If you’ve followed Europe’s debt crisis, you probably noticed that on Monday, the rating agency Moody’s issued a new report warning of the “rising severity of the euro area sovereign crisis.” Ho-hum. Almost every week a rating agency downgrades the debt of some European country or bank — or announces that it might do so. These reports have become routine. Well, this one isn’t. If you read it, you discover that it’s no ordinary warning. It’s a loud alarm that Europe is flirting with a continental meltdown.
Here are some chilling excerpts:
●The crisis could “soon enter a phase that policymakers are unable to control.”
●The likelihood of more countries defaulting “is no longer negligible.” (Moody’s already considers Greece to be on the verge of default.)
●Multiple defaults would increase the odds of “one or more of the weaker member states . . . leaving the euro.”
●The banking system in a country leaving the euro “would most likely cease to function meaningfully for a period of time, substantially impairing the flow of credit to the domestic economy and causing a wave of corporate and household defaults.”
●Weakening economies and financial uncertainty could lead to “downward rating pressures” for the strongest euro-area countries (i.e., Germany, the Netherlands) and some countries outside the euro area (Britain, Sweden).
In fairness, Moody’s says that its “central scenario” assumes that the euro area (the 17 countries using the single currency) will survive and that the Europeans will find ways to rescue the weakest members. Already, Greece, Portugal and Ireland have lost their ability to borrow in private markets. But even under its most optimistic outlook, Moody’s foresees “shocks” that leave more countries — possibly, Italy, Spain and Belgium — unable to borrow in private markets. Unless bailed out, these countries would default. At the moment, there is no agreed-upon mechanism to rescue them.
The Moody’s report signals that Europe’s crisis has entered a new, more dangerous phase. People are openly discussing outcomes that once seemed unthinkable: a breakup of the euro area; mass bank failures. Writing in Tuesday’s Financial Times, Polish Foreign Minister Radoslaw Sikorski warned:
“The breakup of the eurozone would be a crisis of apocalyptic proportions, going beyond our financial system. Once the logic of ‘each man for himself’ takes hold, can we really trust everyone to act in a communitarian way and resist the temptation to settle scores in other areas, such as trade?”
A few pages earlier, Gavyn Davies, a well-known European economist, discussed the consequences of a euro-zone breakup: which countries and investors might win or lose. If national currencies were re-created (say, the German mark, Italian lira and French franc), exchange-rate shifts “would be large and unpredictable.” The financing of international trade could “collapse for an unknown period of time.”
What could cause events to spin out of control is a so-called “sudden stop”: Fearful investors, losing confidence in the euro, would retreat from lending and sell euro-denominated stocks and bonds. Interest rates would rise. Some countries would be unable to borrow or could do so only at punitive rates. A “stampede out of all euro-denominated assets,” writes Davies, could cause prices to plunge.
Europe is about one-fifth of the global economy, and the effects on the rest of the world, including the United States, would almost certainly be bad. Between a fifth and a quarter of U.S. exports go to Europe. On Monday, the Organization for Economic Cooperation and Development in Paris said that the euro area is already in a mild recession that will make its debt problem harder to solve. Pointedly, however, the OECD warned that its 2012 economic forecast might be too optimistic if the debt problem can’t be defused.
European leaders are gathering this week to fashion measures that would reassure lenders and investors. In the past 18 months, there have been many such meetings. None so far has restored confidence.