First they rescued Greece and said that was the end of the matter. Then they rescued Ireland and that too was declared to be the end of the bailouts. And now Portugal is saved and this, we are yet again told, is as far as the contagion will spread. Every time there is a rescue, the proclamations from politicians and policymakers that the European sovereign debt crisis is under control become less credible.
Yesterday the Spanish finance minister, Elena Salgado, "absolutely ruled out" the idea that her nation would be next to call on fiscal support from the fund set up by the eurozone and the International Monetary Fund last year. But why should anyone believe her? We heard the same kind of confident talk from Portuguese and Irish politicians before they bowed to the inevitable.
The situation is a mess. European policymakers are still in denial, both about the causes of this emergency and the measures necessary to end it. They claim that a combination of limited bailouts and fiscal austerity can calm the economic seas. But austerity is making those seas more turbulent. The Greek, Irish, Portuguese and Spanish populations, which all have high unemployment, are already protesting about the spending cuts. Doubts are growing about the ability of the political authorities in these nations to bring their budgets into balance. And the markets are perfectly aware that the financial stability fund is simply not big enough to rescue a nation the size of Spain, should it find itself shunned by the European capital markets.
The situation is made worse by a disastrous lack of co-ordination, or agreement, among the European authorities on the nature of the crisis. Yesterday, only hours after the Portuguese Prime Minister, Jose Socrates, had invited in the eurozone, the European Central Bank raised interest rates. Fiscal relief is thus accompanied by monetary tightening: the eurozone authorities give with one hand and take back with the other. Higher interest rates might be appropriate for fast-growing Germany, but for the likes of Spain, Greece and Ireland they are a disaster.
The public debt burden of the nations on Europe's southern and western periphery is too great for them to bear. And deflation in these states threatens to make that debt burden still greater. This is not a problem of liquidity, but solvency. What these countries need is not more borrowing, but some form of restructuring of their existing debt burden. European banks bought sovereign bonds in the boom years at prices that took no account of the possibility of default. Now markets are panicking about the prospect of not getting their money back and are driving up the interest rates at which they lend to these nations.
The way out is to reduce the debt burden. The holders of this debt – European private banks and the European Central Bank – need to be forced to accept a reduction in the value of their bonds. This would be a serious and inevitably painful step. Several banks across the Continent would need to raise fresh capital to cover these losses. But that scenario looks better than the slow-motion economic car crash that is taking place. The longer the problem is allowed to drag on, the greater the costs will be.
Yet European politicians continue to be driven by events. They are unwilling – or unable – to take the bold measures necessary to get ahead of the situation. And they refuse to face the fact that this is not just a European sovereign debt crisis but also a European banking crisis. And so the eurozone emergency is destined to continue. And while it goes on, the future of the single currency will remain in jeopardy.