Forget Washington. Watch Europe.

The President's $447 billion proposed jobs program is largely irrelevant. Congress will pass it in some form. The Republicans can't afford, 14 months before the next election, to entirely block the proposal. They need to demonstrate that they are part of the solution. Their obstructivism on the debt ceiling legislation hurt them more than it hurt the President. Their obstinacy now would let the President set them up to take the fall next year for high unemployment levels. So we can expect a jobs bill soon, probably in the range of $300 billion to $450 billion. It will help create some jobs, but not enough to dramatically reduce unemployment levels. Net impact: not much for the economy, plenty of grist for the political blame game.

The big stakes are over in Europe. The betting now is pretty much for the entire ranch. Proposals for a United States of Europe, on the one hand, compete with proposals for booting Greece (and perhaps other profligate EU members) out of the European Union. Europeans are facing up to the fact that muddling around with bond exchanges and other kicks of the can down the road won't fend off the swarming bond and derivatives vigilantes.

Neither option is attractive. A United States of Europe would appear to foster stability. But stabilizing its debt problems would soak up a lot of the wealth of the northern EU, leaving less capital available to finance future growth. The unexpectedly large burdens of sovereign and bank debt in Europe could cripple growth for years in a region that already suffers from low growth. Europe's per capita income is on average about a third lower than America's. The costs of unifying may widen that gap (a scary thought for Europeans, considering how stagnant America's economy has become). With the rest of the world's economy slowing, there's no powerful economic engine anywhere for the Europeans to latch onto. (China's economy is only one-third the size of America's, and everyone in the entire world wants a piece of it, so Europe can't count on China.)

Besides, it's unclear that unity would last. It didn't for the Soviet Union. Hell, it didn't for Czechoslovakia and Yugoslavia. Why would it last for the entirety of continental Europe (plus, maybe, the U.K.)? Certainly, unity would last as long as Germany and a few other well-off nations wrote checks to poorer member nations. But that's a gravy train that will run dry, perhaps sooner rather than later. Then what? Singing Kumbaya lasts only for a few minutes.

Splitting up the EU could trigger a financial crisis. Europe's banks have been financing the EU's growth, by making many loans to countries that turn out to be dodgy debtors. The bonds of as many as a third of the EU's members are now suspect. Booting Greece and other libertine nations would likely trigger domino defaults. Banks across the Continent might blow up one after the other, like a string of firecrackers on the Fourth. The well-off countries of Europe would have to commit their national wealth to propping the European banking system. The U.S. financial system would falter as well. But then the big American banks would line up at the Fed to receive their bailouts, which would be forthcoming in nanoseconds with an extra large helping of fries.

Whichever way they go, EU nations may well be damned if they do and damned if they don't. But that won't stop them from doing something, because the status quo is untenable. Whatever they do, the impact in America will likely be big. So read those impenetrable news stories about the EU in the middle of the third section of the newspaper. They're important.

Merkel Has the Bazooka, Not Bernanke

The eyes of the financial markets are on Federal Reserve Chairman Ben Bernanke, who will give the Federal Reserve's unofficial annual Financial State of the Union Address at the Kansas City Fed's Jackson Hole conference on Friday, Aug. 26, 2011. Bernanke will almost surely announce one policy measure or another. QE3 is unlikely; QE2 has turned to be largely a bust. The Fed may well choose something like adjusting the mix of maturities of its bond portfolio, shifting toward greater emphasis on the long end in order to push down longer term interest rates. Such a shift may moderately reduce longer term rates. But those rates are already lower than a snake's belly. So the impact of a portfolio shift on economic growth isn't likely to be more than a sacrifice bunt.

Bernanke's problem is that the markets expect him to expend all ammunition. Primarily because of Bernanke's own predilection toward policy action, and his predecessor's issuance to the financial markets of the Greenspan put, the Fed no longer has the option of holding its fire. The markets expect the Fed to maintain its covering fire, and have priced continuing Fed activism into the market. In effect, the Fed has already fired all its ammo, and will be punished with a market rout if it fails to fire. Bernanke surely knows this and is mustering his now meager forces on the firing line.

