Amid concern in financial markets that the debt crisis could break apart the euro zone, European Central Bank
President Jean-Claude Trichet warned of contagion dangers and called for more action by euro-zone governments to pool fiscal governance. "We are now experiencing extreme tensions," Mr. Trichet said in an interview with Germany's Der Spiegel magazine. The ECB provided a transcript Saturday.
"In the market, there is always a danger of contagion—like the contagion we saw among the private institutions in 2008." Mr. Trichet said. Contagion can flare up quickly, he said, even in "half a day."
Financial markets sensed that danger over the past week, when the recent euro selling turned into a rout, despite the composition the previous weekend of a nearly $1 trillion safety net for problem governments. For many, the response to the Greek debt crisis didn't address longer-term concerns that the euro zone might have become unmanageable in its current form.
What's needed now, Mr. Trichet said, is "a quantum leap" in how Europe manages its fiscal economy, which he says in the most difficult situation since World War II
. "There needs to be major improvements to prevent bad behavior, to ensure effective implementation of the recommendations made by peers and to insure real and effective sanctions in case of breaches," he said.
Having thrown money at the problem and failed, the euro zone is coming to see centralized fiscal oversight as the only means of convincing investors that the Greek debt crisis won't recur. So far, nothing else seems to have convinced investors that the euro is durable.
Early proposals suggest the first steps to a kind of federal government that the euro's critics have said was needed from the inception of the currency project.
German Chancellor Angela Merkel
has warned that the survival of the euro and even the European Union itself is at stake, adding calls for stricter fiscal governance that doesn't allow weaker countries to determine standards. Ms. Merkel argues that at the very least the euro zone needs to reinforce its Stability and Growth Pact by putting real enforcement and penalties behind limits on debt and budget deficits.
The European Commission proposed last Wednesday that EU governments submit their budgets for review by their counterparts in other euro-zone members before they are passed by national parliaments.
It also advocated punitive measures for countries that flout the EU's existing budget rules. These could include cutting them off from EU subsidies and forcing them to make deposits to a rainy-day fund.
It's unclear how this system of mutual scrutiny would work. Also open is the extent to which governments will allow national sovereignty over their budgets to be compromised. The power to tax and spend is at the heart of national government.
Where there is agreement is that what has been done to date hasn't been enough.
The dangers building in the euro system are interlocked and individually capable of triggering a new credit crunch.
Worries about the value of government bonds as collateral could again freeze up money markets,in which banks borrow short-term funds from each other, reprising the U.S. subprime credit crisis.
Government defaults would trigger major losses as bond values are written down in a subsequent debt restructuring. A default by Greece alone could cause writedowns on government debt of between €50 billion and €70 billion. Knock-on defaults elsewhere could be a mortal blow to the euro system.
The European crisis could quickly go global if foreign banks are caught with shrinking European assets, or paying higher rates of interest to secure dwindling liquidity in money markets.
Investors could begin steering clear not just of high-debt countries in Europe, but from debt issued by countries around the world in similar straits.
The severe austerity plans being imposed by euro-zone governments already threaten to sap household spending and pull the region back into economic recession, also affecting world demand.
Pulling the euro together took nearly 10 years and even then got off to a wobbly start after 1999. Unscrambling that egg would be a lot messier and would threaten to stop the affected economy in its tracks for a period. A full split-up could be devastating as the region sought new valuations on assets and trade, likely unleashing a deep recession.
As Europe ponders its next steps, market-watchers are looking for real political cohesion and warn that Europe may be running out of time
"A breakup of the euro-zone remains unlikely, but is no longer unthinkable," Marco Annunziata, chief economist of UniCredit Group, said in a research note late Friday.
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