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Eurozone Begins to Fracture

The headlines lately have focused on the big picture problems in Europe: a bank run in Spain, the prospect of costly bailouts, Greece’s inability to push through reforms, and so forth. But something much more fundamental is happening. At the grassroots level, the euro currency area is falling apart.

The FT reports that, as differences in interest rates paid by governments in the eurozone widen, businesses in weak economies are seeing their borrowing costs surge. Multinational firms can usually find a way around this, but small businesses in countries like Greece, Italy, and Spain have to pay very high interest rates for loans (if they can get the money at all). Their German counterparts, meanwhile, gain a competitive edge by being able to finance at cheaper rates. This is putting a huge political strain on the system as a whole:

David Riley, head of sovereign ratings at Fitch Ratings, said: “The fragmentation is getting worse. If this trend gains even greater momentum we’ll face a fundamental reordering of the eurozone. It undercuts the whole rationale of the euro, and could eventually make it easier for it to break up.”

This is exactly the opposite of the way an economic system is supposed to work. Interest rates should be low when there is no growth or a depression, and they should be high when economic activity is robust. Europe has now achieved exactly the reverse. Business and consumers in prosperous Germany have extremely low interest rates and can borrow freely. Companies in snake-bit countries like Italy and Greece face very high interest rates, even if their own business is sound and their prospects are good.

This is a destructive situation. If it lasts, Europe will be forced to dismantle the currency union, because no economies can survive under these conditions.

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