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Which Road for Europe?

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This month, Europe will either sink deeper into economic crisis, or drastically reverse course. The results from the first round of the French legislative elections Sunday are encouraging. Projections suggest that after the second round next Sunday, President Francois Hollande's Socialist Party will either have an absolute majority, or, at worst, a working majority with other left parties. This will increase Hollande's leverage within Europe as a counterweight to German Chancellor Angela Merkel.

Merkel's strategy, for now, has been to change the subject. With insane austerity policies having been inflicted on weak economies at the insistence of the German government, Merkel, confronted with a worsening crisis, has been speaking grandiosely of deeper European integration.

But the kind of fiscal integration that Merkel proposes will take years if not decades, and the European economy is going up in smoke right now. Fiscal and tax integration will be even less plausible if it includes German-style austerity.

Meanwhile in Spain, Prime Minister Mariano Rajoy has just demonstrated the paradoxical power of the weak. The Spanish banking system is effectively insolvent because of the after-effects of Spain's housing bubble and the speculative attacks on Spanish bonds (which Standard and Poors has just helpfully downgraded by three notches.)

For weeks, the authorities of the European Central Bank and the European Commission, agents of the austerity imposed on Greece, Ireland and Portugal in exchange for bailouts, have been pleading with Rajoy to take bailout money to rescue Spain's banks, which have interlocks with other European banks. And for weeks, Rajoy has replied that he had no interest in making Spain a ward of the ECB, the EC, and the International Monetary Fund.

This time, happily, it was the European authorities who blinked first. Friday, a deal was announced providing up to 100 billion euros, presumably in the form of low-interest loans, to recapitalize the Spanish banks. But unlike the Greek, Irish, and Portuguese deals, Spain is not to be put under the thumb of the austerity police. Details are yet to be announced.

This is a small gain for economic sanity, and one may expect the other small nations to ask for the same kind of restraint granted Spain. However, in the Spanish case this was a bank bailout that will help the Spanish government indirectly, by restoring confidence thus reducing government borrowing costs. In the case of Greece, Portugal and Ireland, the aid went directly to the government to roll over sovereign bonds.

The larger problem, however, is that all of Europe remains under the surveillance of the ECB and the Commission, which have the power under the EU's Stability and Growth pact to demand that governments take steps to reduce deficits to 3 percent of GDP. This benchmark makes no sense when deficits are mainly the consequence of a depressed economy, which reduces tax revenues. Yet all of Europe remains under this austerity regime.

The pact does have an escape clause that permits waivers during economic emergencies. So far, however, Chancellor Merkel and her allies on the European Commission in Brussels have refused to admit that the escape clause is there and are enforcing austerity demands as if these were normal times.

Hollande's working legislative majority, Rajoy's display of nerve, the criticism by ECB President Mario Draghi of the politicians' dithering, and Merkel's increasing isolation among European leaders should increase the chances that the austerity mongers may yet relent. But Merkel, thus far, shows no sign of moderating her stance.

Her talk of deeper European integration is a feint pure and simple. It has impressed a few commentators, but Europe's other leaders see through it. At the upcoming summit of European leaders June 28-29, Merkel is expected to embrace increased European investment funds for hard hit peripheral economies. This will help, but will also take time for its impact to be felt.

If Merkel wants to display her commitment to the European project and economic recovery right now, the most immediate and practical thing she could do is to throw her support behind the suspension of austerity policies. This would be no small reversal, since Merkel has been a prime architect.

Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos. His latest book is A Presidency in Peril.