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Print Edition> World
UPDATED: September 30, 2011 NO. 40 OCTOBER 6, 2011
Europe on the Brink
Deepening debt crisis threatens the unity of the euro zone

DOWN AND OUT: Window-shoppers check products on sale at an Athens store. The Greek Government has announced new austerity measures to secure international financial support and avoid default risks (CHEN ZHANJIE)

The ECB has intervened in European debt securities markets. After buying national debts of Ireland, Portugal, Spain and Italy, the ECB is now holding 96 billion euros ($129 billion) in EU members' government bonds. The European Securities and Markets Authority has announced new bans on short selling in Spain, Italy, Belgium and France in a bid to stem market volatility. The ECB declared on September 15 that it will pump U.S. dollar liquidity into European banks in the coming three months in collaboration with the central banks of the United States, the UK, Japan and Switzerland, intending to help the European banking industry get through the current crisis.

These measures have stabilized the situation for the time being. After the ECB purchased Italian and Spanish government bonds, interest rates of their 10-year bonds fell to about 5 percent. European stock markets also picked up.

Future uncertainties

The EU's anti-crisis measures followed an established tradition: providing liquidity, tightening fiscal discipline, and ECB intervention. These measures did temporarily work to prevent further deterioration. But the EU neglected the institutional defects that have triggered the crisis. Therefore, the debt crisis might occur again in the future.

Fiscal austerity policies have come too late, given the fact that European sovereign debts have long been at alarmingly high levels. As a result, they will not be able to efficiently rein in rising financing costs.

The EU's decision to enlarge the EFSF faces political resistance in countries like Germany. The Germans have expressed strong dissatisfaction at constantly providing huge sums of money to South European debtor nations. They have urged the German Government to take a prudent stance.

Although the ECB's intervention has played a significant role in restoring market confidence, the ECB is likely to encounter difficulties as it purchases government bonds. Analysts pointed out that the ECB would have to buy at least 100 billion euros ($135.2 billion) in Italian and Spanish bonds to stabilize the long-term interest rates of the two nations' government bonds. This amount is so huge that it will greatly limit the ability of the ECB to implement monetary policies. Worse still, excessive liquidity could give rise to growing inflationary pressure.

Currently, opinions vary in the ECB on financial market intervention. Most of the ECB Executive Board members hoped the EFSF could be put into operation as soon as possible so that the ECB can quit.

Rating agency Standard & Poor's downgraded Italy's sovereign debt rating on September 19 because of its lagging economy. It was the sixth euro-zone country that was downgraded in 2011 after Spain, Ireland, Greece, Portugal and Cyprus.

Global repercussions

The runaway European debt crisis poses a serious danger to world economic recovery and international financial stability.

According to the European Commission's 2011 interim economic forecast released on September 15, Europe's economic growth in 2011 might drop because of the debt crisis and financial market turbulence. The report made downward revisions for the estimated economic growth rates of both the EU and the euro zone in the second half of this year. Sluggish growth in the EU will hinder progress in global economic recovery. The International Monetary Fund also issued a report recently, stating that the international financial system is facing growing risks because of Europe's debt crisis.

The EU is now China's biggest trade partner. The European debt crisis not only influences China's exports and its economic growth, but also threatens the security of China's euro assets.

European countries have high expectations for China, hoping China can buy more European government bonds and help South European nations out of trouble. But the security of China's investment can hardly be guaranteed given the euro zone's poor economic governance. China will purchase more European bonds provided that its own interests are protected. In other words, if EU members show greater solidarity to overcome the crisis, China may increase its investment. European nations shouldn't overestimate China's role in tackling the debt crisis.

The author is an associate research fellow with the China Institute of International Studies

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