Governmental action can give the markets a lift when it's unexpected. The one thing the markets don't expect is for Germany and France to sign off on the concept of Euro bonds. At the moment, the world's biggest economic problem isn't America, but the European Union and its spiraling debt crisis. Things have been going from bad to worse, and may lead to another financial crisis a la 2008. Perhaps the one clear way out of the mess would be for the EU to combine and issue Euro bonds, community-wide debt to replace the sickly sovereign debt of profligate members like Greece, Ireland and Portugal, and possibly Spain and Italy. But Euro bonds would amount to a massive transfer of wealth from Germany, and to a lesser degree France, to the weaker nations. The German electorate has yet to wrap their brains around this concept, and it may take a few centuries before they do. They can't simply hand over the wealth--that would feel like they were held up. But imposing strict fiscal controls over beneficiary nations would bring back images of storm troopers goose stepping into foreign capitals. For some reason, many European nations have a problem with this.

Nevertheless, Merkel holds the bazooka. She can surprise the markets by endorsing Euro bonds. It's doubtful she will. But if we're going to have a big upside surprise this August, it will come from Germany, not Jackson Hole.

European Credit Default Swaps: EU 15, Speculators Love?

An undercurrent of the EU sovereign debt crisis is that the Euro zone nations detest the speculators they believe have been gambling on the outcome of the Greek and other bailout efforts. Hedge funds and perhaps some investment banks dabble in credit default swaps protecting against defaults by various Euro zone nations as a way to gain speculative profits. While CDS's may have originated as hedging instruments, just about any financial instrument can be used to speculate as well as hedge. And CDS's, like many derivatives, can be traded on a leveraged basis, which makes them all the more appealing as speculative investments.

Euro zone governments loath speculators in CDS's of EU member nations' debt. Although CDS's nominally take their value from the market for the underlying financial instrument, there is a belief that derivatives markets can affect the markets for underlying financial instruments. In other words, a lot of CDS speculation on a Greek default might push the value of Greek bonds lower, increasing the potential for default by raising the market interest rates Greece must pay. The toxic interaction in the 1987 U.S. stock market crash between stocks and a type of derivatives contract called portfolio insurance fuels such beliefs. Portfolio insurance purported to guarantee the value of portfolios. Mutual funds, pension funds and other institutional investors flocked to this product (which is now extinct). When stocks dipped on Black Monday (Oct. 19, 1987), portfolio insurers began short selling underlying stocks in order hedge themselves against further stock drops. That short selling only increased the downward pressure on stocks, which triggered more selling and short selling. This increased selling impelled more short selling by portfolio insurers, which served only to fuel more panic. The market dropped a total of 22% that day, the greatest percentage drop ever, not excluding the 1929 stock market crash.

The EU's second bailout for Greece involves an expectation of a "voluntary" bond exchange by private holders of Greek debt for longer term debt, something that underlies the credit agencies' view of this bailout as a default. This exchange will entail a 20% loss for those holders. The exchange feature would lower the market value of Greek bonds and, perhaps, might be the sort of thing against which a CDS holder would expect protection. But the International Swaps and Derivatives Association, a trade organization composed of derivatives dealers, has decided that CDS obligations will not be triggered by the second Greek bailout because it doesn't change the terms for all holders of Greek debt. In other words, if a hedge fund holds a CDS on Greek debt and was hoping for a payout because the EU's bailout, part deux, would be considered a default by the rating agencies, it's out of luck.

How many speculators have been hurt by this decision, and how large their losses are, is unknown. The amount is probably not trivial, because all the volatility surrounding the Greek debt situation would provide a plenitude of speculative opportunities. Don't expect a lot of publicity about these losses. The speculators, knowing the EU member nations are probably quietly gloating over this victory, have plenty of reason to lick their wounds in silence. And don't be surprised if the EU, in the next bailout of Greece, Ireland, Portugal or whomever, doesn't try to structure things so that CDS's payment requirements again aren't triggered, and the speculators get spanked again.

With the Second Greek Bailout, Will Greece Become Germany or Germany Become Greece?

The second Euro zone bailout for Greece confirms what was pretty clear from the tea leaves: the political leadership of the EU intends to stand behind all the public debt and all of the banks of all its members. This bailout gives the can another kick down the road, pushing back debt maturities but still leaving Greece facing an unsustainable debt load. While there is a provision for an exchange of bonds by private holders that would involve a 20% loss for them, that's a pretty generous deal considering that these bonds traded at a 50% discount in the open market. You can call it bailout light. The bond exchanges won't do much to reduce Greece's total debt load. More bailouts loom.

