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Europe's week of reckoning

Published:Monday | June 25, 2012 | 12:00 AM

By John Rapley

Greek voters walked up to the edge of the abyss last week. At the last moment, they stepped back. After threatening to elect a government that would tear up the austerity programme agreed with the country's European partners, Greeks opted to stick with the devil they know - at least for now. A majority of seats in the new Parliament went to parties nominally committed to continuing with the programme, which brings with it a promised bailout. Markets rallied as investors heaved a sigh of relief.

Relief that proved to be short-lived: by the end of the week, markets were swooning again, and bond yields in other peripheral European economies, like Spain and Italy, rose to dangerous levels. For investors know what governments struggle to admit. At best, the Greek election bought a few weeks of respite. But the underlying crisis is no closer to resolution.

Later this week, European leaders will meet in a summit to decide what they will do about their worsening predicament. Italian Prime Minister Mario Monti put it aptly when he said Europe has this week to save the euro. Any effort to do so will require closer integration, with Germany lending its full and unconditional support.

Therein lies the problem. Europe needs to vote confidence in itself by giving full support to the financial undertakings of its member parts. Failing this, investors will continue to flee the weak links in the chain, fearing this or that country will be left to its own devices.

However, German Chancellor Angela Merkel is resisting calls for an unconditional commitment to backstop neighbouring governments. As the prudent daughter of a Lutheran pastor, she, like England's Margaret Thatcher before her, thinks governments, like individuals, should take responsibility for their own affairs and not look to others for help.

Europe's leaders are piling the pressure on Ms Merkel. Last week, the head of the International Monetary Fund (IMF), Christine Lagarde, added her voice when she called for a European fiscal union. Such a union could issue the joint debt needed to underwrite Europe's banks and governments. Yet if Ms Merkel is increasingly isolated within Europe, she retains strong support back in Germany. Polls continue to show her compatriots reluctant to run to the rescue of their more profligate partners.


It may be galling to ordinary Germans to provide lifelines to notoriously spendthrift Greeks or Italians. They may consider their southern neighbours beyond redemption: after all, they take dives during football matches. But if they stand firm, Germans risk cutting off their noses to spite their faces. If European economies sink deeper into crisis, they will drag Germany down with them.

Besides, while Germany's good citizens might feel that Europe wouldn't have these problems if everyone were a bit more like them, the truth is that Germans wouldn't be as prosperous as they are today had they not, back in happier times, been just a little bit Greek themselves. When the euro was created, investors were assured they could lend in one country, then take their matured investments and go spend them in another. Because there was no risk of their money losing value, they had implicit guarantees.

That eliminated the risk of lending to fiscally careless, and, therefore, higher-risk, countries like Italy and Greece. Higher risk, of course, meant higher interest rates. Investors, including German banks, crowded into the periphery. That extra demand for, say, Greek or Italian bonds drove down borrowing costs in Athens and Rome. In effect, those governments were being egged on. With a nod and wink, Germany was telling them to go ahead and spend. And it was that spending which drove the German boom.

Germany may have outsourced its irresponsibility to the periphery, but it was indeed irresponsible. Now the bill has come due. It can stick its dining partners with the bill. But Germany knows full well that its partners are broke. Either it will suck up its share, or we will all be left to do so.

John Rapley is a research associate at the International Growth Centre, London School of Economics and Political Science. Email feedback to and