Looking back over the last 18 months of Europe's debt crisis, economist Lorenzo Bini Smaghi, a member of the European Central Bank's executive board, recently invoked Winston Churchill's famous quip, "You can always count on Americans to do the right thing -- after they've tried everything else."
And Europeans too, he assured his audience, would also get it right -- eventually. But all the coming and going since the Greek crisis broke out has taken its toll, which can be seen in the growing lack of market confidence that a lasting solution to the underlying problems will finally be found. Even the Americans seem to be having difficulty doing the right thing this time around, or at least doing it at the right moment, as the market turbulence following Standard & Poor's downgrade of U.S. overeign debt served to underline.
It's probably too soon to say whether Europe's leaders have actually agreed on what would be the "right thing" to do, but at least they now seem to recognize the full extent of the problems they're facing. Fundamental changes to the continent's financial system are now on the table. Options now being openly debated even include a measure thought unthinkable a year ago: ending Europe's 13-year experiment with a single currency. But even if this ultimate possibility -- the so-called nuclear option -- were to come to pass, as always there would be a right way and a wrong way of going about it.
So how bad is it? In a word, very. The latest round in the European sovereign debt crisis has been, without a shadow of a doubt, the most serious and the most potentially destabilizing for the global financial system of any we have seen to date. Pressure on the bond spreads in the debt markets of the countries on Europe's troubled periphery have become so extreme that the European Central Bank (ECB) was forced to change course only three days after its regular monthly meeting in August, intervening with shock and awe in the Spanish and Italian bond markets. While the size of the intervention is still unknown, market estimates range from between 4 billion euros and 9 billion euros in the space of two days. To put this number in some sort of perspective, the entire bond-purchasing program to date for Greece, Ireland, and Portugal has only involved some 74 billion euros, and this in more than a year of intervention.
Along with earlier interventions in Ireland, Portugal, and Greece, the ECB has become the "buyer of last resort" of peripheral Europe's bonds, but this can only be an interim measure because the volume of bonds that would need to be purchased on an ongoing basis is so massive that it would put the bank well outside the limits of its original founding charter.
The gravity of the situation was highlighted on Aug. 3, when European Commission President José Manuel Barroso explained to reporters that the current "tensions in bond markets reflect a growing concern among investors about the systemic capacity of the euro area to respond to the evolving crisis."
To be clear, what is involved is no longer an issue of Greek debt restructuring or of the extent of private-sector involvement in any such debt adjustment. The current crisis is an existential one, which if left unresolved will result in a contagion -- a matter of life of death for Europe's single currency. At the very same moment in which the ECB was deciding on its latest program of bond purchases, concerns were already being aired in the German media that the sums involved in a generalized rescue might be too large for even the richest countries in the core to accept.
As former British Prime Minister Gordon Brown put it Aug. 7: "Now no number of weekend phone calls can solve what is a financial, macroeconomic, and fiscal crisis rolled into one." Solving the crisis involves "a radical restructuring of both Europe's banks and the euro, and will almost certainly require intervention by the G-20 and the International Monetary Fund."