As the Crisis Bites, Splits Open Up in Europe

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Germany's Chancellor Angela Merkel holds a press conference at the end of an Economic summit of European leaders in Brussels.

Meeting in Brussels for a long Sunday lunch, European Union leaders were supposed to clear the air after weeks of jibes, sneers and slurs over who is to blame for the economic crisis. But after a three-hour meal of goat cheese, beef stew and apple crumble, they emerged as ratty as ever, barely concealing their long-standing gripes and graphically revealing how far the E.U. is from any coordinated response to the downturn.

The major split is over how much Europe's richer western countries should do to help their poorer eastern neighbors. Hungarian Prime Minister Ferenc Gyurcsany has appealed for $230 billion in aid for eastern member states who have been hardest hit by the economic crisis, plus streamlined access to the Eurozone, or the 16 countries who use Europe's common currency. Without help, he says, there is likely to be a new economic "Iron Curtain" across Europe. (See pictures of the changes in Europe.)

But German Chancellor Angela Merkel rejected calls for a mass bailout. And Luxembourg Prime Minister Jean-Claude Juncker, who chairs meetings of the Eurozone's finance ministers, dismissed appeals by wannabe members to relax entry criteria for single European currency. U.K. Prime Minister Gordon Brown — clearly eying French President Nicolas Sarkozy — denounced protectionism as a "road to ruin". And Sarkozy himself testily denied being protectionist but then accused eastern Europe of putting the entire E.U. at economic and political risk.

Indeed, the summit was hastily convened after Sarkozy made jingoistic noises last month about pulling French car-making operations out of eastern Europe. The beleaguered eastern members fear 'Old Europe' is on a wayward drift from the E.U.'s core principles of a single market, which could leave 'New Europe' abandoned in the economic vortex.

The summit itself ended in reluctant pledges to help eastern Europeans, but only on a country-by-country basis, as well as repeated mantras about avoiding protectionism. But if the show of unity was unconvincing, the issues are very real. Crashing exchange rates, soaring debts and failing banks: eastern European economies have fallen far faster and harder than their richer, Western neighbors. Czech Prime Minister Mirek Topolanek — whose country currently holds the E.U.'s presidency — says the developing recession is "the greatest crisis in the history of European integration."

Poland's zloty has dropped 29% against the euro in the past six months, the Hungarian forint by 20%, the Romanian Ieu 17% and the Czech koruna 12%. Latvia has now followed Romania in seeing its government bonds labeled as junk by Standard & Poor's rating agency. (Its government was forced to quit two weeks ago). Once lauded as darlings of global capitalism, these countries now warn of social and political unrest if their economies are allowed to collapse. (See pictures of the global financial crisis.)

Yet a report authored last month by Katinka Barysch, of the Centre for European Reform think-tank, says they were merely following E.U. recommendations: opening their markets to trade and investment and selling their local banks to western European ones. It helped to drive the export boom of the past five years but left them more vulnerable to the crisis. Western banks have lent $1.6 trillion to Eastern Europe, but the crisis could see them pull back yank credit lines from their local subsidiaries, triggering a domino effect of collapsing financial institutions.

Respite of sorts came to the region last week when a $31 billion package was announced by the European Bank for Reconstruction and Development (EBRD), the European Investment Bank (EIB) and the World Bank. But World Bank President Robert Zoellick says East European banks need $140 billion of fresh capital, much of which may have to come from Western Europe.

Can the E.U. come up with an effective answer? Its fudged response so far is partly down to a lack of institutional architecture: the European Central Bank, for example, has far fewer resources than the U.S. Federal Reserve, while the European Commission can only work with the budget provided by E.U. member states. At the same time, leaders like Sarkozy, Merkel and Brown have been too busy putting out fires at home to provide strong leadership out of the crisis.

Eastern Europe now fears the narrow instinct of individual governments will be to look to their own backyards first, only thinking of the European dimension as an afterthought. Without any clear direction, there is also a risk that instability in the east could infect everyone else and drag down the euro. Last week, Moody's Investor Services, a credit-rating agency, warned of default risks for banks in six western European states that are overextended in the east. If that occurs, it could jeopardize one of the E.U.'s finest achievements, the embrace and revival of Eastern Europe.

The E.U. is still some way from splitting asunder — another summit in Brussels will take place over two days at the end of the month. But at the moment, the odds are that it will involve more long lunches, and more papering over the cracks.

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