Opening Remarks

How the Strauss-Kahn Case Damages Europe


Dominique Strauss-Kahn was buckled up and headed for Berlin on May 15 when he was yanked off an Air France jet on the tarmac, charged with the sexual assault of a hotel maid, and thrown into New York City's Rikers Island prison complex. The act for which he stands accused (and to which his lawyers say he intends to plead not guilty) is despicable. Even if he is exonerated, it's difficult to imagine how the man known as DSK could make a credible return to power. In the calculus of damage, it's not only Strauss-Kahn who will lose. It is Europe.

While the International Monetary Fund is a global concern, saving the European Union has been Strauss-Kahn's primary mission in recent years. "At these high levels and issues of national and global importance, personal stature and personal chemistry do matter," wrote Jan Randolph, head of sovereign risk analysis at IHS Global Insight, after Strauss-Kahn's arrest. "DSK has been involved right from the start." The IMF's managing director—a high-living socialist who was apparently hiding more paradoxes than previously known—used his charisma to keep Greek Prime Minister George Papandreou committed to politically harmful but necessary reforms. He prodded and coddled German Chancellor Angela Merkel over the design of the various bailout packages, their terms, and the need for a more permanent solution to the wider euro zone crisis, Randolph wrote. "The presumption was that with Strauss-Kahn at the helm, the IMF would not turn its back on Europe, that the IMF would continue to support Europe. Now, with Strauss-Kahn gone, that proposition becomes a little dubious," says Eswar Prasad, a senior fellow at the Brookings Institution in Washington. The next IMF chief may not be nearly as charismatic as DSK—and may not even be European.

Strauss-Kahn's departure from the scene couldn't have come at a worse moment. Little noticed in the U.S., but momentous inside Europe, was Denmark's unilateral decision on May 11 to check the papers of people arriving from other European nations. That's the equivalent of New York asking for papers at the Lincoln Tunnel crossing from New Jersey, and appears to violate the 1985 Schengen Agreement, which removed border-crossing procedures among 25 European states. Ian Goldin, co-author of a forthcoming book on migration called Exceptional People, says Schengen is "one of the greatest achievements of Europe." German Interior Minister Hans-Peter Friedrich says that Denmark's action could set off a "spiral of mistrust." European Commission President José Manuel Barroso of Portugal warned Danish Prime Minister Lars Lokke Rasmussen in a letter that there were "important doubts" about Denmark's compliance with European and international law and cautioned him against taking "unilateral steps." Germany's Der Spiegel said Barroso's letter "sounded like the prologue to a declaration of war."

In the U.S., financial and demographic flows between states are large, constant, and for that reason scarcely remarked upon. Not so between the still-sovereign nations of Europe. Outside of a cosmopolitan few, Europeans' loyalty is first to their town or nation, and only then to "Europe," which, nearly two decades after the 1992 Maastricht Treaty, is still more of a landmass than an idea. Europe's equivalents of the Tea Party are populist, nationalist parties like the True Finns and the Danish People's Party, which resent Arab immigrants, the Eurocrats in Brussels, and members of the elites like Strauss-Kahn who are taking them places they don't want to go. Finland's demand for tough terms on Portugal's bailout can be traced directly to the rise of the True Finns, who captured a fifth of the vote in April elections.

The backdrop for the intra-European tension is, of course, financial distress. It's no longer fellow feeling that's keeping aid flowing to Greece, Ireland, and Portugal; it's fear. If those countries default on their sovereign debts, it will blow a hole in the banks that hold their loans and bonds. By the latest count of the Bank for International Settlements in Basel, Switzerland, foreign banks (mostly in Europe) held over $1 trillion worth of Spanish, Greek, Irish, and Portuguese debt at the end of 2010.

The latest idea, launched by Luxembourg Prime Minister Jean-Claude Juncker, is to give breathing room to debtors in a way that (it's hoped) doesn't qualify as a default that would force banks to take writedowns. It's called "soft restructuring," or even "re-profiling," a European Commission mot du jour that belongs in the same linguistic category as "terminating with extreme prejudice" for murder.

Opposing the would-be re-profilers, European Central Bank officials are standing firm against any sort of restructuring. On May 18, Juergen Stark, a member of the bank's executive board, said a restructuring of Greek debt "would create a catastrophe" by wiping out most or all of the capital of Greece's own banks.

The friction between the nations that give and those that receive is only getting worse. Europe's richer members don't want to hand over, without strings, any more aid money; their populations won't stand for it. "Greece will have to implement huge reforms. Greece will have to rapidly, rapidly privatize many public entities," Juncker said on May 17. Only then, he said, would the EU consider further aid.

The populations of debtor nations are in no mood to swallow more austerity. Greek unions kept ferries docked at ports, grounded flights, and shut hospitals and schools in early May in protests against Prime Minister Papandreou's plans to sell state assets and usher in more spending cuts. The Irish, meanwhile, have been insisting on getting an aid package at least as generous as the ones being handed out to the Greeks and the Portuguese. The looming worry is Spain, whose economy is twice the size of those three nations' combined. The Workers' Socialist Party of Spanish Prime Minister José Luis Rodríguez Zapatero is likely to lose big in regional elections on May 22 in a rebuke of his government's austerity polices, nationwide polls show.

It doesn't help that Germany, the biggest creditor on the continent, is thriving. It's the only major nation in Europe whose unemployment rate in April was lower than it was in September 2008 (7.1 percent now; 7.6 percent then). Ireland's rose to 14.6 percent, from 7.1 percent then; Spain's to 21.3 percent in the first quarter of 2011, from 12.3 percent in the third quarter of 2008. Yoked to a single currency, the sluggish nations can't depreciate their currencies to export their way back to health. The European Central Bank is torn between Germany's need for higher interest rates to avoid inflation and the weaker countries' need for super-low rates. The compromise is a key lending rate of 1.25 percent, vs. the zero to 0.25 percent range maintained by the Federal Reserve.

Strauss-Kahn, before his arrest, had been considered a favorite to succeed Nicolas Sarkozy as French President. As one of the EU's true believers, he had demonstrated the leadership and persuasiveness needed to prod the European countries that expressed little more than a vague commitment to back up their pledges with cash. The tragedy of his downfall echoes far beyond an 11-by-13-foot jail cell at Rikers.

Coy_190
Coy is Bloomberg Businessweek's economics editor. His Twitter handle is @petercoy.

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