The Greek Bailout, Part Deux, necessitates more austerity. A nation where the public sector is 40% of GDP, Greece is looking at years of constraint in government spending. Politically, that will be a challenge. But the alternative--departure from the Euro zone to pursue other interests--would be worse. So Greece will have to man up and tighten its belt. Right?

Well, not so fast. The second bailout requires closer political supervision of Athens by Brussels than ever before. The same will be true for Ireland, Portugal and other nations, if they tap into the brave new bailout facility. The Euro zone is cruising toward political union. For a while, no high ranking European officials will say so. But political union is essential to prevent the bailout process from fostering an ever bigger sovereign debt bubble. Otherwise, the bailees could allow their public debt to keep growing, and stick the costs on their wealthy northern European benefactors. Greece, therefore, must become Germany.

But will it? There are obvious cultural, historical and linguistic differences between the two nations, differences that have existed for thousands of years. There are also lingering memories of World War II, in which Greece suffered under harsh German occupation. Greece won't transform itself over the next five years into the new Pomerania.

The very concept of political union implies a melding of traditions and cultures. All member nations of the EU will have a political voice, and they will have to listen to each other. All will influence the others. Such is the case with political amalgamation. The Roman Empire, at its indolent, libertine, epicurean peak, was a far cry from the relatively simple, disciplined world of Cincinnatus. America, the world's melting pot, has grown far from the spare, repressed, colorless culture of the Puritans, absorbing words, foods and values from wave after wave of immigrants. As the EU becomes the United States of Europe, Germany will absorb ideas and values from other members, including Greece. Southern Europe will also change to more closely resemble its northern neighbors. But the final outcome is unpredictable. Consider Daimler-Benz's acquisition of Chrysler Corporation.

Daimler-Benz merged with Chrysler in 1998. The idea was to give Daimler-Benz a bigger presence in North America, while joining Chrysler with a company that had much higher product quality standards. The Mercedes vehicles of the 1980s and early 1990s generally had excellent reviews for quality, reliability and safety. Chrysler, it was hoped, would become Mercedes.

That didn't happened. During the decade that Daimler-Benz was affiliated with Chrysler, Mercedes' products frequently got mediocre reviews for quality and reliability and Chrysler's products remained as crummy as ever. (See Consumer Reports.) In other words, Mercedes became Chrysler. Things got so bad the two companies went their separate ways.

Maybe Germany will become Greece. With a raucous, unruly union on its hands, Germany may find it easier to defer problems than face the pain of resolving them. The second Greek bailout's tack of pushing debt maturities back--another kick down the road for the can--doesn't portend well for a Germanic EU. Actual reduction of Greek and other sovereign debt loads is the litmus test for the EU's viability, and that fat lady ain't singing yet.

It will be up to the legislatures of individual Euro bloc nations to approve the second Greek bailout. Chances are they will, maybe with a teaspoon or two of rancor. The chances of a major financial crisis from the EU's sovereign debt problems have diminished for a couple of months, perhaps. But don't let your guard down. The American debt ceiling squabble is accelerating rapidly from 60 to 120. Ireland and Portugal may take their hats into their hands, and line for their second turns at the bailout trough. Ours is a world living on borrowed money, and consequently, we're never truly in control of our lives.

What Are They Not Telling Us About the Euro Debt Crisis?

The European Union is scrambling to put together a second bailout for Greece, which would follow the bailout granted last year that everyone now admits isn't enough. See http://www.cnbc.com/id/43219315. The insufficiency of last year's bailout isn't exactly a surprise, since financial markets Cassandras were predicting its failure almost as soon as it was announced. But the celerity of Bailout, Part Deux is notable. Even though objecting conservative political groups in northern Europe have grown more vociferous, there seems little hesitation on the part of Europe's mainstream leaders to gather planes, trains and buses to take more bailout money to Greece. A second, and speedier than the first, bailout only heightens the hazardous morality of the situation. For all practical purposes, every Euro bloc nation is assuming responsibility for all the sovereign and bank debt of all other Euro bloc nations.

