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The Eurozone Crisis Is Back and We Are All in Its Crosshairs

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Once again, the Eurozone debt crisis threatens to suck the oxygen out of the global economy. Two years of austerity across most of Europe continues to produce the predicted effects: We learned this week that Europe's private sector keeps on contracting. Moreover, global investors began to bail again on Spain, driving interest rates on 10-year Spanish government bonds to an unsustainable 7.6 percent. Greek, Portuguese and Irish public finance faced comparable rates, so they have to rely on bailouts. Yet, there isn't nearly enough money in those bailout facilities to rescue Spain, too. That's why this week, Moody's downgraded its outlook for the region's strongest economies, Germany and the Netherlands. If anything, that move was cautious. If Spain spirals into default, it would likely trigger a continent-wide banking crisis, followed in all likelihood by a real depression. It also could upend our own economy on the eve of the election.

It's a crisis with lots of nubs. For one, Spain is in the middle of the world's sharpest housing contraction and a recession currently forecast to last into 2014. That what happens when austerity dramatically slows public spending while the nation's private banks are writing down tens of billions of Euros in mortgage loans gone bad. The result is that government revenues have been falling faster than government spending, piling up more debt -- and now several of the country's provincial governments say they also cannot keep on going without a lot more support from Madrid.

That is why foreign investors see a growing risk that, sometime soon, Spain's government won't have the money to service its fast-rising debts. The 7.6 percent interest rate on new Spanish debt is the market's current demand to offset that risk. But unless Brussels and Berlin step in with new, credible assurances for those holding Spanish bonds, the interest rate will keep on rising until everyone begins to dump the bonds. Madrid would have to try to borrow even more money, and if it cannot, a sovereign debt default would quickly follow.

Eurozone leaders have tried to head off all of this, but only through a series of indirect and inadequate measures. The immediate threat from a major sovereign debt default is the collapse of dozens of large banks that hold the sovereign debt. German and French banks, for example, hold $600 billion in Spanish bonds. The Eurozone could have followed the basic rule of monetary unions, and used the European Central Bank (ECB) to guarantee those bonds in some way. That's what the Federal Reserve has done for a century here (and the Treasury did it for 50 years before the Fed was created). Yes, it would be harder for the Eurozone to pull that off, since it has no single national government. But it does have a single central bank.

Yet, Angela Merkel has consistently vetoed that course, preferring instead to build a new political and economic environment that could head off future defaults. So, while Greece and Spain slowly sink, with Italy not far behind, Merkel pursues continent-wide banking regulation to discourage future bank runs from one Euro country to another. She also is pushing for continent-wide fiscal arrangements, to head off the large deficit spending down the road that can cripple an unproductive economy when bad times strike. For the current crisis, she has agreed to spend €100 billion from the Eurozone to pay the bills of Greece's government this year. She also has allocated another €100 billion to bail out the balance sheets of Spanish banks. And she has allowed banks in Germany, France, Italy, and elsewhere to use their Spanish and Italian bonds as collateral from hundreds of billions of Euros in low-cost loans from the ECB.

This week, the markets rendered their latest judgment on those steps. The sky-high interest rates now in Greece, Spain, and looming in Italy tell us that all of Mrs. Merkel's handiwork will not be enough to head off a sovereign debt default. The results could be disastrous for many major European banks and the Eurozone economies. How bad could it be? Even before facing final default, Greece has seen its GDP shrink by 25 percent, its average wage fall by nearly 20 percent, unemployment rise past 20 percent, and government pensions cut back 30 percent.

One final word. On this side of the Atlantic, the political season has made every development fodder for campaign attacks. So, we can count on the president's opponents charging that America under his leadership is following the path of Spain and Greece. That is nonsense. The Eurozone faces a crisis of confidence about the capacity of its less productive economies, burdened by deep recessions and large debt overhangs, to honor their future debts. The irreducible proof is the rising risk premium on new Greek, Spanish and Italian bonds. There is not the slightest hint of such doubts about the United States. The interest rate on 10-year U.S. Treasury bonds is 1.75 percent, less than one-fourth Spain's level; and actual yields are even lower. And while Europe is deep into a double-dip recession with fast-rising unemployment, we have had nearly three years of slow but steady growth and job creation.

To be sure, a European banking crisis triggered by a sovereign debt default, one which spread from Spain to Italy and then across the continent, would almost certainly end our own expansion. American exports to Europe -- our largest foreign market -- would fall sharply. American banks would be hit by losses on thousands of investments and other deals that involve European banks which such a crisis will take down. In the end, our presidential election may well turn on events entirely beyond the influence or control of either President Obama or former Governor Romney. Not even their legions of consultants and operatives, and the stream of billionaires funding the campaign's television wars, will be able to override the economic consequences here at home of either a full-blown Eurozone meltdown or, for that matter, the successful resolution of the crisis.