Across Western Europe, the “lifestyle superpower,” the assumptions and gains of a lifetime are suddenly in doubt. The deficit crisis that threatens the euro has also undermined the sustainability of the European standard of social welfare, built by left-leaning governments since the end of World War II.

Europeans have boasted about their social model, with its generous vacations and early retirements, its national health care systems and extensive welfare benefits, contrasting it with the comparative harshness of American capitalism.

Europeans have benefited from low military spending, protected by NATO and the American nuclear umbrella. They have also translated higher taxes into a cradle-to-grave safety net. “The Europe that protects” is a slogan of the European Union.

But all over Europe governments with big budgets, falling tax revenues and aging populations are experiencing rising deficits, with more bad news ahead.

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Germany moved Friday to shore up the euro and stabilize heavily indebted European nations, approving the country’s share of a nearly $1 trillion euro-region bailout.

The lower house of the German parliament voted 319 to 73 in favor of the package, which was put together two weeks ago. There were 195 abstentions. The upper house, the Bundesrat, was scheduled to pass the measure later Friday.

Under the plan, Germany is to lend as much as $184 billion to debt-ridden states in the euro zone to backstop the European currency and protect the nations from default. The package follows an earlier rescue for Greece.

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Europe’s leaders scrambled to restore unity in the face of the sovereign debt crisis after Germany dismayed allies with a unilateral ban on naked short selling.

The ban, introduced with no warning to other European nations, knocked global stock markets and sent the euro tumbling to fresh four-year lows against the dollar. An unrepentant Angela Merkel, German chancellor, told parliament in Berlin on Wednesday that the eurozone crisis was the greatest test for the European Union since its creation.

“It is a question of survival,” she said. “The euro is in danger. If the euro fails, then Europe fails. If we succeed, Europe will be stronger.”

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Shocked European ministers are preparing for emergency talks to shore up the euro after markets fell in reaction to panic measures in Germany.

Angela Merkel stunned EU capitals by warning that the euro was in danger and triggered fears of a fresh financial meltdown by announcing a ban on risky trading practices by speculators. The German Chancellor’s actions opened up new cracks in the single currency, drawing sharp criticism from France and prompting Brussels to issue an appeal for unity.

Shares in London plunged by nearly 3 per cent, with similar falls in Paris, Berlin and Madrid. The euro plummeted to a new low against the dollar before making a slight recovery.

European finance ministers, who have just hammered out a massive rescue plan for Greece, will hear controversial calls from Germany at a meeting tomorrow for changes to the Lisbon treaty to give Brussels powers to co-ordinate national budgets.

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“Bond market vigilantes have already woken up in Greece, in Spain, in Portugal, in Ireland, in Iceland, and soon enough they could wake up in the U.K., in Japan, in the United States, if we keep on running very large fiscal deficits,” Roubini said at an event at the London School of Economics yesterday. “The chances are, they are going to wake up in the United States in the next three years and say, ”˜this is unsustainable.’”

The euro has touched a four-year low against the dollar on concern nations with the largest budget deficits will struggle to meet the European Union’s austerity requirements. Roubini, speaking in a lecture hall packed with students who then queued to meet him at a book-signing, suggested that the public debt burden incurred after the banking panic of 2008 may now cause the financial crisis to metamorphose.

“There is now a massive re-leveraging of the public sector, with budget deficits on the order of 10 percent” of gross domestic product “in a number of countries,” Roubini said. “History would suggest that maybe this crisis is not really over. We just finished the first stage and there’s a risk of ending up in the second stage of this financial crisis.”

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You know, Charlie, for 60 years you could really say being in politics, being a political leader, was, on balance, about giving things away to people. That’s what you did most of your time.

I think we’re entering an era — how long it will last, I dare not predict — where being in politics is going to be more than anything else about taking things away from people. And that shift from leaders giving things away to leaders taking things away, I don’t think we know what that looks like over time. It’s going to be very, very interesting.

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SPIEGEL: So, what was in danger? Just the banks? The euro? The European Union?

