Thursday, December 31, 2009

NEVER BEFORE has Europe's economy seemed so fragile:
Day by day, fears are growing that Greece or another weak country may default on its sovereign debt obligations, forcing the richer countries in Europe to ride to the rescue or risk having one or more of its most vulnerable members leave the 16-nation euro zone.

Many European economists discount such a fracture as a remote possibility. But that doesn’t mean Europe has safely emerged from crisis.

Instead, it faces a longer-term challenge to restore the fiscal credibility of at least half the countries that use the euro. The true test for the world’s largest common currency zone, analysts say, will be whether it can withstand the economic, political and social strains once the European Central Bank begins to raise interest rates in response to economic improvements in Germany, France and other Northern European countries.

At that point, the laggards on the union’s fringe — Portugal, Ireland, Italy, Greece and Spain (the so-called Piigs) — will face even tougher choices to cope with what looks like several more years of stagnant economies, high unemployment and gaping budget deficits.

“If inflation picks up in France and Germany, the smaller economies will be left behind in stagnation and deflation,” said Jordi Galí, a Spanish economist recognized for his work on business cycles who heads the Center for Research in International Economics in Barcelona. “Such an asymmetric recovery is pretty likely, and if the E.C.B. raises rates, it could get very ugly.”
It's not a matter of if, but when.