What gives? People don't cover the debts of other people they can't control without powerful reasons. Even if Europe's banks have stupidly overextended loans to Greece--and Ireland, Portugal, Spain, Italy and all the other troubled Euro bloc nations--one wonders why they can't take appropriate haircuts on that debt, recapitalize the dumb banks, and move on. The U.S. just largely did that with its banking system to get past the mortgage market morass. While the process was painful and very costly, and left us with high unemployment, the financial system survived. Exactly what is it about Europe's sovereign debt crisis that is so scary?

It may depend on what we don't know. Importantly, the derivatives markets continue to be opaque. Unknown are the size and concentration of credit default swap and currency derivatives exposures that might be affected by a Greek default (which we assume would trigger falling values for Ireland's, Portugal's, Spain's and perhaps Italy's and Belgium's debt). Because derivatives contracts can be traded on a highly leveraged basis, the costs of a Greek default could be multiplied many times over by speculative enthusiasm in the derivatives markets. And because there are no organized exchanges or clearing houses for most derivatives contracts, it's very difficult to find out whether this multiplicity of risk, if it exists, is appropriately dispersed or disastrously concentrated a la AIG, circa 2008.

Even though many European politicians are making noise about soft defaults and other largely symbolic concessions by creditors, the European Central Bank has very firmly stated it will not accept any bailout that involves a restructuring of Greek (or other dodgy) debt. The ECB's resolute refusal to agree to any restructuring whatsoever is another twist in the entrails that indicates something, like a snake pit of derivatives exposures, is mucking up the situation.

We learned from the 2007-08 financial crisis that what we don't know could hurt us. One would hope that financial regulators and other government officials have moved up the learning curve. Perhaps they have. Perhaps they're keeping mum to avoid triggering a run on their banks. It seems that a deep fog has settled over the European financial system, and the costs and ramifications of the Euro sovereign debt crisis might end up gradually emerging, dank and fetid, like a monster from a swamp, except this might be a real swamp and it could be a real monster.

Slow Mo Euro Woes

High ranking Greek officials have several times in recent days strenuously denied that Greece is considering leaving the Euro bloc. The strength and frequency of their denials leaves the distinct impression that Greece is thinking of leaving the Euro bloc. Although bailed out last year, Greece is still struggling. Maybe it's all just a wink and a bluff, but the Greeks seem to have gotten somewhere. Late last week, high level Euro bloc finance officials conceded that Greece would likely get a sweeter bailout.

The Irish government, fresh from being bailed out just six months ago, has put in its claim for more porridge if the Greeks get more. Seems that when it comes to bailouts, the bailees expect most favored nation status as a matter of course. The Euro powers will be hard put to deny the Irish equality in handouts, as an Irish departure from the Euro bloc could be as damaging as a Greek withdrawal. And it seems likely that Portugal, which just signed up for a bailout, would get an improved package along with Greece and Ireland.

The Euro crisis is pretty much playing out as predicted last year--the bailouts were inadequate and the bailees would return to the trough for more. Germany, France and the other wealthy EU nations will pony up. Their own banks hold large amounts of Greek, Irish, Portuguese and other funky EU sovereign debt, and a dissolution of the EU, even partial, could trigger big losses.

At the same time, however, the political waters in Europe have become more treacherous. A recent election in Finland, of all places, signaled that the anti-bailout interests are growing in influence. One might dismiss that as due to something in reindeer milk, except that anti-Euro groups through Europe are rising in the polls. The pro-EU politicians are drawing out the bailout process, apparently hoping that doling out the pain gradually over time will make the bailouts easier to swallow. But that also brings the problem back into the headlines time and again. The EU is bogging down in repetitive bailout syndrome. Whether its strategy of rationing pain slowly works, or becomes the death of a thousand bailouts, remains to be seen. The keys to EU prosperity--balancing the union's economic imbalances and spurring greater growth--seem consigned to the back burner. That gives the political scalawags room to dance, and they'll choose a danse macabre for the EU if they can.

A Question for the Chairman: Is the Fed Doing Its Part to Reduce the Federal Deficit?

This week, Chairman Ben Bernanke of the Federal Reserve holds the first ever press conference by a Fed Chairman. The wisdom of opening himself up to volleys of dumb, loaded, and unfair questions isn't crystal clear. Since, however, he's voluntarily decided to position the seat of his pants in the middle of a firing range, here's a question that should be posed to him.

It's Econ 101 that the lower the price of something, the more of it people will consume. Isn't the Fed making it easy for the federal government to run massive deficits by keeping interest rates ultra low?

