Behind the scenes this week, the euro zone nearly imploded. Zachary Karabell on the wonky move that stopped it.
FROM THE DAILY BEAST | DECEMBER 1, 2011
As Americans went about their lives this past week recovering from turkey, bemused by the latest Herman Cain dramas, the world almost changed dramatically. Fortunately, the largest central banks joined forces to stem the mounting financial crisis—for now.
World equity markets rallied powerfully yesterday after the move, to the tune of more than 4 percent. Yet stock markets were not the real story. What happened was nothing less than a Rubicon moment in what was shaping up to be a financial meltdown of global proportions that would have made what happened in the fall of 2008 look tepid.
The reason, of course, is the crisis of the euro zone. And a crisis it is, with every major European leader attesting to just that. In the past two weeks, that crisis went from slow burn to raging fire. You wouldn’t have known that from the mainstream media, but the panic in finance-land was palpable, so much so that I began to wonder if we were at an August 1914 moment, when the world was about to change forever—and not in good ways.
It wasn’t just the normal array of doomsday voices noticing a sudden deterioration of credit markets and adding their own pessimism about things like fiat currencies and towering mountains of debt. It was the clear indication that the European Union and the common currency were in peril, and that there is no road map for its dissolution. As one European minister put it, it is fairly easy to make an omelet out of a bunch of eggs, but how to do you make a bunch of eggs out of an omelet? The path to creating the euro was complicated enough, but the way out? There is none.
And that is what Europe has been confronting: the end of its bold experiment of economic union. As much as I recoil at hyperbole, that prospect demands it. If the euro zone dissolves rapidly, the global economy implodes. Period. That means stocks everywhere crash; hundreds of millions of jobs are imperiled; bond markets freeze; money markets seize; banks fail; governments panic; and people riot. Some of that happened in anticipation of such a failure—in Italy, in England, in Greece—but these were barely dress rehearsals.
Yes, in time, people would—as humans always do—find a way through. But if the euro zone collapses as an economic union, there is only the yawning unknown and the chaos that would ensue before clarity. The effects would be profoundly disruptive. In the past week, I had vaguely Matrix moments as I watched people go about their lives seemingly oblivious to a reality that might radically disrupt their lives.
So what happened to reverse the tide? An announcement that the largest central banks in the world, including the U.S. Federal Reserve and the European Central Bank, had agreed to reduce the cost of bank borrowing of dollars by half a percent. A seemingly innocuous and highly technical decision that only a few large institutions really grasp, it sent global stock markets up 4 percent, eased credit markets. and in an instant changed the tenor in finance-land from one of intense panic to sudden calm.
Arcane, yes, but central to our lives nonetheless. The crisis was unfolding in the world of daily cash flow, an esoteric world of finance, unlike the reviled Wall Street of outlandish profits, that is a global utility pumping trillions of dollars around the world. It provides the daily dose of money that allows billions to do whatever they must do: buy food, gasoline, get their kids to school, go to work, collect government benefits, and so on. The freezing of that system was what so imperiled the global economy after the collapse of Lehman in the fall of 2008, and that was only one large bank. The implosion of Euroland, in the form of depository banks unable to fund themselves and governments unable to tap markets for the cash they need to operate, would have been many orders of magnitude greater.
The world’s largest central banks acting jointly—along with the Chinese central banks easing conditions simultaneously—was a sign of two things: one, the situation was more dire than almost anyone was acknowledging in public, and two, there is a global political determination not to allow that to happen. For the moment, we can use the past tense, because the immediate crisis has subsided. But there should be no illusion of how serious this almost was and how serious it remains.
The problems of the euro zone have metastasized from Greece and peripheral nations to Italy and France. Silvio Berlusconi survived nearly two decades of scandals, financial and sexual, as well as a no-growth economy, and yet was pushed out within weeks by a bond market that sent Italian yields well above 7 percent. For the past two months, Angela Merkel and Nicolas Sarkozy have met so often to try to contain the financial panic that they have been dubbed “Merkozy.”
The core issue is at the heart of the euro paradox: how do you have a common currency with no common economic policy, and how do you prevent rich states from bailing out poorer or more profligate ones? The answer is: you can’t. Germany has balked at subsidizing the debts of its neighbors, even as its own prosperity depends on those neighbors. So it has refused to allow for common bonds or to give the nod to the European Central Bank to issue more currency. The result has been recession and a gradual freezing of financial activity in Euroland, which in the past weeks went from a slow burn to a rapid deterioration.
Now the Europeans are faced with doing in a crisis what they couldn’t do during years of calm prosperity: relinquish sovereign control of their economic lives, with Italy and Greece and Spain allowing Germans and French to pass judgment on their budgets and finances, and Germans bowing to the bitter fact that they will have to pay more than their share.
There are bound to be flares as this occurs, but it will occur for the simple reason that it must, or else those Armageddon fears become economic realities. Yes, even then, life would go on, just as it did in the 1930s, just as it always has, but those are not outcomes to welcome or to court.
This crisis has been a sharp reminder that we live in a deeply interconnected global financial system where the risk of a meltdown remains. This one has been avoided for now. There may be another abyss in weeks or months. But each time crisis is averted, we learn collectively. Many dismiss that idea, saying that cans are being kicked down the road, debt is not being dealt with, and the system is irremediably flawed. Perhaps. Or perhaps it is simply a messy process, fraught with fear, as we learn how to manage this new world the only way humans ever have, by stops and starts, courting disaster, and trying at all costs to construct a stable future.