Europe confronts its debt crisis in key meetings this week

McClatchy NewspapersDecember 5, 2011 

WASHINGTON — After months of dithering and false starts, Europe faces a pivotal week as investors await a credible last-ditch solution to its debt crisis. The outlines of a potential solution emerged Monday, and how the rest of the week plays out will have significant bearing on ordinary Americans as well as Europeans.

German Chancellor Angela Merkel and French President Nicolas Sarkozy ended a lunch meeting Monday at the Elysee Palace in Paris with a call for amendments to European Union treaties that'd radically change how the EU functions. The amendments will be discussed by European leaders at a summit meeting that opens Thursday.

The proposed changes are being closely watched by global investors. Market reaction later this week may prove the difference between a cheerful holiday stock-market rally in the United States or a Scrooge-like plunge in the year's final weeks. The European Central Bank also meets on Thursday and is expected to lower its benchmark lending rates for the second straight month.

Europe has tried on three other occasions to come up with a comprehensive action plan, but each solution proved insufficient. There's more at stake now as Rescue 4.0 takes shape ahead of the EU leaders' meeting. U.S. Treasury Secretary Tim Geithner flies to Europe Tuesday to push for a comprehensive plan to end months of global financial spillover from Europe's debt crisis.

"In some sense, it's the last chance. There always will be another ... but the consequences of failure this time to put in place a convincing, comprehensive program will be severe," said Edwin Truman, a senior researcher at the Peterson Institute for International Economics and a former assistant treasury secretary.

U.S. blue-chip stocks initially traded up in triple digits much of Monday, buoyed by news that Italy had announced Sunday by emergency decree a tough "Save Italy" austerity program. But the market rally faded in the afternoon on news that credit-rating agency Standard & Poor's has put 15 countries that use the euro on review for a possible downgrade because EU leaders have so far failed to forge a credible rescue plan.

Although the Dow Jones industrial average lost steam, it still closed up 78.41 points at 12,097.83. The S&P 500 finished up 12.80 points at 1,257.08, and the NASDAQ rose 28.83 points to end at 2,655.76.

Here are answers to questions about the European rescue efforts.

Q: What did the leaders of Germany and France actually propose?

A: They reached a compromise trying to bridge the interests of healthier European economies and weaker ones. To assuage German voters, who don't want to bail out spendthrift neighbors such Greece and Italy, the plan calls for binding budget rules for the 17 member countries that use the euro as their currency. If a country runs a deficit beyond set limits, automatic penalties would kick in. They also proposed monthly meetings of European leaders in an attempt to have more coordinated, centralized governance.

Q: Why does this matter?

A: At the heart of Europe's problems is the fact that some countries managed their debts well while others did not. They share a common currency, yet they don't have common budget rules — and no consequences for debt mismanagement beyond the cold, brutal reaction of investors refusing to purchase government bonds unless they're paid a crippling interest rate. If these proposals are adopted when European leaders meet late this week, they could create much more centralized decision-making in the European Union.

Q: Is that a good thing?

A: It addresses what has been a big EU shortcoming. Decision-making has been like herding cats. But it also introduces new complications, because further down the road some countrymen may find it frustrating that European bureaucrats have so much sway over their internal governance. Europe's history is ancient, and national pride still burns strong in member countries. The yield of sovereignty to a centralized power could lead to resentments that imperil EU stability.

Q: Why do all these political changes in Europe matter to the global economy?

A: The EU is a huge global economic player. In order to resolve its debt crisis, most analysts say it must free its central bank to purchase government bonds as a buyer of last resort. The European Central Bank has been purchasing bonds from healthier nations as a way of pushing back against investors , sometimes called "bond vigilantes," who demand high interest rates in exchange for perceived high risks of government default. Financial analysts think the central bank must commit to open-ended and aggressive bond buying to really calm the markets. The new central bank president, Mario Draghi, has hinted that he's preparing to get aggressive. So far Germany has resisted this aggressive bond buying, but the proposed new political rules would meet an important German demand and could pave the way for a stronger European Central Bank, which could end the global financial turmoil with bold moves.

Q: How many bonds would the European Central Bank have to buy?

A: Tough question. In a research note Monday, investment analyst Ed Yardeni pointed to recent reporting from Bloomberg News, which obtained tens of thousands of documents from the Federal Reserve through the Freedom of Information Act. Bloomberg concluded, on the basis of these documents, that the Fed's rescue efforts committed nearly $8 trillion to banks and other financial firms through guarantees and loans in a bid to end the U.S. financial crisis in 2008 and 2009.

"This suggests that the Europeans may need much more than a bazooka to win their battle with the bond vigilantes," wrote Yardeni, who coined the phrase "bond vigilantes" during Latin America's debt crisis in the 1980s.

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