The Euro at Gettysburg

The sovereign debt crisis in Europe is evolving into a struggle over European union. Despite decades of increasing commercial and financial harmonization, Europeans haven't resolved many of their underlying differences and the harmonies are becoming dissonant.

The initial problem was Greece. When Greece adopted the Euro, it hoped to benefit from a stable currency it could use to borrow at comparatively low rates. The key word here is borrow. Germany and other wealthy Euro bloc nations initially welcomed Greece, thinking they were getting easier access to an export customer. Everything worked fine as long as Greece could borrow enough to finance its purchases from Germany and other exporters. The tough task of building Greece's economy to balance its consumption of goods from other nations with industries and businesses of its own that would attract foreign customers somehow got lost in the glow of apparent short term prosperity.

Bailing Greece out required Germany to stop averting its eyes to the ultimate flaw in its strategy of growth through exports: a continuing trade imbalance with the rest of the world cannot be sustained indefinitely. Obdurate exporters sooner or later have to finance their export customers. Japan and China have financed America's consumption. Germany found out the hard way that many of its banks had financed Greece's consumption. Even though much of the German electorate went Tea Party, the German government ultimately joined in a bailout of Greece in order to bail out Germany's banks.

Now Ireland, bogged down in a real estate crisis, has been compelled to seek a bailout. Although the Irish government has the liquid resources to cover its debts until next year, it made the mistake of guaranteeing the obligations of Ireland's banks. This temporarily kept those banks from collapsing. But Irish banks are, to a large degree, mortgage banks. Ireland's real estate crisis may be more severe than America's, and the liabilities of Ireland's banks are enormous for a nation of Ireland's size. By backing Irish banks, Ireland's government transferred their potential insolvency onto itself. It now has little choice but to take a bailout the EU has been pressing upon it.

One of the weird things about the Irish crisis is that the bailers have been urging the bailee to take the handout. That's because the EU has much bigger problems that the Irish mess is exacerbating. Bond vigilantes see a row of dominos to exploit. If Ireland falls, Portugal is likely to be next, and Spain could follow. The EU desperately wants to forestall the domino effect. While it can keep Greece, Ireland and Portugal afloat, add Spain and all bets could be off.

The EU isn't limiting itself to assistance. It can't resist the temptation to seek change. Ireland has been urged by other EU nations to raise the level of its corporate income tax, which is set at a low rate to attract foreign investment. Other EU nations view the Irish corporate tax as a competitive threat. Ireland has firmly refused to raise its corporate taxes, fearing a further diminution of its now fading prosperity. Although everyone publicly insists that Ireland raising the corporate tax rate isn't a condition to the bailout, discussion of this point will likely not end with the bailout.

The intimations of other EU nations that Ireland raise its low corporate rate is a sign that the EU in its current iteration cannot last. Either the union becomes more centralized, with greater control exercised from Brussels, or the Euro must be abandoned and national currencies reinstated. Ireland's defiant refusal to change its tax laws tells us that the outcome isn't without doubt.

The bailers want more. Germany's chancellor, Angela Merkel, recently convinced other EU nations to agree that bond investors might have to share losses from sovereign debt defaults. The bond market threw a hissy fit. Its consternation was surely fueled by the experience of Dubai debtholders (remember the Dubai debt crisis, only a year ago but now seemingly so distant?), who recently had to compromise their claims. There is ultimately nothing golden about sovereign debt, and bondholders may be facing a loperamide moment as they attain a deepened appreciation of their risks. Unhappy bond investors may try to force the issue of union--either the EU becomes more like a single nation and its debt market stabilizes, or short sellers and their derivatives cousins clean up.

In a way, the European debt crisis resembles the battle of Gettysburg. Like the first day of the Civil War battle, the struggle over Greece's debt is where the lines were drawn and positions were taken. In the second day at Gettysburg, the fight went to the periphery. The far left flank of the Union line held at Little Round Top, and then the far right flank held in the contest for Culp's Hill. Europe's current problems are with nations on the periphery of the EU: Ireland and Portugal. Thus far, the EU seems to be holding. But the battle will be determined if and when it reaches the large nations of the EU. Spain may become the first large European nation to be targeted by bond speculators. It's trying to cope with a virulent real estate downturn. A trillion Euros of public debt and another trillion in private debt held by foreigners takes Spain's debt burdens beyond the capacity of existing EU bailout facilities. The willingness of Germany and other wealthy EU members to pony up more bailout money is by no means clear. Chances are they would only if they could impose greater centralized control.

The European imperative for union is in no wise as powerful as America's in 1861. (Remember Yugoslavia? Czechslovakia? The Soviet Union?) The EU has no heros, no 1st Minnesotas, or 20th Maines or Third Brigades from New York. Individual field commanders at Gettysburg--Buford, Reynolds, Hancock, Chamberlain and Greene--took turns acting on their own initiative to hold the line for the Union. But individual national leaders in the EU haven't such latitude; they must act collectively or not at all. If the crisis morphs into its third phase (i.e., Spain), the EU will be put to the test. By the third day of Gettysburg, the Union Army was buoyed by confidence from its successes on the first two days, and it met Pickett's challenge resolutely. But the desire for unity among EU nations is, at best, a work in progress. Before the Civil War, America was known as "these United States." Afterward, it was "the United States." Is Europe ready for that?