Are we watching Europe’s Wile E. Coyote moment?

The Global Exchange - The Globe and Mail

October 13, 2011

Poor old Europe. Like the protagonists in the famous cartoon, Europe is chasing after a solution to a crisis that began in May, 2010, but a happy ending remains elusive. Wile E. Coyote chases after the Roadrunner but never quite catches him.

Markets have not only rejected solution after solution, but even politicians outside the euro zone have become vocal. The U.S. is pleading with European politicians to get their act together and the UK’s prime minister insists that a “big bazooka” solution is the only way to go.

But the main protagonists in the real European drama, President Nicolas Sarkozy of France and German Chancellor Angela Merkel, still do not appear to realize that they may well have already run off a cliff with disastrous consequences for the world economy.

Like Wile E. Coyote, who falls in the canyon below only after he actually realizes that there is nothing underneath him but air and gravity, the principal actors in the European drama seem to believe that they can float in thin air if only financial markets and the public would believe them.

Unfortunately, the effects of gravity can’t be avoided. The sovereign crisis that began in Greece is spreading, while various smaller countries in the euro zone, such as Finland and Slovakia, either demand protection from future bailouts or refuse to support the expansion of the European Financial Stability Facility.

Even before an enlarged facility is put in place it is already considered to be vastly under-sized in relation to the expected cost of restructuring the sovereign debt of many euro zone countries. Adding to the misery is the growing realization that the banking sector is weak -- parts of it are likely insolvent -- and in need of massive capital injections if it is to avoid complete collapse.

In the meantime, the French are pushing for a transactions tax that will surely diminish the size of the financial system as institutions move elsewhere, and thereby weaken the ability of European economies to grow and prosper. After all, the global financial crisis of 2008-9 highlighted how much the real economy and the financial sector rely on each other.

For its part, the German government insists that no default can take place until 2013 when the appropriate institutional mechanisms are in place -- as if financial markets are in the mood to wait until then.

Instead of emphasizing how the creation of the euro and the existence of the EU can actually be forces for good when a crisis hits, the main players are laying bare for all to see the failure of the governance structure in place. One only need look at the very uncomfortable position the European Central Bank has been placed under as the reluctant lender of last resort when it was never designed to fulfill this function.

There is also too little co-operation or co-ordination in making collective decisions, giving the rest of the world the impression that some euro zone members are happy to extract the benefits from a monetary union but take a not-in-my-backyard attitude when difficulties in the union emerge. No wonder the Scandinavians, among many others, are looking at the rest of Europe with dismay. Norway, Sweden, and Finland all suffered from large banking crises and managed to extricate themselves largely on their own.

In contrast, the EU and the euro zone seem unwilling to take the necessary measures to restore confidence, instead insisting that a comprehensive solution is always just one summit away. The rest of the world also has a stake in the outcome since financial markets, and indeed goods markets, are so inter-connected.

Unfortunately, the G20 is also playing the role of innocent bystander. The financial relief expected from China and Brazil is also not forthcoming likely for the reasons mentioned above.

The spirit of co-operation that followed the crisis of 2008-9 has seemingly dissipated and there is little stomach among politicians to deal with a global problem through collective action. The days leading up to the Cannes summit in November look to be gloomy to say the least.

Pierre Siklos is a senior fellow at The Centre for International Governance Innovation.

The opinions expressed in this article/multimedia are those of the author(s) and do not necessarily reflect the views of CIGI or its Board of Directors.

About the Author

Pierre Siklos is a CIGI senior fellow. His research interests include applied time series analysis and monetary policy, with a focus on inflation and financial markets.