- The Washington Times - Friday, August 12, 2011

With markets tumbling on both sides of the Atlantic, French President Nicolas Sarkozy interrupted his summer vacation to hold an emergency meeting about the crisis.

Europe’s out-of-control debt poses far greater and more immediate risk to global markets than Standard & Poor’s U.S. downgrade. When U.S. exchanges began their plunge, investors flocked to U.S. Treasuries, a sign that there’s still a bit of optimism that America will pull through. The liquidity and debt problems in several European nations, however, are so severe that the big two - France and Germany - don’t have enough cash to bail them all out.

The second Greek bailout’s $157 billion from the International Monetary Fund and the European Financial Stability Fund (EFSF) was supposed to end Europe’s debt crisis. Now Ireland and Portugal are standing in line for handouts. The EFSF has allocated 450 billion euros out of a 750 billion euro fund for these three countries, leaving just 300 billion to cover future disasters. Failures ahead promise to be big as Italy and Spain are likely to be the next dominoes.

Madrid and Rome will need more than 700 billion euros to finance their current deficits and pay debt maturing in 2012. The markets recognize this and have imposed heavier borrowing costs on both. In response, banks in these countries earlier this month engaged in a massive sell-off of bonds, with the European Central Bank (ECB) as the main buyer. The effort was a success on paper because it lowered yields and reduced the cost of borrowing for the Italian and Spanish governments. But, because the ECB “sterilizes” its bond purchases by using term deposits to reabsorb the amount of cash it spends, it also drains liquidity from the interbank market.


Such short-term fixes are going to be as ineffective as the Greek bailout. They might provide temporary relief from one symptom while the underlying problems - governments that are too big, spend too much and borrow beyond their capacity to repay - grow worse. European opposition to spending cuts such as Prime Minister Silvio Berlusconi’s attempts to tackle Italy’s budget deficit has been fierce and overwhelming.

It’s big trouble when anybody has to depend on France coming to their rescue, as it is the most highly indebted country to hold the prized AAA credit rating. The Paris government has racked up debt that’s 85 percent of gross domestic product, which is perilously close to the 90 percent level identified by Carmen Reinhart of the Peterson Institute and Kenneth Rogoff of Harvard as the tipping point where debt begins to act as a significant drag on economic growth. Small wonder the French economy is predicted to grow at an anemic 0.2 percent in the third quarter of this year - worse even than America. France is one half-step away from full-blown recession.

All this leaves Germany holding the bag. Even if Berlin were willing to bail out its feckless fellow EU members, it simply doesn’t have the capacity to do it. Germany has indicated it won’t support further increases in the EFSF. Current plans are unlikely to stop the contagion from spreading, which means more credit downgrades are in the offing. France could be next. Those looking for stability in international markets should be nervous.

Nita Ghei is a contributing Opinion writer for The Washington Times.