Over There at the EU Crisis

Paralysis now grips Europe. The EU has no solution for its sovereign debt-banking-economic crisis. Greece is in a political netherworld, with a second election to be held this month to determine, perhaps, if the electorate can choose a government.

But Greece is a side show. Spain now occupies center stage, with a banking crisis that the country itself cannot solve. Although Spain's sovereign debt is, proportionately speaking, no greater than Germany's, enormous losses from a collapsed real estate market have overwhelmed Spain's banks. The government, directly and indirectly, is in the process of taking over its banking system. But it cannot handle the shipload of liabilities it is assuming. So it has turned to the EU.

The EU, in its familiar, inimitable fashion, wallows in dysfunction as it squirms around to find someone to pick up the tab. The European Central Bank, by holding interest rates steady today, has signaled its firm intention not to take responsibility for the messes made by politicians. Most of Europe's politicians have raised their eyebrows in the direction of Germany. But the Germans fear, not irrationally, that they are being asked to pick up the tab not only for the table, but for the entire restaurant. Any bailout of Spain's banks would surely entail greater EU (read, German) control over Spain's banks. That may or may not be acceptable to the Spanish, since German control over Spain's credit spigots means German control over Spain's economy.

Not surprisingly, hints and even calls for American action have grown. It's not at all crazy for Europe to look westward. In 1917 and 1941, the United States called its men to arms in order to end world wars emanating from Europe's endemic political dysfunction. Over 400,000 Americans made the supreme sacrifice in Europe during these two wars and American taxpayers coughed up many, many billions of dollars to stop Europeans from killing each other. In 1947, America adopted the Marshall Plan, an extraordinary act of generosity that propped up a Europe devastated by war and prevented much of the continent from falling under Soviet control. Surely, it's quite rational for Europe to expect America to step up again and reach for the tab. We've fostered the greatest case of moral hazard in human history, and now have to live with the consequences.

But America has its own problems. The vituperative animosity between Republicans and Democrats, well-exemplified by the bitterness of Wisconsin's recall election, prevents the President and Congress from taking effective action before this fall's presidential election. Action thereafter, even if possible, may be too late.

That leaves the Federal Reserve. Market players twitch their ears around, hoping for any sound of Chairman Bernanke warming up his helicopter. We know from the 2008 financial crisis that Bernanke's default setting is to act. That setting isn't going to change in the foreseeable future. Whether or not the Fed can do anything effective is a different question. More QE might temporarily support the stock markets--and, naturally, that's Wall Street's underlying motive in encouraging an activist Fed. Never mind the spectacle of America's capitalists par excellence looking for more government intervention. But there's little reason to think that QE III will save Europe. The sources of the badness in Europe's bad debt won't be cured by Fed purchases of dollar denominated debt.

Is there any way the Fed could have an impact in Europe? The answer is maybe, but it would involve replacing the Euro with the U.S. dollar. Since the Fed can (and perhaps will) printed unlimited quantities of dollars, it could buy up Euro-denominated debt if the sellers would accept dollars. Because the EU crisis involves the heart of the European financial system (banks, central banks and sovereign debt), the result would be to make the dollar Europe's continental currency. Not necessarily for all daily spending at the supermarket and the gas station, but at least for all significant central banking, interbank and monetary policy transactions. With the dollar the only financial asset in the world that is readily available to provide a measure of stability to Europe, conversion from the Euro to the dollar may be the one card the Fed might effectively play.

Europeans wouldn't readily cotton to such a notion, because it would recreate the 1950s and 1960s, when the dollar played such a role and the United States exercised extra-sovereign power over Western Europe. But it might be the way the Fed, being the only central bank in the world with the inclination and capacity to act, could prop up Europe.

In essence, the EU faces a choice between dissolution, German dominance, or in this perhaps far fetched scenario, American dominance. Given the history of the past century, in which America was the most generous and benevolent of super powers, what do we think Europeans might prefer? Germany's stubborn insistence on its world view during the current crisis has, however unfairly, brought back in many European minds images of jackbooted stormtroopers and civilian killings by screaming Stuka dive bombers. But American intervention, if it occurs, would stir memories of raw, inexperienced GIs by dint of sheer determination and courage pushing their way through murderous German fire onto the heights overlooking Omaha Beach, and continuing from there to liberate a continent. A European return to the dollar may be the only real choice left. Time will tell.