Trichet: We are now experiencing severe tensions, which are coming after the events of 2007-2008. At that time, private institutions and markets were about to collapse completely. That triggered a very bold and comprehensive financial support by governments. And now we see the signature of some governments put into question. This is a problem for almost all industrialized countries. In the G-7, the major economies have a yearly deficit of around 10 percent of gross domesitc product (GDP). In the euro area as a whole it averages 7 percent of GDP. In this situation with extremely elevated deficits across the globe, the markets have singled out a weak link: Greece. Also taking into account the fact that its statistics were incorrect at one time, market pressure was concentrated there and a drastic adjustment program was necessary.

SPIEGEL: Apparently it was not only Greece that came under attack. Portugal was next …

Trichet: In the market, there is always a danger of contagion — like the contagion we saw among the private institutions in 2008. And it can occur quickly. Sometimes it is a question of half days. This is an issue for the industrialized world as a whole….

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“We have not relented on our principles,” Mr. [Jean-Claude] Trichet told Der Spiegel, the German newsmagazine, according to a transcript on the bank’s Web site. “Price stability is our primary mandate and compass.”

And in an interview broadcast on Sunday, the U.S. Treasury secretary, Timothy F. Geithner, signaled his confidence that Europe would resolve its debt crisis and that the American economy would withstand its impact. “Europe has the capacity to manage through this,” Mr. Geithner told Bloomberg Television. “And I think they will.”

As investors absorb the details ”” and the potential weaknesses ”” of the $1 trillion European rescue plan, Mr. Geithner seemed to be trying to draw a sharp, if implicit, contrast to remarks last week from another senior economic adviser to President Barack Obama, Paul A. Volcker. Mr. Volcker, a former Federal Reserve chairman, startled some investors when he spoke of a possible “disintegration” of the euro zone ”” a striking shift from his expressions of confidence of only two months earlier.

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It’s easy to look at the protesters and the politicians in Greece ”” and at the other European countries with huge debts ”” and wonder why they don’t get it. They have been enjoying more generous government benefits than they can afford. No mass rally and no bailout fund will change that. Only benefit cuts or tax increases can.

Yet in the back of your mind comes a nagging question: how different, really, is the United States?

The numbers on our federal debt are becoming frighteningly familiar. The debt is projected to equal 140 percent of gross domestic product within two decades. Add in the budget troubles of state governments, and the true shortfall grows even larger. Greece’s debt, by comparison, equals about 115 percent of its G.D.P. today.

The United States will probably not face the same kind of crisis as Greece, for all sorts of reasons. But the basic problem is the same. Both countries have a bigger government than they’re paying for. And politicians, spendthrift as some may be, are not the main source of the problem.

We, the people, are.

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Now governments are struggling to cope with the aftermath. But, in insisting that there will be no defaults, they are protecting the financial sector from its stupidity. The people of indebted countries are expected to pay, instead. Is this going to prove an acceptable bargain, in the absence of a return to growth in stricken countries? Hardly.

So where do we go from here? We must start by recognising that all we have done is buy a little time. In the eurozone’s first real crisis, governments have been driven to desperate attempts to prevent defaults, as finance has dried up. Now they confront big choices.

The first and most fundamental is whether to go towards greater integration or towards disintegration. The answer has to be the former. Of course, it is possible to imagine a return to national currencies. But this would cause the financial system to implode, since the relations between assets and liabilities now in euros would become so uncertain. There would be massive capital flight into the banks of those countries deemed safe.

The second is how to manage divergence. The eurozone cannot rely on markets alone. It will have to police divergence in upswings and cushion adjustment in downswings.

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I used to think Europe had got it right. Let the US be a military superpower; let China be an economic superpower ”“ Europe would be the lifestyle superpower. The days when European empires dominated the globe had gone. But that was just fine. Europe could still be the place with the most beautiful cities, the best food and wine, the richest cultural history, the longest holidays, the best football teams. Life for most ordinary Europeans has never been more comfortable.

