The End Of Europe

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The worries have now come to a head. Borrowing costs for Europe's weaker economies, like Greece, Ireland, Portugal, Spain and Italy, have skyrocketed as halfhearted measures to stabilize markets have made investors suddenly wary that the European center is not going to hold and that richer countries like Germany simply aren't committed to the monetary union. That's why bond spreads are widening, European stocks are tanking and the European Central Bank is desperately trying to calm markets by buying up weaker countries' debt.

All this could have happened six months ago or three months ago or three months from now. But the crisis exploded in the past week because of the slow-growth news coming out of the U.S. As improbable as it sounds, "Europe's Plan A, B and C was to outgrow its debt problem via the normalization of the economic situation in the U.S.," says Harvard economist Kenneth Rogoff. "When they saw the U.S. growth numbers coming in so much weaker than they expected, it became clear that the world wasn't going to normalize. And they panicked."

While economists were betting on 4% growth in the U.S. earlier this year, numbers released in recent days show that the American economy grew a paltry 1.3% in the second quarter of this year, after a truly anemic first-quarter figure of 0.4%. With growth like that, we can't even save ourselves from 9%-plus unemployment at home, let alone save the world. The much feared 2% economy, now the consensus prediction for U.S. growth this year, has become a reality. We are no longer the economic counterweight to Europe. We are Europe.

According to Rogoff, the pre-eminent seer of the crisis, who wrote the sovereign-debt history This Time Is Different: Eight Centuries of Financial Follies with economist Carmen Reinhart in 2009, Europe and the U.S. are not experiencing a typical recession or even a double-dip Great Recession. That problem can ultimately be corrected with the right mix of conventional policy tools like quantitative easing and massive bailouts. Rather, the West is going through something much more profound: a second Great Contraction of growth, the first being the period after the Great Depression. It is a slow- or no-growth waltz that plays out not over months but over many years. That's what happens after deep financial crises that require bailouts by beleaguered states, which are then left with few resources and tools to cope with a stagnant, high-unemployment environment rife with populist politics, social instability and violence of the kind we've most likely only begun to see in the streets of Athens and London.

It's a very different era than the historically exceptional period of rapid global growth from 1991 to 2008, the period in which the European Union, the euro and the dream of greater European integration were born. The linchpin of this age of optimism was, of course, the U.S. It helped rebuild Europe after World War II and toppled its main ideological competitor, the Soviet Union. The dollar and U.S. government debt, backed by America's well-functioning democracy and strong growth prospects, remained the largest, most liquid and (seemingly) safest investments on the planet. It was in this environment, in which all boats were rising, that the euro began to gain strength.

Needless to say, the global picture has changed. It is a measure not only of the long tail of America's special position in the global economy but also of just how bad things are in Europe and elsewhere that there hasn't been a rush out of U.S. Treasuries. Following the S&P downgrade, ascribed to our slower growth and debt-ceiling shenanigans, investors piled into Treasuries as the market tanked. China, the largest foreign holder of T-bills, issued a stern warning to the U.S. to "cure its addiction to debt." But central bankers from Beijing aren't breaking down doors in Frankfurt to convert their dollar holdings to euros. The euro is the only viable alternative to the dollar as a global reserve currency. The British pound is history, and emerging-market currencies are still too small, volatile and controlled. And while plenty of investors are fleeing into gold, the world gold market isn't big enough to accommodate serious dollar diversification without massive inflation in gold itself. Prices are already at record levels.