Opinion The decline of the West

For months we have been told that Europe’s salvation lies in austerity,Germany’s prescription of fiscal discipline to its deficits. But when Chancellor Merkel of Germany and President Sarkozy of France meet they will find evidence of what they did not expect — failing banks,waning growth and capital flight.

These past few weeks have demonstrated that Europe has a deeply flawed banking system,a widening competitiveness gap,and a debt crisis that cannot get much better if the economy gets worse. It is an already lethal cocktail that becomes more deadly when mixed inside the euro,a currency created without the resilience to withstand difficult times and which has no structure for effective decision-making. Either the euro has to be fundamentally reformed by Europe’s political leaders and the European Central Bank or it will collapse. After the events of the last few days I know for sure there is not even a chance of a middle way.

I was present at the eurozone meeting in the immediate wake of the Lehman Brothers crash. I remember the sceptical looks when I explained that European banks were in fact more vulnerable than US banks,that they were far more highly leveraged and far more dependent on short-term wholesale funding. In fact,half of America’s toxic sub-prime assets had been bought by reckless institutions in Europe. Yet even as the crisis grew,it was difficult to get Europe’s leaders to accept that it was anything other than an Anglo-Saxon one.

There is no escaping the basic fact that Europe’s difficulties are indicative of deep structural defects — its declining competitiveness,ageing population and persistently high unemployment. Even as recently as a month ago,Europe could have avoided the events now driving it to breaking point. A stabilisation fund of some 2 trillion euros could have convinced the markets that Europe meant business wherever it was confronted with problems. But Europe has flinched at every turn from showing the decisiveness that its problems require.

The time for extemporised solutions is gone. The Continent has to commit to a plan that underpins the several trillions in funding needed to ensure that governments from Greece,Ireland and Portugal to Spain,Italy and Belgium are adequately funded. So there is no way out except through the biggest recapitalisation of the banks in European history and a wholesale reformation of the euro,which will require the coordination of its monetary and fiscal policy,fiscal transfers from rich to poor nations and a commitment to a common European debt facility. It will require an undertaking that is pan-European,involve commitment from the private sector,and will have to draw on support from the IMF,and possibly China and America.

These massive guarantees will necessitate a big shift in Europe’s thinking; that if the world used to need Europe,Europe now needs the world. We will need a repositioning from consumption-led growth to export-led growth. It will require the kind of radical capital product and labour market reforms only a few countries have tried.

But for all this to happen Germany will have to take the lead.