The key to the euro crisis: Economic growth

The struggle to save the euro is beginning to look like a chase scene from an Indiana Jones movie. First, our hero dodges the landslide, then runs from the spear-wielding aborigines, then is surprised by a snake ("I hate snakes!"), then is pursued by well-armed Germans and has to escape on horseback, only to plunge over a waterfall, only to be captured by … you get the idea.

So this week we had 48 hours of excitement after Greek Prime Minister George Papandreou announced he was going to hold a referendum on Greece’s acceptance of the European bailout. Consternation reigned, and markets tumbled. And then he said, in the best tradition of Emily Litella: "Never mind." Markets rebounded, and the bus lurched on toward the next crisis.

As I’ve emphasized before, I’m no macroeconomist (although my respect for some of them has been dropping steadily since 2007). From my decidedly non-expert perspective, here’s what I’ve concluded.

The real issue with respect to Greece and Italy (and thus, the euro) is whether genuine economic growth can be restored to these economies. All the bailouts and austerity and haircuts (i.e., voluntary reductions in debt) in the world won’t help these states (and especially not Italy) if they can’t generate enough economic growth to pay back what they owe. (Strict austerity is a problem here, by the way, because it reduces growth in the short term). If they don’t grow they can’t pay, which will place a lot of European banks at risk of major losses and maybe bankruptcies. And because this whole arrangement depends on confidence — a debt is an asset if you think it will be repaid, but it’s a loss if you believe it won’t — you’ll get a credit event if the markets ever conclude that growth won’t happen and the debts won’t get repaid, and the euro is probably finished (at least in its present form). End of story.

So the fact that things have calmed down a bit (just as they do at the end of a good chase scene), doesn’t tell us much about the future. All these diplomatic machinations to arrange rescue packages, etc., can buy time, but they won’t solve the problem if economic growth does not return. And the big difference between this thriller and a Spielberg movie is that the script is being written as we go along and we have no guarantee of a happy ending.