Watching the European debt crisis unfold from the United States is like watching a movie of a slow-motion train wreck, with every day bringing just one additional frame. That's especially true when you consider that the debt crisis really began in the 1990s, when new and complicated derivative products started masking the true extent of debt for the 17 countries that make up the Eurozone, and who held it.
These complicated debt instruments funded profligate government spending in the 1990s that couldn't be turned off when the tech bust and 9/11 occurred. "Sovereign debt"-or the debt of sovereign nations-exploded. In Ireland, the debt crisis and the housing crisis converged when the government also became a guarantor for banks that financed a housing bubble there.
The net effect: As a percentage of GDP, the debt of Eurozone countries grew by more than 30 percent from 2007 to 2010, while some countries saw debt grow much faster. By 2010, Ireland and Portugal both needed bailouts from the International Monetary Fund or other Eurozone countries.
If the damage had been contained to Ireland and Portugal, which together account for less than 4 percent of Eurozone economic activity, that might have been the end of the story. But 2011 brought Greece and then Italy to the brink of default. The Greeks added drama to the story by rioting against the austerity measures imposed as a condition for the bailouts. These riots made many in the rest of the world think Greeks were both ungrateful and out of touch with the hard realities of their situation. Their dislocation from reality spooked the global markets, with August and September being two of the most volatile months in stock market history.
Then came Italy, the country "too big to fail, too big to bail." Italy's debt and interest rates soured, quickly becoming unsustainable. The only good news is that Italy, unlike Greece, seemed more willing to take its medicine. The long-embattled Silvio Berlusconi resigned as prime minister, and former EU Commissioner Mario Monti took his place. He quickly set about implementing reforms.
Less noted in the financial upheaval is what some call the EU's "democratic deficit"-a growing gap between an unelected bureaucracy in Brussels and citizens of EU member states who feel increasingly frustrated and impotent in the face of overarching policies. That's a problem likely to grow worse under the circumstances, as Eurozone and global financial leaders override popular opposition to austerity measures and the policies demanded by leaders of the more powerful EU countries win out over the rest.
Even if the Eurozone remedies imposed on countries like Greece and Italy ultimately prove to be correct, "they come with an enormous, corrosive cost to basic concepts of representative government throughout the EU," said former U.S. ambassador to the UN John Bolton.
By the end of 2011, those issues remained in the balance. Bank of England Governor Mervyn King warned in early December of a "systemic crisis," adding that "none of us really know" how the Eurozone would survive if the crisis explodes into sovereign default.
The United States has a huge stake in the outcome-U.S. money market funds hold more than $900 billion of the short-term debt of European banks-so Treasury Secretary Timothy Geithner flew to Europe to be part of a summit of European leaders in December aimed at keeping the crisis from spreading. Jan Eberly, assistant secretary for economic policy at Treasury, said a European recession could choke a U.S. recovery and is "absolutely a source of concern."