Eurozone tottering--updated 2x

European Central Bank HQ in Frankfurt

Standard & Poors downgraded the debt of Spain today as borrowing costs continued to rise for the PIIGS. (Reports here and here.) The current credit crisis is also spreading beyond the eurozone as Hungary also saw its bond rates going up. Meanwhile Germany, the primary source of funds for a proposed Greek bailout, continued to hem and haw about what, if anything, it was willing to do. As has been predicted for months, Greece's credit problems are spreading across the southern tier of Europe and beyond.

Mostly the US has just been watching all this out of the corner of its eye. Obviously we have plenty on our own plate right now. Yet as Europe discovered when Lehman imploded, finance and credit today is all international. A credit earthquake in Europe will inevitably send a tsunami in our direction. (See Simon Johnson’s “Wake the President.”)

The global economy is still very fragile--much more so than most people realize. Government officials, especially here in the US, have done a good job of putting out the message: "We've turned the corner, the crisis is past." They know how crucial public confidence is in reviving economic activity. Nonetheless, the 2008 financial meltdown revealed real and fundamental problems in the global economy which have still gotten little attention. Most of what ailed the system then, still ails it now.

A credit crisis in Europe could well trigger the same kind of panic as happened in fall 2008. Again, the banks will demand government bailouts to prevent a complete financial meltdown. This time, though, most government tanks are close to empty. A second massive bailout is just not in the cards, which means the economic dominoes will fall however they want.

Another option which is also a threat to the US is that the eurozone actually gets its act together and does something constructive. Most agree this would inevitably mean a significant devaluation of the euro. This is already predicted for the pound once British elections are past. The result: European goods become cheaper (wine, travel, BMWs!) and American goods become more expensive. Oops. There goes President Obama’s plan to grow the economy via expanded exports.

It’s easy to portray Germany as the bad guy in the current mess but it really is like the person trying to decide how to rescue a drowning man without himself getting pulled under. Germany has avoided many of the financial pitfalls other countries have fallen into and is still relatively healthy economically. It sees the Greek bailout, likely followed by bailouts of who knows how many other countries, as a continuation of the problem rather than a solution. It will not go in debt to finance these loans and German taxpayers have no interest in digging deeper to pay for them.

Like the US in 2008, Europe wants to push its problems down the road, hoping time will miraculously produce a solution. The US wants this to be a problem Europeans will solve by themselves. Meanwhile, many major banks have insured themselves against European sovereign defaults via the CDS market making their role in all this ever more suspicious. Thus once again for them it’s “heads we win, tails you lose.”

What tangled webs we weave.

Update: Paul Krugman wonders today whether events are making the unthinkable thinkable or even inevitable. Namely, it may well be that Greece's exit from the euro is around the corner, with others to follow. Carrying this out will be a huge mess but that's what we have already. Krugman's personal plan: "I think I’ll go hide under the table now."

Update 2: Paul better move over. Felix Salmon wants to join him.