In the Netherlands, the center-right government of Mark Rutte fell, unable to cobble together a coalition to pass budget cuts required by EU fiscal rules – rules that mandate that eurozone countries run annual deficits no more than 3% of GDP, which would force stringent austerity upon the Dutch to bring down a deficit that is currently projected to be 4.6% of GDP in 2012. Rutte, along with Merkel of Germany, was a hardline advocate of the 3% fiscal discipline rules.
But given that the sober Dutch are in no danger of defaulting on their AAA-rated bonds, why the turmoil and panic? Because, perhaps, the Dutch are indeed sober – and a significant number of them have said “enough”. Having seen the devastation inflicted on the Greek, Irish and Spanish economies by tough austerity measures, many have concluded that the pain is simply not worth it to meet an arbitrary 3% deficit rule.
Moreover, Greece, Ireland and Spain have shown that meeting a deficit number in a depressed economy is akin to chasing a moving target: because budget cuts depress the economy, to achieve a one percentage point of GDP reduction in the deficit requires cutting by more than one percentage point. And when one misses one's target, even more cuts are necessary. Better, then, not to go there at all, reason the Dutch.
When markets contemplate that it's likely that another austerity-skeptic, François Hollande, will win the presidency in France, then the pattern becomes impossible to ignore: the “core” eurozone countries are fragmenting. While it would be foolish to make predictions, what is probable is that Germany's political isolation within the eurozone will deepen, leaving German taxpayers unwilling to continue backstopping the whole system.
Unthinkable as it seems, the logical conclusion is that the eurozone cannot continue to exist, at least in its present form. Markets, which hate unquantifiable uncertainty, are sensing this. We are likely to be in for an extended period of gut-wrenching turbulence.
What are the implications for the US, economically and politically? Direct links between the US and eurozone economies are fairly minor: we don't export that much to them, they don't import that much from us, and US banks have had an extended time to cut their exposure to eurozone risk. Yet the collateral damage could still prove significant.