For the past 18 months, European policymakers have been trying to deal with a crisis that represents the biggest challenge to the European integration project since its creation after World War II. The very symbol of it, the euro, is under threat. The idea of the euro's demise, unthinkable only a few months ago, has since been openly considered by many. It would carry traumatic and long-lasting consequences. The crisis has already had a profound political impact, sweeping aside leaders in no fewer than five member countries of the European Union (EU), two of which, Greece and Italy, now have unelected, "technocratic" national emergency governments. If after Greece, Portugal and Ireland, Italy were to fall into the debt spiral, it might be the domino piece that could bring down the entire European Monetary Union (EMU).
Politicians have been behind the curve, although considering the many different opinions for tackling the crisis, the multitude of parliamentary and electoral processes involved, and the constraints of treaties not designed to withstand these unprecedented stresses, the measures that have been adopted at the level of the EMU, such as the establishment of the European Financial Stability Fund, have been remarkable. Nevertheless, the markets have discounted every announcement and have continued to operate in a state of quasi-panic, as they move at a different speed than the political activities.
So is there hope after the latest EU summit? It is easy to take a grim view. The EMU has had no fiscal solidarity, no fiscal discipline, and no lender of last resort. To regain a level of competitiveness comparable to Germany's, weaker European economies would have to suffer through a painful internal deflation, since a currency devaluation is not possible within the euro zone. This is hardly a recipe for growth, especially at a time of severe fiscal tightening.
Moreover, European banks are in a difficult position. Depositors in countries that are seen as candidates to abandon the euro are withdrawing their money. Bank funding is also impaired by the increase in borrowing cost, paralleling that of their respective sovereigns, while their collateral is decreasing in value. Since the amount of leverage in the system is still high, equity valuations and capital ratios are squeezed. The result is both a weak financial system and a credit crunch that choke the real economy and reinforce a spiral of lower or negative growth.
For all the difficulties and risks, there may yet be a positive resolution to this crisis for one simple reason: the stakes are too high in this game of economics and politics.
The key resides in re-establishing confidence. The European Central Bank (ECB) is probably the only institution that has the power to do so in the short term. The new president of the ECB, Mario Draghi, has announced very significant further support measures for the battered European banking system that should help stem the damaging deleveraging that made them sell European sovereign debt. But the ECB's most powerful weapon - intervening in the bond market - is still locked away. Draghi needs to create consensus among the German "hawks" who worry about the inflationary risks of debt monetization and the moral hazards of letting profligate governments off the hook. But if it really does come down to risking that consensus or saving the euro, it is likely Draghi will choose the latter, and the results of the summit might give him enough justification for doing that.
It is now very clear that, in the long term, if it wants to survive Europe needs to move towards tighter fiscal integration, and EU leaders have laid the ground to do so in this summit. There are, nevertheless, great uncertainties left as this complex process continues to unfold. The changes will happen neither quickly nor easily, as shown by Britain's refusal to agree to a new pact. But a more fiscally-integrated and responsible Europe should regain competitiveness on a global scale and find growth again. Jean Monnet, one of the founding fathers of the EU, once observed that Europe advances by finding solutions for its crises. Solving the current crisis may be turn out to be Europe's biggest step forward.