There is No Political Solution to Europe’s Debt Crisis

Europe’s sovereign debt crisis isn’t coming to an end until its political class recognizes that a recession is unavoidable.

Commentators have lamented for months the fact that Europe’s leaders seem incapable of solving the continent’s spiraling debt crisis that has most recently engulfed Italy and could soon reach France. Their endless summitry produces little but compromises and feeble accords that fail to restore confidence from financial markets is the consensus among experts. If only they would do this or that, they complain, the crisis could be over in a heartbeat — glaring over the fact that the politicians usually did do this or that months ago before the experts said they needed an even bigger bailout fund or ever-closer union.

Europe’s debt crisis isn’t coming to an end until its political class recognizes that a recession is unavoidable. Such high levels of debt as were amassed in the years preceding the downturn require a contraction and painful bank deleveraging process to restore a modicum of economic sanity in the eurozone.

That means that banks which loaned endlessly to bankrupt countries like Greece and Italy have to write off part of their outstanding loans and it requires that especially public-sector workers in the peripheral countries of the single currency area accept pay and pension cuts. Neither is quite willing to take their losses yet. The fantasy that they won’t have to is unfortunately perpetuated by Europe’s leaders every time they convene and promise to pull out the “bazooka” to shoot a hole in the financial uncertainty and end the crisis overnight.

The road ahead will be tough. Short of printing money and inflating the debt, the only way out of Europe’s crisis is strict fiscal consolidation (otherwise known as spending no more than you take in) and the prospect of sustainable growth.

To that end, at least some banks that are sitting on their money because they know what’s coming will have to collapse. If they’ve invested billions in worthless peripheral sovereign bonds, they deserve the same fate any other business does that makes a lousy investment decision — failure.

Moreover, countries like Greece and to a lesser degree Italy and Spain, will have to enact major economic reforms to boost their competitiveness. They will have to cut wages, reduce pension obligations, eliminate burdensome labor laws as well as totally superfluous restrictions on production and trade that do more to hurt their economies than protect their industries.

That means that these countries have to break the power of the unions which is an unpopular thing to do in places that have enjoyed economic expansion for roughly two decades not in spite of but because they became part of Europe’s single market and reduced trade restrictions.

National politicians never praised the benefits of European Union membership. Across Southern Europe, they met entry criteria to the letter or they cooked the books but they never embraced trade liberalization and economic integration as a path to prosperity because in the short term, it made jobs redundant and voters angry.

Now they blame Germany for insisting that they enter the age of globalization, modernize their economies in a matter of years where it took the Germans two decades and rein in their pervasive welfare states. In reality, they have only themselves to blame and it’s going to get much harder for them in the years to come if they don’t do what’s good for them now.