During the last several months, two separate media narratives have been playing out on both sides of the Atlantic. In the United States, the collective voice of the press has been focused on domestic issues and popular cultural absurdities such as the birth of Jay-Z and Beyonce’s new baby, Blue Ivy Carter.
Meanwhile, the European media has been almost exclusively covering what has been called the greatest threat to Europe since 1945: the European Union Sovereign Debt Crisis. Even President Barack Obama has said that the European Union (EU) debt crisis is “the biggest headwind the American economy is facing right now.” Despite this, it’s fair to say that the majority of Americans do not understand the brewing economic crisis.
They should.
The crisis is the result of an ongoing attempt to unify the nations of Europe into a “United States of Europe” — a consolidated economic region able to compete with both the United States and China. Countries euro area are bound together in a monetary union, which means they share a common currency (the Euro) and a central bank (the European Central Bank).
All of this seems like a sensible attempt at international cooperation, but ignores one glaring fact: The nations of Europe have been waging war on one another for the better part of the last 2000 years.
Scars from this shared history cover the continent and factor into the economic, political and cultural realities of modern Europe. While nations are bound together by the decisions of a single central bank, each nation still controls its own budget and foreign policy. Most importantly, each clings to its national identity. As a result, a group of vastly different countries that tend to distrust one another have been forced into an intimate union. Put simply, it’s the equivalent of forcing Kansas and Missouri to merge.
Normally, an independent country has several tools to prevent economic problems from occurring. These include using a combination of spending less money, asking others for help and printing more or less currency to support an ailing economy. However, the EU has married 17 countries with different fiscal and political regimes into a single monetary union. As a result, each EU nation has lost part of its ability to alleviate economic distress, because it cannot enact independent monetary policy. All 17 nations are now subject to the whims of the European Central Bank, which has been known to serve the needs of more powerful EU nations before those of the periphery.
European economic cooperation worked for a short time, but the 2008 global financial crisis reopened old wounds. Smaller EU economies (Greece, Ireland and Portugal) did not weather the crisis well and are now facing the prospect of a sovereign default (meaning that a country’s debt is so large that it is no longer able to realistically pay it off). As a result, these weaker EU economies are asking the more powerful EU members, primarily Germany and France, for a bailout to avoid default. Understandably, these larger nations are hesitant to pay for the sins of their smaller neighbors.
A sovereign default has the potential to throw all of Europe and indeed the world into prolonged economic downturn.
By definition, someone’s debt is someone else’s asset. Unfortunately for the global economic system, much of the bad debt in the EU is held by large multinational banks in Germany, France and the U.S.
If one of the troubled EU countries is allowed to default, any bank that holds a significant portion of that debt is also subject to fail. Because these large banks also happen to hold one another’s debt, global banks could conceivably begin to fall like dominos if a single collapse occurred.
The event would freeze global markets and bring about unprecedented economic calamity. This scenario is known as “financial contagion” because of its similarity to the spread of an infectious disease in a global pandemic.
Given this unfortunate reality, it is important to understand that events happening halfway around the world can have a significant effect on our lives. The truth is, we no longer live in a world where all the solutions to our economic woes lie conveniently within our borders.
During the past several decades, the forces of globalization have made national economies and our lives more interdependent than ever before. At its core, this trend has been a powerful force for good, raising hundreds of millions around the world out of abject poverty and into a new global middle class.
However, it has also placed some uncomfortable pressure on developed countries, which have had their position of economic dominance for the past half-century challenged. As we continue the debate about how to heal our own economy, it would do us well to consider the global realities of our economic system.