People watch Irish Finance Minister speak on television in a pub window, in Dublin Wednesday as the Irish government unveiled a range of tough austerity measures designed to help solve the country's debt crisis.Peter Morrison
Europe is sinking ever deeper into a crisis of confidence that its leaders seem unable to stop, threatening the region's political and social stability.
The debt troubles of the weaker links in the euro zone are snowballing, driving the costs of government borrowing even higher, forcing brutal cutbacks and undermining the common currency.
The planned European bailout for Ireland failed to soothe rattled markets Wednesday, and persistent defences of their solvency by Spanish and Portuguese politicians didn't do the trick either.
Instead, worried investors fled in droves from troubled euro zone bonds, taking Spanish and Portuguese bond yields to their widest levels against comparable German bonds since before the adoption of the euro.
At the same time, Ireland's embattled government unveiled a harsh austerity plan, angering its public, while Portugal was effectively shut down by a national strike similar to those that have played out in several countries.
What has made bond holders so nervous and turned Europe into a potential powder keg is the fear that Portugal and Spain will soon have no choice but to follow Greece and Ireland and accept multibillion-euro rescue packages, in the face of high deficits, soaring debt levels and crushingly high public financing costs. Banks handling a Spanish bond issue decided this week to wait for the current storm to pass before coming to market, published reports indicated Wednesday.
"The markets should not expect that the higher bond yields and borrowing costs experienced this year for the peripheral euro zone sovereigns [bonds]will come down significantly, even in the best-case scenarios," said Sonia Pangusion, a senior economist with IHS Global Insight.
What nervous investors need to see is a clear long-term strategy for cleaning up the mess and a firm commitment from Berlin to pay for it, if necessary, euro zone watchers say.
The confidence-rebuilding exercise could begin next week at the European Central Bank's next policy-setting meeting, if the ECB extends the existing lending facilities for troubled banks in Ireland, Greece and other euro zone countries and squelches the hawkish rhetoric.
German policy makers, including Chancellor Angela Merkel, helped fuel the flight by again warning that bondholders would have to bear a share of the cost of future bailouts. Hawkish comments from ECB insiders also stoked fears that the central bank will soon cut off the banks' lifelines.
And Ms. Merkel did her part by openly fretting about the future of the euro itself, warning that its situation was "exceptionally serious."
This provoked the ire of Austrian central bank head Ewald Nowotny, an ECB board member, who unhelpfully declared: "This is not differentiating between the euro as a currency and the problems of individual states. … The euro is not in danger, individual states are in danger," he said in a TV interview.
Ms. Merkel is "right, but she shouldn't be saying stuff like that," said Benjamin Reitzes, an economist who tracks the region's developments for BMO Nesbitt Burns in Toronto. "All she's doing is confirming people's worst fears, that there is a chance that the euro could collapse. That prompts more speculative bets from people that the euro's going to fall pretty sharply. It's kind of a self-fulfilling prophecy."
One problem is that no one knows how many more billions will have to be injected into the euro zone's struggling banks and to shore up fiscally challenged governments on the periphery. Or who is going to foot the bills.
"At this point, talking about the differences between countries and what certain countries have gotten right and others have gotten wrong is almost irrelevant, because once investor panic sets in, it's really going to drive what happens," says Marko Papic, senior European analyst with Stratfor, a global intelligence firm based in Austin, Tex.
Investors were already fully aware of the deficit woes and banking problems faced by the region's have-nots. "Now investors want to see if Germany is serious about the EFSF [the European Financial Stability Facility]and whether it can be enacted smoothly," Mr. Papic said.
"It's not a question of Ireland any more. It's what the EU will do for Portugal and especially Spain," he said. "It doesn't have to come to a bailout. But Europe will have to do something to calm the markets."
In fact, Europe's €750-billion backstop, which includes the as-yet-unfunded EFSF and funding from the International Monetary Fund and the European Commission, is large enough "to bail out Ireland, Portugal and Spain for the next two to three years," Mr. Papic said. "The problem - and this is what investors are starting to realize - is that this is starting to look very bad in the long term, because German intentions are unclear."
But worries about the future of the euro are bound to persist, because "countries are going to be yearning to use all their policy levers [to resolve their financial crises] which means devaluing," said Arthur Heinmaa, managing partner with Toron Investment Management in Toronto. And that would require reclaiming their own currencies.