The stated purpose of low interest rates is to stimulate the economy. But they also stimulate government borrowing. Look at Japan. Its public debt is something like 200% of its GDP (America's is around 70%). But interest rates in Japan are so low that the government's annual bill for borrowing all this moola isn't terribly painful. Most Japanese government debt is held by Japanese citizens, who seem perfectly willing to refinance the government every time its debt falls due, asking for scarcely any interest income at all. From an economic standpoint, it makes sense for the Japanese government to keep borrowing. Since it can roll over maturing debt at will for ultra low rates, it never really needs to control its deficits and can keep borrowing more at minimal interest expense. The U.S. Treasury, too, can easily roll over its debt at historically low prices. So its need to reduce deficits isn't pressing.

The Fed's low interest rate policy is inflating commodities and equities, but its impact beyond that is unclear. Big banks aren't increasing the net amounts of their loan portfolios and small businesses still limp along with working capital from their owners' credit cards. Real estate remains moribund, with more of the same expected for the future. Raising interest rates will make financial markets speculators unhappy. But let's remember that central bank manipulation of asset prices doesn't produce lasting prosperity, but indeed the opposite (for further reading, see 2007-08 financial crisis).

For all the political hoopla over deficits, reality is that money talks and bullsh . . . uh, political dialogue walks. What's forced Greece, Ireland, Portugal and other Euro bloc nations to rein in their spending? Not frowning bureaucrats in Brussels, but rising interest rates demanded by their creditors. Chairman Bernanke recently scolded Congress and the administration for not doing enough to reduce the deficit. Well, remember, Mr. Chairman, money talks and bu . . . well, you know. If you want the government to reduce the deficit, make it pay for borrowing.

Euro Zone on a Slippery Slope

After taking a break for the holidays, the Euro zone's debt crisis is back in full swing. Portugal is now under pressure to take a bailout. As previously choreographed for Greece and Ireland, the Portuguese government is strenuously resisting the idea, proclaiming that it has more than met its goal this year for deficit reduction. If things go according to script, the bond markets will smack Portugal around, and European leaders will pressure Lisbon to bite the bullet before other dominoes--think Spain and Belgium--being to teeter.

This time, China and Japan have joined the fun. Both nations committed to buy bonds to help shaky Euro bloc nations, Spanish debt in the case of China and special bailout bonds jointly issued by the Euro bloc nations in the case of Japan. This isn't altruism. Both Asian nations are export-driven, and already hold significant amounts of Euro-denominated investments. They have plenty to gain if the Euro zone stabilizes and much to lose if it doesn't.

Europeans may welcome the Asian infusion. But it changes the landscape. The more China and Japan help Europe, the more they would want the EU to remain intact. Germany and other wealthy EU members may find themselves increasingly constrained to support their profligate neighbors, even as their citizens become more restive over the costs. The political dialogue in Europe could deteriorate, particularly if EU leaders appear to pay heed to China and Japan while their citizens pay more taxes.

The Euro zone is on a slippery slope. That China and Japan would openly acknowledge their support for Euro zone debt highlights Europe's inability to finance itself. The more Europe needs outside help, the fewer options the Euro zone will have. Unity will be its only rational option. The need to pay back Revolutionary War debt was one of the major reasons why the 13 rebellious British colonies in North America remained united after attaining independence--ultimately, the United States assumed responsibility for this debt as part of the price of ratification of the Constitution. Europe will have to move toward greater political union in order to establish greater fiscal control and restraint.

But people aren't always rational. In the preceding century, Europe was the principal battleground for two world wars that killed tens of millions. Why? Historians still debate that question, but there's no rational explanation. Although the Euro's problems won't lead to war (the Europeans learned from WWII not to be trigger happy), precipitous secessions by wealthier Euro bloc members can't be excluded. Electorates have a limited tolerance for bailouts, as the American mid-term elections last year illustrate.

There's no to know for certain how things in Europe will end up. But the continent cannot maintain the status quo. It's on a slippery slope, and time will tell which way it slips.

Bondholder Bonanza in Europe

If you believe in reincarnation, think seriously about coming back as a holder of Euro-denominated bonds. (Or, skip the reincarnation part and just buy some.) Today, the bailout of Ireland makes clear that every nation in the European Union guarantees the obligations of every other EU nation, and also the obligations of every bank in every EU nation. Holders of European debt are in Heaven, dancing cheek to cheek with EU taxpayers.

