Why the Euro Zone Could Unravel Shockingly Fast

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Last week, I attended an informal seminar on the outlook for the euro given by the Foreign Policy Research Institute (FPRI). Two knowledgeable and thoughtful experts analyzed the current woes and historical flaws of the European Union and the common euro currency. The small, sophisticated audience asked sharp questions in response: How would a Greek exit from the euro zone be managed? What was being done to improve labor-market flexibility in Italy? And what would today’s crisis mean to the potential expansion of the E.U. to Turkey and beyond? As I sat listening, it occurred to me that all such policy discussions presuppose that there is in fact a policy to discuss. The real problem facing the euro zone, however, is that there is no longer any such policy, no overall strategy, no big picture.

Political and financial leaders acknowledge the challenges facing the euro zone. But they continue to insist that solutions will be found to keep the system working. Italian Prime Minister Mario Monti has said that some form of euro bonds backed by the countries collectively would allow Greece to remain in the common currency. German Chancellor Angela Merkel remains hesitant about any such bonds, which would largely be supported by Germany’s credit rating. But she has said she is open to greater common financial support.

(VIDEO: Interview with Italian Prime Minister Mario Monti)

The trouble is that such schemes to muddle through are no longer adequate. Debt continues to compound for the financially weakest European countries, and sooner or later it will become unsupportable. Only a massive common financial commitment could turn that trend around. But at this point, there is no grand purpose that could motivate such an enormous commitment. For the past few years, the euro has  been held together simply by whatever practical advantages it offers. And when those practical advantages become too costly, the euro zone could unravel with astonishing speed.

Things were not always so. Following World War II, European unity was essential. Institutions were needed to revive Europe’s shattered economies, to ensure that there would never again be a war between France and Germany and to defend Western countries against the threat of Soviet invasion. These policy objectives were met with a series of multinational organizations, including the forerunner to today’s European Union.

Then a strange thing happened: just when those problems were dissipating, the E.U. began a rush toward aggressive integration and central control. The Berlin Wall fell in 1989, and the Soviet Union broke up in 1991, but monetary union was launched in 1993. Over the following 20 years, the European Union grew from 12 to 27 members. The euro currency went into daily use in 2002. The European Union we know today took shape in 2009, when the Lisbon Treaty went into full effect.

(MORE: Euro Crisis: Why a Greek Exit Could Be Much Worse than Expected)

What caused the drive for expansion and centralization in Europe at the very time the economic and military needs for such unification were declining? Was it some subconscious fear that if Germany stopped giving money to Greece, it might have to invade Poland, as European Parliament member Daniel Hannan once joked? A more serious theory is that Europe is somehow destined by its common culture to move irreversibly toward greater union. The formation of the United States is often cited as a model for such inevitable consolidation. But that parallel ignores two important facts. First, Ontario and the Canadian Maritime Provinces were never joined to the other English-speaking colonies in North America. And more important, those that did combine to become the United States were compelled to stay together because of their fear of the British Empire, a threat that remained potent until the end of the War of 1812. After 1815, with that British threat diminished, the divisions in the United States began to re-emerge – not just between North and South but also between the new Western states and the older Eastern ones.

An alternative explanation for the E.U. is that powerful elites created the drive for unification to further their own interests, irrespective of the consequences for the citizens of the individual European states. These elites include not just the overpaid bureaucrats and functionaries swanning around Brussels and Strasbourg but also multinational corporations and international bankers who profit from increased trade. Like the U.S. lending money to third-world countries to buy American fighter aircraft, the Germans were basically lending money to Southern Europeans to buy very fine washing machines and coffeemakers. There’s doubtless some truth to that explanation, but in fact, the benefits of economic integration were political as well. Reforms that were too painful for national politicians to undertake on their own could be justified if they were required by the country’s membership in the euro zone. It is, for example, far easier for a Prime Minister to cut government jobs or collect more taxes if the changes can be blamed on Brussels or Berlin.

(MORE: Democracy Could Destroy the Euro)

Over time, any grand design or overriding purpose disappeared. Taking its place were the private interests of bureaucrats, business people and bankers and financial and political advantages that were purely short-term. This worked perfectly well, as long as the economies of European countries were growing fast enough to cover the costs of keeping everybody happy. Just as the so-called honest graft of old-time Chicago’s political machine powered “the city that worked,” for a decade the euro was the currency of the continent that worked. This was not necessarily a bad thing. Worthwhile political and financial reforms were made in the weakest countries. Prosperity became more widespread. Yet in place of a true common interest among the 27 members of the E.U. — or even the 17 members of the euro zone — there was merely a sort of polygamous marriage of convenience.

The trouble with such arrangements is that they work only until they become inconvenient. Once bad times arrive and growth slows, there is little to hold the system together. Once the cost of membership exceeds the benefits, national interests re-emerge and it becomes only a matter of time before someone heads for the exit. This is just as true from the perspective of Germany, being asked to write one check after another to cover other nations’ shortfalls, as it is from that of Greece, being asked to impose austerity policies that go far beyond any constructive budget cuts.

As soon as one state actually leaves, all the others will have to consider whether to stay or to go. Ironically, if Greece leaves and looks as if it will recover fairly quickly, the pressures on other troubled economies to leave sooner rather than later will increase. Robert Zoellick, president of the World Bank, recently wrote that Europe is approaching a “break the glass” moment, when someone finally pulls the fire alarm.

What might a future Europe actually look like? I got to ask the last question at the FPRI seminar: why Europe today needs anything more than a free-trade zone, easy terms for people traveling and working in other countries, a European military entity within NATO and some multinational bodies to coordinate foreign and economic policy. No one had an answer. I suspect that’s where Europe is heading, although I have no idea how it will get there. The final result will likely be a looser community of Europeans that is more flexible albeit less ambitious and grandiose.

At least they’ll always have Brussels.

MORE: Why the European Union Is Less than Ideal

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