Unresolved debt crisis sets off political shock waves

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Europe's debt problems are erupting into a full-blown political crisis that that could go from merely damaging economic confidence to shattering the euro zone if it intensifies.

Since the European Union summit on fixing the debt crisis ended Sunday night in Brussels, Italian Prime Minister Silvio Berlusconi has been humiliated, British Prime Minister David Cameron has scrambled to defuse a Tory rebellion on EU membership and German Chancellor Angela Merkel has decided to risk the future of the new European bailout fund on a full parliamentary vote.

The political upheaval comes as the EU is set to unveil a full crisis-fighting package at a second summit on Wednesday, one that economists, investors and global leaders from Beijing to Ottawa think should have come a long time ago. Endless political infighting and delays on dealing with Europe's debt burden have been blamed for extending the crisis, which began two years ago this month when Greece admitted that its debt load was much higher than officially stated.

There is little doubt that the foot-dragging and turmoil are sapping investor and business confidence when they are needed most. Without economic growth, the weakest countries will find it nearly impossible to reverse a buildup of debt that cannot be paid off. New business data released on Monday put the 17-country euro zone at the brink of a fresh recession, if it is not in recession already.

The tensions have come to a boil over the past 48 hours. On Sunday, Mr. Berlusconi, the leader of Europe's most indebted country, suffered the humiliation of not only being dressed down by European Union leaders for his go-slow approach on economic and financial reforms, but being ridiculed for it.

At a news conference, Ms. Merkel and French President Nicolas Sarkozy were asked whether Mr. Berlusconi had reassured them that the Italian economy, the euro zone's third largest, would get fixed. "Merkozy," as they are now dubbed, exchanged glances and smirked, prompting laughter from the reporters. There could be no more damning indictment of the Italians' economic leadership.

For the most part, the Italian media came out in support of Mr. Berlusconi even if some commentators agreed that the country's government is "paralyzed," making it incapable of delivering the reforms needed to insulate it from Greek debt contagion. Indeed, almost no euro zone leader can be applauded for genuine leadership as the currency union goes through an existential crisis.

Late on Monday, as Mr. Berlusconi held an emergency cabinet meeting to devise new economic reform packages to get the stalled economy moving again, dozens of Mr. Cameron's own MPs were lobbying for a referendum on Britain's continued EU membership.

The British Prime Minister, whose country is in the EU but not in the euro zone, meaning it does not share the euro, argued strongly against a referendum.

"First, it's not right because our national interest is to be in the EU, helping to determine the rules governing the single market – our biggest export market, which consumes more than 50 per cent of our exports and which drives much of the investment into the U.K.," he told MPs.

The revolt took at least one casualty Monday, when referendum advocate Adam Holloway told MPs that the only "honest course of action" for him was to resign as parliamentary secretary to Minister for Europe David Lidington.

In Berlin, Ms. Merkel's Christian Democrats have decided to put the euro zone's fix-it package, dominated by the €440-billion bailout fund known as the European Financial Stability Facility (EFSF), to a vote of the entire parliament instead of the parliamentary budget committee. While the leader of Europe's wealthiest economy and prime sponsor of the bailout package is expected to win the vote, Ms. Merkel risks an embarrassing rebellion among the minority of party members who disapprove of bailing out countries they consider the authors of their own misfortune.

As EU politicians squabble, Europe's economies are suffering. The growth of almost every country in the euro zone and in the wider EU has gone into reverse this year. Deutsche Bank's economists predict that Germany's growth will decline to 2.8 per cent this year from 3.6 per cent last year. Next year, the German economy is expected to expand by only 0.4 per cent.

France's growth, at 1.4 per cent, is expected to be flat year-on-year and fall to a negligible 0.3 per cent in 2012. Almost every forecast puts Italy in recession next year while Greece and Portugal are to remain mired in brutal downturns that could endure for years.

On Monday a closely watched business survey, the Purchasing Managers Index (PMI), left little doubt that the euro zone is slowing to the point that it is in recession or on the edge of one. The PMI in October fell to 47.2, according to data services firm Markit, the lowest level since the region came out of recession in mid-2009. A reading of 50 or less signals a drop in business activity.

In a note published Monday, James Nixon, European economist at the French bank Société Générale, said the PMI figures point "to the euro area slipping back into recession in the fourth quarter" with France and the countries on the Mediterranean frontier slowing down alarmingly fast.