The Germans (and French, kind of) made some noise about bondholders sharing in the losses from future national financial crises. But when push comes to shove, which could be in a week or two with Portugal, it's essentially a certainty that the dour Chancellor Merkel and frenetic President Sarkozy will hold their noses and sign another blank check. That's because the real beneficiaries of these bailouts aren't Ireland, Greece or whoever. They're German, French and other EU banks, which hold shiploads of Irish, Greek, etc. debt. A default by these nations would put the banks down the street from Chancellor Merkel's or President Sarkozy's office at risk, and those banks and their various constituencies are the real reason the wealthy EU nations are spreading Christmas cheer to the poorer EU nations.

It doesn't have to be this way. The sovereign debt crisis began with a dust up in Dubai about a year ago. While Dubai's problems quickly moved off the front page with the revelations of Greece economizing on the truth about its budget deficit, a workout continued quietly. Not long ago, the Dubai debt problem was resolved with some bond holders taking losses. Farther back in time, international financial crises in Latin America during the 1970s and 1980s involved banks taking losses on their loans. There is nothing magical about being a creditor that necessarily insulates one from loss.

The distressed nations can't devalue their currencies to boost their economies through exports (a standard maneuver in such circumstances). They all use the Euro, and its value is maintained by the European Central Bank. Only the long, poorly paved road of austerity and higher taxes is open to them. Without bailouts, defaults would loom and the debtor nations might have to leave the Euro bloc. Since Germany and France want the Euro to work, they are left with little choice except to make nice-nice with bondholders.

But just as American taxpayers are tired of bailing out bankers in New York, German taxpayers may eventually tire of bailing out the money men in Frankfurt. The poorer EU nations aren't leaving the Euro bloc--with Germany backstopping them, they have every incentive to stay. The Germans may, in the end, be the ones who leave. The more the Germans bail out profligacy in other nations and reckless lending by their own banks, the more their own financial condition will deteriorate. If Germany guaranteed all EU sovereign and bank debt, it would be in lousy shape. Since it more or less implicitly has done just that, it is. German taxpayers have already carried the substantial burden of incorporating East Germany in the West. They very possibly won't want the burden of incorporating the entire EU into Germany.

Thankfulness

Turkey Day approaches, so let's see who's thankful.

GS to Feds. Goldman Sachs surely is thankful to the federal law enforcement personnel who are so assiduously pursuing suspected insider trading by hedge funds and other money managers. This evidently could be a big case, big enough to make the investing public forget all about ABACUS-2007-AC1 and Fabrice Tourre's juvenile e-mails.

Fed to Ireland. The Federal Reserve may be quietly grateful that Ireland is having such well-publicized debt problems. It's brought Europe's sovereign debt crisis back onto the front page, and if liquidity problems crop up as a result, the Fed will have more justification for its quantitative easing program.

G-20 to North Korea. The gonzo maniacs in North Korea, by revealing their uranium enrichment plant and shelling a South Korean island, have pushed the G-20 and the possibility of a currency devaluation war right out of the news. The potential for a real shooting war in Korea forces the international community to think about what it has in common, at a time when it should give that issue careful thought. Indeed, just days after they acrimoniously failed to reach a trade agreement, South Korea and the U.S. are vividly reminded that they are allies.

Lisa Murkowski to Palin (Bristol). The voting controversy over "Dancing With the Stars" has completely overshadowed any voting controversies in Alaska. For once, a Murkowski may be grateful to a Palin.

Charles Rangel to His Democratic Colleagues. One can't help but suspect that Congressman Rangel might be quietly thankful he's being tried and punished by a House of Representatives controlled by the outgoing Democratic majority. Things could well have been a lot tougher for him if he had stalled the proceedings into the next term.

David Cameron to William and Kate. The prospect of a royal wedding contrasts brightly against the dour grayness of governmental austerity. The prime minister may be grateful for the loss of some front page coverage.

NBA to LeBron. Just about everyone likes seeing a big talker taken down a notch. LeBron has provided this spectacle to basketball fans from sea to shining sea. Schadenfreude spurs growing fan interest with each Miami loss.

America to Salehis. We haven't seen Tareq and Michaele Salehi, the alleged White House party crashers, in the news for quite a while. That's something to be thankful for.

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?