It was a great strategy. But there was one big flaw in it. Europe cannot afford its comfortable retirement.

Greece’s financial crisis is, unfortunately, an extreme example of a broader European problem. Investors have been looking nervously at debt-levels and budget deficits in Spain, Portugal and Ireland for months. But even Europe’s big four ”“ Britain, France, Italy and Germany ”“ are hardly immune from concern. Italy’s public debt is about 115 per cent of gross domestic product. Some 20 per cent of this needs to be rolled over during the course of 2010. Britain is currently running a budget-deficit of nearly 12 per cent of GDP, one of the largest in Europe. George Osborne, who is likely to end up as chancellor of the exchequer in the new government, has described Britain’s official economic forecasts as a “work of fiction”. The French government has not produced a balanced budget for more than 30 years. And one of the reasons for the deep bitterness in Germany at bailing out Greece, is the knowledge that Germany is already struggling to balance its own books.

It is true that the citizens of Latvia and Ireland have already swallowed actual cuts in wages and pensions. But these are both countries that have experienced real poverty in living memory, followed by massive and unsustainable booms. They know that the last few years have been a bit unreal.

As the riots on the streets of Athens illustrate, however, not all Europeans will react so stoically to deep cuts in spending.

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…as details crystallized of the package’s main component ”” a promise by the European Union’s member states to back 440 billion euros, or $560 billion, in new loans to bail out European economies ”” the wisdom of solving a debt crisis by taking on more debt was challenged by some analysts.

“Lending more money to already overborrowed governments does not solve their problems,” Carl Weinberg, chief economist of High Frequency Economics in Valhalla, N.Y., said in a note. “Had we any Greek bonds in our portfolio, we would not feel rescued this morning.”

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Put yourself in the position of a holder of Greek government debt a few years out, just prior to a probable default. Anticipating a default, you would liquidate the bonds to a level that reflects the likelihood of incomplete recovery. Working backward, and given the anticipated recovery projected by a variety of ratings services and economists, one would require an estimated annual coupon approaching 20% in order to accept the default risk. For European governments and the IMF to accept a yield of only 5% is to implicitly provide the remainder as a non-recourse subsidy. Even then, investors are unlikely to be willing to roll over existing debt when it matures – the May 19th roll-over is the first date Europe hopes to get past using bailout funds. In the event Greece fails to bring its budget significantly into balance, ongoing membership as one of the euro-zone countries implies ongoing subsidies from other countries, many of which are also running substantial deficits. This would eventually be intolerable. If investors are at all forward looking, the window of relief about Greece (and the euro more generally) is likely to be much shorter than 18 months.

Still, for Greece, it appears that the IMF and EU will provide the funding for the May 19th rollover of Greece’s debt, so there’s some legitimate potential for short-term relief. The larger problem is that Portugal and Spain are also running untenable deficits (think of Greece as the Bear Stearns of Euro-area countries). European officials deny the possibility of contagion that might call for additional bailouts, but my impression is that Greece is the focus because its debt is the closest to rollover. The attempt to cast Greece as unique is a bit strained – Christine LaGarde, the French finance minister suggested last week “Greece was a special case because it reported special numbers, provided funny statistics.” In other words, Greece gets the bailout because it had the most misleading accounting?

The bottom line is that 1) aid from other European nations is the only thing that may prevent the markets from provoking an immediate default through an unwillingness to roll-over existing debt; 2) the aid to Greece is likely to turn out to be a non-recourse subsidy, throwing good money after bad and inducing higher inflationary pressures several years out than are already likely; 3) Greece appears unlikely to remain among euro-zone countries over the long-term; and 4) the backward induction of investors about these concerns may provoke weakened confidence about sovereign debt in the euro-area more generally.

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What we’re seeing in Greece is the death spiral of the welfare state. This isn’t Greece’s problem alone, and that’s why its crisis has rattled global stock markets and threatens economic recovery. Virtually every advanced nation, including the United States, faces the same prospect. Aging populations have been promised huge health and retirement benefits, which countries haven’t fully covered with taxes. The reckoning has arrived in Greece, but it awaits most wealthy societies.

