First Dubai, Next Europe

NYTimes:  When it looked as if Dubai would go bust last month, making global financial markets swoon, its wealthy neighboring emirate stepped in and bailed it out with a $10 billion loan. Unfortunately Dubai isn’t the only one teetering on the brink. Greece is also in trouble; so is Ireland. Others could follow. Unless the world’s richest nations come to the rescue of weakened states, the global financial crisis might sprout another leg and stop the nascent recovery in its tracks.

Dubai created its problems. The oil-poor emirate borrowed lavishly to pay for a construction binge, and went bust when its housing bubble imploded. Other countries, like Greece and Ireland, are also suffering a hard landing from a decade of debt-fueled profligacy. But there are also innocent bystanders who could be swept away by the financial tide. Government budgets have been battered across the board by the global recession — reducing tax revenues as unemployment insurance and fiscal stimulus measures have increased expenditures. This has reduced governments’ options to fight the continued economic weakness.

The most immediately vulnerable countries are in the European Union. Greece’s budget deficit exploded as recession took its toll, leading to a downgrade of its credit rating and a collapse in the price of its bonds. Ireland’s economy is expected to contract 7.5 percent in 2009, Italy’s 5.1 percent and Spain’s 3.8 percent.

This is a compelling case for the sounder European economies to come to the rescue of their poor neighbors. Statements like the German finance minister’s suggestion that Greece sink or swim alone amount to a shot in the European foot. If Greece were to default on its debts, investors would run from other European countries with low growth and big debts — pushing some of the weaker ones into a crisis of their own.

Growth in these countries is hindered severely by the remarkably strong euro, which has sapped their international competitiveness. With overstretched budgets taking further fiscal stimulus off the table, financial analysts have suggested that nations may be tempted to abandon the euro to achieve growth. Pain is also spreading outside Europe. Rating agencies have downgraded the credit of Mexico, whose budget deficit opened sharply as the economy contracted 7.3 percent last year.

These strains could have deep and lasting repercussions. A breakdown of the euro would be disastrous — sending a potent shock through already jittery financial markets — deepening and extending this worldwide recession. Some observers worry about the secularly tolerant Dubai being driven into the arms of the much more conservative Abu Dhabi. And the world economy is too fragile to withstand another round of careening markets.

We understand that voters in the rich, industrial world might be feeling deep bailout fatigue. Still, bailouts will be necessary. To begin with, the more powerful countries of the European Union — like Germany — must come to the rescue of their weaker neighbors. But other countries, including the United States and China, must stand ready to provide help. It might be expensive. But it would be cheaper than another round of crisis.