Sorry, Europe, the Crisis Isn’t Over • Containing the North Korean Threat

Europe’s leaders have gained some breathing space. It’s time to get to work

Financial conditions in Europe are improving, and the sense of imminent doom has lifted. Some commentators are daring to say that Europe’s economic crisis is over. We think they speak too soon.

It’s true that some crucial indicators look better. Governments that were on the brink of bankruptcy last summer have seen bond yields fall to supportable levels. Six months ago, Spanish 10-year bonds paid more than 7 percent; today the rate is 5.2 percent. Italy’s 10-year borrowing cost has fallen from 6.5 percent to 4.3 percent. And this week, Italy sold €8.5 billion ($11.5 billion) of six-month bills at 0.731 percent, the lowest rate in almost three years.

Unfortunately, what confidence can give, lack of confidence can just as suddenly take away — and that’s especially true if the underlying issues haven’t been resolved. In Europe, they haven’t. In some ways, conditions are getting worse.

The International Monetary Fund’s economic forecasters have marked down Europe’s prospects yet again. They expect the euro area’s output to shrink 0.2 percent this year (a reduction of 0.3 percentage points since the previous forecast) and to recover very slowly in 2014.

Output is expected to shrink 1.5 percent in Spain (where unemployment stands at more than 25 percent) and 1 percent in Italy (where the jobless rate is almost 11 percent). Prospects that dire call into question Europe’s political stability, and that puts recovery in doubt.

Because of the single currency, there isn’t a lot that monetary policy can do to lift the region’s struggling economies. Fiscal policy continues to widen rather than narrow intra-European disparities. The region’s weak economies, under pressure to improve their finances, are trying hard to curb public spending and raise revenue, which adds to the contraction.

The weaklings’ banks are under greater-than-average stress as well — early repayment of European Central Bank loans notwithstanding — so their households and companies struggle to get credit.

European Union leaders should attend to unfinished business. Even now, fiscal transfers from strong economies to weak ones would help soften the economic cycle and lessen the shocking disparities in output and employment across the region. More flexible labor markets are also vital. And the just-proposed banking union, combined with better regulation, would strengthen financial markets and help make the recent improvement in confidence more durable.

In these and other areas, however, Europe’s governments continue to dither. The easing of crisis conditions has a downside: It accommodates their tendency to act only when forced to. Last summer’s moves by the ECB, including the relaunching of the euro — as its president, Mario Draghi, said last week — gave Europe’s leaders breathing space. They would be fools to waste it.

To defuse a brewing nuclear dispute, the U.S. should lean on China

With his bombastic threat of “high-profile” retaliation against the U.S. (translation: more tests of nuclear bombs and missiles), North Korean leader Kim Jong Un seems determined to tantrum his way to the top of President Barack Obama’s second-term foreign policy agenda.

As the mythical Orientalism goes, in crisis there is opportunity. North Korea’s bellicose response to tighter United Nations sanctions has raised tensions with its closest ally, China. That offers a chance to contain and even reduce the dangers posed by one of the world’s most opaque and oppressive regimes.

The U.S., which is technically still at war with North Korea, has predicated peace talks on the country’s willingness to give up its pursuit of nuclear weapons. Six-nation talks — involving North Korea, the U.S., China, Japan, Russia, and South Korea — to ease tensions haven’t been held since December 2008. In its most recent statement, the North said it will give up its nukes only when everyone else gives up theirs, and that the six-party talks and a previous agreement of principles with the U.S. are null and void.

A sliver of hope comes from China, North Korea’s biggest trading partner and supplier of aid. Not only does China now support tighter sanctions, albeit not as tight as the U.S. wanted, but Xi Jinping, the general secretary of the Communist Party, has also called the North’s nuclear program “intolerable.” The newly installed Xi has little interest in another regional dust-up, especially given China’s territorial spat with Japan and the need to make nice with a reelected Obama administration.

So when North Korea goes ahead with its nuclear test, which looks imminent, the Obama administration should push the Chinese hard for a coordinated response. If the Chinese balk, the U.S. will be justified in cooperating more closely with Japan and South Korea on missile defense, maritime patrols, counter-proliferation initiatives, and other strategic efforts that China won’t like. The U.S. also has to build relations with South Korea’s incoming president, Park Geun Hye, who wisely wants to move away from the reflexively hard-line stance of her predecessor. The U.S. would be smart to take up Park’s suggestion of a China-U.S.-South Korea dialogue.

The challenge will be to find ways to expose and constrain North Korean behavior without deepening the isolation and privation of its people. What North Korea needs is more visits by the likes of Eric Schmidt, executive chairman of Google. It needs more economic and cultural engagement with the rest of the world. That may be hard to do when the air is filled with acrid belligerence. Whoever said that healing the last wound of the Cold War was going to be easy?

To read William D. Cohan on the latest Barclays scandal and A. Gary Shilling on the outlook for 2013, go to: Bloomberg.com/view

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