Americans dislike the term “welfare state” and substitute the bland word “entitlements.” Vocabulary doesn’t alter the reality. Countries cannot overspend and overborrow forever. By delaying hard decisions about spending and taxes, governments maneuver themselves into a cul-de-sac. To be sure, Greece’s plight is usually described as a European crisis — especially for the euro, the common money used by 16 countries — and this is true. But only to a point.

Euro coins and notes were introduced in 2002. The currency clearly hasn’t lived up to its promises. It was supposed to lubricate faster economic growth by eliminating the cost and confusion of constantly converting between national currencies. More important, it would promote political unity. With a common currency, people would feel “European.” Their identities as Germans, Italians and Spaniards would gradually blend into a continental identity.

None of this has happened. Economic growth in the countries using the currency averaged 2.1 percent annually from 1992 to 2001 and 1.7 percent from 2002 to 2008. Multiple currencies were never a big obstacle to growth; high taxes, pervasive regulations and generous subsidies were….

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Even more alarming is the exposure of other EU banks to Greek debt, which totals $193 billion, according to the Bank for International Settlements. Factor in the risk of copycat crises in Portugal and Spain, and you begin to see the outlines of a disastrous Europewide banking crisis. The only way out of that will be further compromises by the ECB about the paper it accepts as collateral. Already last week it waived its rules, continuing to hold Greek bonds, despite their junk status. If this continues, there is only one way for the euro to go, and that’s down.

Keep this in perspective. When the euro was launched back in January 1999, it was worth less than $1.20, and for most of its first three years it was down below parity with the dollar. So its recent slide from close to $1.60 before the global financial crisis to $1.27 last week is far from unprecedented. But the way this crisis is unfolding, further declines seem likely. It will surely be at least a year before investors wake up to the fact that the fiscal predicament of the United States is actually worse than that of the euro zone.

The difference is, of course, that the United States has a federal system, while the euro zone does not. In America, Texas automatically bails out Michigan via the redistribution of income and corporation tax receipts. What the Greek crisis has belatedly revealed is that such fiscal centralization is the necessary corollary of a monetary union.

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The fear that began in Athens, raced through Europe and finally shook the stock market in the United States is now affecting the broader global economy, from the ability of Asian corporations to raise money to the outlook for money-market funds where American savers park their cash.

What was once a local worry about the debt burden of one of Europe’s smallest economies has quickly gone global. Already, jittery investors have forced Brazil to scale back bond sales as interest rates soared and caused currencies in Asia like the Korean won to weaken. Ten companies around the world that had planned to issue stock delayed their offerings, the most in a single week since October 2008.

The increased global anxiety threatens to slow the recovery in the United States, where job growth has finally picked up after the deepest recession since the Great Depression. It could also inhibit consumer spending as stock portfolios shrink and loans are harder to come by.

“It’s not just a European problem, it’s the U.S., Japan and the U.K. right now,” said Ian Kelson, a bond fund manager in London with T. Rowe Price. “It’s across the board.”

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Yesterday night’s important news out of Europe points to renewed efforts to rescue Greece and safeguard the Euro. The news will undoubtedly be accompanied by additional announcements out of Brussels and Berlin, as well as Washington DC. In the process, the stakes are getting even bigger”¦for Greece, Europe and the global economy.

As the announcements multiply, it is even more important to be clear about the key question. This is best summarized by a simple, and disturbing image, that a friend alerted me to:

With Greece (as well as Portugal and some other countries) now visibly drowning in a sea of debt, the question is whether the rescuer (EU/IMF) can pull off the rescue or, instead, get pulled down with all parties drowning.

So far, the attempts at rescue-including last Sunday’s dramatic EUR 110 billion announcement-have have been incomplete with respect to both design and implementation. They were thus viewed as insufficient and not credible by analysts and markets. As a result, the Greek crisis morphed in the following days into something much more sinister for Europe and the global economy.

