking big risks with the ECB's own balance sheet, flooding the market with liquidity -- have so far been avoided.
While Gros and others believe it's premature to write an obituary for the currency, they predict it will be very tough for EU leaders to persuade investors to put money back into bonds of debt-plagued Spain, Portugal and Italy.
"It is not only a question of leadership, but a question of understanding the dynamic of the marketplace," notes Nicolas Véron, resident scholar at Bruegel, another Brussels think tank. "There has been a lack of ability to react swiftly in the policymaker world, but now the bigger question is, how can you lure investors back to debt issued by peripheral countries?"
Until now, EU leaders have dragged their feet, acting at the last minute to respond to a crisis. Six months after Greece became the first EU country to get a lifeline, in the form of a €110 billion bailout, Ireland accepted an €85 billion rescue package. First Dublin agreed to accelerate the restructuring of its troubled banking sector. While other countries had nationalized banks during the financial crisis, the Irish government of Prime Minister Brian Cowen went further, shocking its EU neighbors by guaranteeing the debts of the most profligate -- Anglo Irish Bank Corp. Ltd. and five other banks -- without first consulting the European Commission or EU-member governments. That made it much harder to force losses on the banks' bondholders.
On the regulatory front, EU leaders have created a European-wide structure including a supranational supervisory agency that will start operations in January to try to keep governments from having to orchestrate future bailouts.
Who might be next?
EU finance ministers, gathered at a meeting in December, expressed confidence that Spain and Portugal will be able to keep their budget deficits under control. They insisted that there was no need to bolster the EU's general bailout fund, arguing that the existing €750 billion credit line would see these countries through any future crisis. Whether this is true remains an open question.
Meanwhile, European leaders continue their quibbling and finger-pointing. As Europe's largest economy, Germany is predictably opposed to paying the bulk of any larger bailout fund or launching Europe-wide bond sales. German Chancellor Angela Merkel's immediate concern -- as it was in holding out against the bailout package for Greece -- is to avoid alienating and angering taxpayers in her own country. But if Merkel heeds the words of former German Chancellor Helmut Schmidt, she might be inspired to take bold action.
"In general, Europe lacks political leaders," the 92-year-old statesman lamented in a recent interview. "It lacks people in high positions in the national states or in the European institutions with sufficient overview of domestic and international questions and sufficient power of judgment."
It may be that strong political leadership cannot save the European monetary union, but it could be doomed without it. - Renee Cordes
