The Dark Cloud over Europe’s Nascent Recovery

Europe seems to be right on time—for once. The comforting consensus a year ago was that the crisis gripping the European Union since 2009 would begin to fade in the third quarter of this year. And here we are:

• The Irish government announces that its three-year economic emergency will end next month, the first EU basket case to walk out of the ward. “At last,” Prime Minister Enda Kenny tells his Fine Gael party, “the era of the bailout will be no more.”

• Britain reports third-quarter growth of 0.8 percent, the strongest performance since 3Q 2010 and enough to spur George Osborne, the chancellor of the exchequer, to assert that his policies of extreme austerity—the world’s most radical—are validated.

• Now Spain, the euro zone’s fourth-largest economy and among the most embattled of the euro zone’s crisis countries, gives us a third-quarter growth number of 0.1 percent. This puts the Spanish back in positive territory for the first time since 2011.

Nothing to complain about in any of this, one is tempted to conclude: Europe is on its way out of its deepest hole since the Great Depression.

Unfortunately, if not altogether unexpectedly, there is all too much to complain about.The Financial Times calls the euro zone’s recovery “a job half-done.” And I call that overly generous on the FT’s part.

The markets are already leaping in. Even as the central bank in Madrid made public its 3Q report, bottom-fishing investors were bidding up billions of euros’ worth of bad, mortgage-based loans—the toxic assets bundled before the 2008 crisis.

I stand among the optimists by way of the euro’s prospects for survival, but too much remains unresolved in the EU to read much into the newest numbers.

There are fundamental questions hanging over the big European banks, over the balance of power between Brussels and the EU’s sovereign members, and over the political equation in Italy, France, Greece, and numerous other nations hit hard during the crisis years.

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There is one other biggie out in front of us. Does the Germany of Chancellor Angela Merkel, who has proven positively acrobatic in balancing EU membership with domestic political pressures, take any ownership share of the European crisis?

Germany is German, or Germany is German and European—or maybe even European (first) and then German? An answer is on the way. As Merkel negotiates a governing coalition with the Social Democrats, this will be crucial to the pace, extent, and vitality of Europe’s long-term recovery.

Europe’s nascent recovery, if we are calling it such, is so far quantitative and little more. We should have more in the way of qualitative progress—institutional adjustment and moves toward political settlements—than we have so far seen.

Last week PriceWaterhouseCoopers reported that those non-performing loans suddenly gaining appeal roughly doubled between the onset of the financial crisis and 2012, to $2.53 trillion. Further, PwC expects this figure to continue rising. Why? “Uncertain economic climate,” the PwC report says. Translation: atrocious unemployment and social dislocation, paltry domestic demand, and a consequent reliance on exports (which, in turn, translates as modestly improved competitiveness because wages are falling and middle classes crumbling).

We now await a thorough review of assets held by 130 European financial institutions, due later this month from the European Central Bank. This is crucial. The intent is finally to get to the bottom of just how bad the toxic loan problem is, how extensive, and where the rot runs most deeply.

We are looking for how much Mario Draghi, the ECB’s president, can come up with to meet what everyone knows is an imposing recapitalization challenge. We are also watching to see how well a review of this magnitude will go, given that the central bank botched previous reviews (2010 and 2011) and—not least—there are domestic interests at issue in the case of each lender.

“The balance sheet assessment is the first real test of the euro zone’s commitment to a banking union,” the FT commented recently. This is the very broadest reason to watch how Draghi does.

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And this means watch more than just the technocratic stuff. The euro crisis has made it obvious that the EU requires a structural and institutional reformation if the single currency is going to work. But the price of the EU’s inadequacies to date is also all too painfully clear: Suffering, unconscionable joblessness, and radical social dislocation in crisis-hit countries are hardening an always-latent alienation from Brussels and the European project altogether.

So we tip into the politics of Europe’s frail recovery. It encompasses questions of sovereignty, culture, and (not at all stretching the point) even philosophic perspective. And the mistake so far has been to under-estimate the importance of politics in any lasting solution to the euro crisis.

When the Cameron government in London argues for reduced EU regulation, and François Hollande shouts across the Channel that no damage can be done to the Continental tradition of social-democratic safeguards, you have culture and ideology in play.

In this context, it was a mistake, or a form of denial, to discount (as the markets and the technocrats did) the street protests we witnessed all of last year and most of this one. And it is far from clear European leaders have learned this lesson. You do not have to be a leftie to see that increasing pressure for structural reforms, as many political figures are, while leaving the political and social questions unaddressed is unwise.

And here it comes from the other direction. Golden Dawn, Greece’s crypto–fascist action group, is odious. So is Marine Le Pen, head of France’s Front National and the disturbing victor in a recent local election. Fine enough to defund Golden Dawn, as an Athens court just did, and editorialize that Le Pen must be countered.

It is time, though, to acknowledge that Europe’s far-right populists are scoring off the warranted discontent of very many damaged lives. To stop Le Pen you have to ameliorate the conditions that make her politics attractive. The ugly truth is that until Europe works for more Europeans, the resentment her FN mines is legitimate.

As to Germany, Merkel’s current talks with the Social Democrats are intended to create a grand coalition by which the chancellor can continue to govern and provide a map for where she intends to take the nation in coming years. Stabilizing the euro zone is first among the goals Merkel has just articulated. But wait: She has been saying that regularly for several years.

The one thing Germany ought to do in the service of this goal now is stimulate domestic demand such that it can consume more of the output of crisis economies. That is to be European. Instead, Germany’s traditional reliance on export-led growth remains intact, pushing its current account surplus near its 2006 high of almost $250 billion.

This is not a glowing example of German rectitude. Berlin is effectively making the euro stronger—it is up 4 percent this year, to about $1.35 at the moment—at the expense of others, notably its troubled, euro-denominated neighbors. They are cutting paychecks and heading toward third-world status, and Germany is strengthening their currency.

The danger of Japan-style deflation in Europe is now creating pressure for the ECB to drop interest rates. The strategy has worked, in the U.S. and lately in Japan. But it leaves the question open: Is Germany effectively transferring the onus of economic adjustment onto the world outside the EU?

“There is an element of hype in Enda Kenny’s presentation of the bailout exit,” the Irish Times observed the other day. Leave it to the Irish to put the point the pithiest in a language forced upon them: The thought applies across Europe. It is not yet where it ought to be or says it is, and little of the hard work lies behind it.