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European Union officials were working out the details of a financial support mechanism on Saturday to prevent Greece’s debt turmoil spreading to Portugal and Spain, ready for approval by EU finance ministers on Sunday.

The leaders of the 16 countries that use the single currency said on Friday after talks with the European Central Bank and the executive European Commission that they would take whatever steps were needed to protect the stability of the euro area.

Both Italian Prime Minister Silvio Berlusconi and French President Nicolas Sarkozy cancelled trips to Moscow to mark the anniversary of the end of world war two in order to continue consultations over the crisis, though German Chancellor Angela Merkel said she would still go.

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The basic flaw in the IMF-EU sponsored program to restore Greek fiscal sustainability through a program of draconian public expenditure cuts is that if successfully implemented it will have the unwanted effect of increasing rather than reducing Greece’s public-debt-to-GDP ratio. Since if Greece’s nominal GDP were to decline over the next few years by 30 percent as a result of a deep recession and price deflation, Greece’s public-debt-to-GDP ratio would arithmetically rise from its present level of around 120 percent towards 175 percent. It is calculations of this sort that have recently led Standard and Poor’s to warn Greek bond holders that they might eventually retrieve only 30 to 50 cents on the dollar on their bond holdings.

A major write-down of Greece’s $400 billion sovereign debt would deal a serious blow to an already enfeebled European banking system, which holds the majority of that debt. Indeed, if Greece’s debt does need to be written down by anywhere near the Standard and Poor’s estimate, one could see the IMF having to revise up by at least 20 percent its present estimate of the European banks’ likely loan losses from the 2008”“2009 global economic crisis.

The even greater risk to the European banking system from a Greek failure is that it would bring very much into play Portugal, Spain, and Ireland. These countries, which between them have around US$1.5 trillion in sovereign debt, suffer from similar, albeit less acute, public finance and international competitiveness problems. And they too are stuck in a Euro-zone straightjacket that severely constrains their ability to deal with these problems in a credible manner.

In considering the timing of the Federal Reserve’s exit strategy, Bernanke would make the gravest of errors were he to underestimate the potential fallout of a Greek failure on the U.S. and global economies….

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Citigroup Inc. Chief Economist Willem Buiter said European governments have delayed an inevitable Greek debt restructuring because they’re “wimps” and don’t want to bail out their own banks.

“If the European area governments weren’t such wimps, they would have done it right away,” Buiter, a former adviser to the International Monetary Fund and World Bank, said today in remarks at the Council on Foreign Relations in New York. “It’s been a disgraceful episode for European heads of state, especially in Germany, for the narrow-minded parochialism that has been displayed.”

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Clashes in Athens broke out at the end of a main protest that drew tens of thousands of people as police pushed back a few thousand demonstrators outside parliament.

The violence was quickly contained with riot police firing tear gas at the protesters, who had earlier pelted them with stone, oranges and bottles. Several small fires burned in surrounding streets. No injuries or arrests were reported.

Demonstrators banging drums and shouting anti-government slogans through bullhorns, unfurled a giant black banner outside parliament earlier Thursday. More than 30,000 demonstrators filled downtown streets, chanting “They declared war. Now fight back.”

Prime Minister George Papandreou expelled three Socialist deputies who dissented in the vote, reducing the party’s number of seats to 157 in the 300-member parliament.

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This story, in short, is not over.

For the eurozone, two lessons are clear: first, it has a choice ”“ either it allows sovereign defaults, however messy, or it creates a true fiscal union, with strong discipline and funds sufficient to cushion adjustment in crushed economies ”“ Mr Buiter recommends a European Monetary Fund of €2,000bn; and, second, adjustment in the eurozone is not going to work without offsetting adjustments in core countries. If the eurozone is willing to live with close to stagnant overall demand, it will become an arena for beggar-my-neighbour competitive disinflation, with growing reliance on world markets as a vent for surplus. Few are going to like this outcome.

