Euro zone crisis racing ahead of convincing ideas

Despite two hefty bailout packages for Greece and Italy, the establishment of a permanent crisis resolution mechanism, harsh austerity measures and reassurances from leaders, Europe’s debt crisis does not seem to be going away. In fact, the latest fear centres not on the known weak links of the euro zone such as Portugal and Spain, but stronger economies such as Italy, Belgium and even Germany.

The extra yield investors demand to hold Belgian 10-year bonds compared to benchmark German ones of similar maturity has more than doubled in the past four months. This week, the Italian spread also climbed to its highest level since the euro zone came into force in 1999.

Belgium has been at a political stalemate since April, when its government collapsed. Having been unable to cobble a coalition, the country has been warned by ratings agency Standard & Poor's that its credit rating is at risk of being downgraded in the event of continued political deadlock. Despite strong economic fundamentals, Belgium, which plays host to the European Union institutions, has a national debt almost equal to its annual output, adding to investor nervousness.

Interest rates are rising even on German bonds, the region’s benchmark. On Tuesday, the yield on these bonds was at 2.67 per cent, significantly higher than the 2.1 per cent of last summer. The rise follows worries that in the event of heavyweight economies like Spain or Italy ending up in need of bailouts, even financially robust Germany will be stretched to the limit.

Not enough
What’s clear is that Europe’s strategy thus far, of long-drawn, negotiated bailouts of countries like Greece and Ireland has failed to assuage markets. Analysts are describing the current situation as a self-fulfilling prophesy, with investors avoiding buying the bonds of countries they perceive as even slightly vulnerable, leading to the debt-servicing costs of those countries shooting up.

Euro zone leaders, in particular those from Germany and France, have added fuel to the market fire by calling for bondholders to share the pain of losses, although following investor panic, these demands have been toned down.

Other ideas to secure the region’s long-term economic health include the setting up of a European Monetary Fund or EMF, along the lines of the International Monetary Fund. The main purported benefit of an EMF would be to free the euro zone of the ‘outside’ involvement of the IMF and thus maintain confidence in the ability of Europe to set its own house in order.

The idea faces considerable opposition. Some dismiss it as overly grandiose and impracticable; others believe it would only encourage bad fiscal habits amongst euro zone states.

Given the current lack of alternatives, it appears the euro zone will stick to the strategy of coming to the rescue of member-countries once they are on the verge of collapse. It is increasingly apparent, however, that this is insufficient to stem the contagion spreading across Europe and threatening the future of the European Union itself.