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The Consequences of the Slow-Moving European Debt Crisis

In Europe, the policies of retrenchment that have been imposed upon Greece and Ireland have begun to produce their inevitable consequences: contracting economies, rising unemployment and social turmoil, falling tax revenues, rising deficits and rapidly rising ratios of debt to national income, the exact opposite of the purported aims of precisely these same policies. Equally predictably, this combination of events has led the Greek government to seek, behind the thinnest veil of "secrecy," a restructuring of its debt obligations, presumably to delay the substantial maturities of the next few years into the more distant future. Academic economists, newspaper columnists and these commentaries have pointed out that a prompt restructuring would be the least painful alternative. However, banks throughout Europe, which own substantial amounts of sovereign debt from Greece and other troubled countries, along with the European Central Bank (ECB), which now also owns a very large amount of these bonds, have argued strongly against contemplating any kind of restructuring or default, at least for another year or two. Worse yet, the European Central Bank has threatened to turn a restructuring into a cataclysm by immediately refusing to recognize any Greek debt, or the debt of any other country that restructures, as collateral for loans to banks from the ECB.

The effect of such a collision would be to make nearly every bank in Greece immediately insolvent, to make many other major banks in Europe drastically undercapitalized, and, as is often the case in head-on collisions, to destroy more than half of the capital of the ECB itself, along with the Greek banks. The governments of Germany, France and the UK continue to be paralyzed when it comes to any effective or coordinated responses to these problems. The banks are fighting their usual good fight to be bailed out. They want the ECB and economically strongest European governments to support the markets for weak sovereign debts, to extend new loans and guarantees to weak peripheral country governments and to protect the bonds the banks already own against any consequences of a default, should one occur. Over the past fourteen months, Europeans have been more skeptical than their American counterparts of the various wishful solutions and glittering grand agreements that have been paraded before them.

Perhaps in the next few weeks, certainly in the next few years, we will see some combination of debt defaults or restructurings in Greece and probably Ireland and Portugal; a widespread banking crisis in much of Europe; and a gradual dissolution of the Euro zone, one country at a time. Some aspects of a unified Europe will survive, but the curtain will have fallen on the world's longest-running and most inspiring vision of a world beyond industrial expansion and beyond war.

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