The crises now unfolding confirm the wisdom of those who saw the euro as a highly risky venture. These shocks are not that surprising. On the contrary, they could have been expected. The fear that yoking together such diverse countries would increase tension, rather than reduce it, also appears vindicated: look at the surge of anti-European sentiment inside Germany. Yet, now that the eurozone has been created, it must work. The attempted rescue of Greece is just the beginning of the story. Much more still needs to be done, in responding to the immediate crisis and in reforming the eurozone itself, in the not too distant future.

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Greece is “on the brink of the abyss”, President Karolos Papoulias has warned, after three people died during protests over planned austerity measures.

“We are all responsible so that it does not take the step into the void,” the president said in a statement.

It followed a day of violence during which protesters set fire to a bank, killing three employees.

Greece’s government has vowed to pursue the spending cuts – a condition of its 110bn euro ($142bn; £95bn) bail-out.

“We are prepared to pay the heavy political cost,” Finance Minister George Papaconstantinou told parliament during Wednesday’s debate on the bill.

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Millions of Greek workers were expected to participate in the strike called by Greece’s two major umbrella unions, private-sector GSEE and public-sector Adedy, amid widespread discontent over the measures.

In a statement, GSEE President Yannis Panagopoulos called on workers, retirees and youth to vigorously resist the “harsh and antisocial measures.”

The strikes are a key test for Prime Minister George Papandreou as he tries to turn around his economically beleaguered country. Greece’s fiscal problems have forced Athens to pay six percentage points more than Germany to borrow money, and they have sparked fears of similar problems in other weak European economies.

Some political analysts said the strikes are unlikely to shake the government’s resolve to push through the cuts, at least for now.

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Greece announced Sunday that it had reached an agreement on a long-delayed rescue package that will require years of painful fiscal belt-tightening, but the deal probably will not defuse the potential threats to other European countries also suffering from mounting debts and troubled economies.

“I have done and will do everything not to let the country go bankrupt,” Prime Minister George Papandreou said in a televised address that urged Greeks to accept “great sacrifices” to avoid “catastrophe.”

The bailout, which was worked out over weeks of negotiations with the International Monetary Fund and Greece’s European partners, calls for as much as €110 billion, or $145 billion, in loans intended to stave off an immediate debt default and stop the spread of economic contagion to other parts of the region.

But analysts warned that Greece itself has not yet solved its fundamental problems and that other sovereign debt crises could arise as lenders and market speculators turn their attention to a handful of similarly vulnerable nations.

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Greece outlined deep spending cuts and tax increases Sunday to free up a multi-billion-euro rescue by the International Monetary Fund and European Union, the first bailout for one of the 16 countries using the euro.

The measures, which include tax increases and salary and pension cuts for civil servants, aim to reduce the budget deficit to below 3 per cent of gross domestic product by 2014, from the current 13.6 per cent of GDP, Finance Minister George Papaconstantinou said.

“We are called on today to make a basic choice. The choice is between collapse or salvation,” he said.

The full amount of the three-year IMF/euro-zone package will be announced in Brussels after an emergency euro-zone finance ministers’ meeting, where Mr. Papaconstantinou was heading after his Athens news conference. He said the amount would be “close to” widely reported figures. French and other officials have said it would be 120 billion euros.

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Greece will default on its national debt. That default will be due in large part to its membership in the European Monetary Union. If it were not part of the euro system, Greece might not have gotten into its current predicament and, even if it had gotten into its current predicament, it could have avoided the need to default.

Greece’s default on its national debt need not mean an explicit refusal to make principal and interest payments when they come due. More likely would be an IMF-organized restructuring of the existing debt, swapping new bonds with lower principal and interest for existing bonds. Or it could be a “soft default” in which Greece unilaterally services its existing debt with new debt rather than paying in cash. But, whatever form the default takes, the current owners of Greek debt will get less than the full amount that they are now owed.

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With Greece inching closer to the brink of financial collapse, fear that the debt crisis will spread rattled markets for a second day Wednesday, while an extraordinary collection of global financial leaders gathered in Berlin to seek a solution.

Shares fell 2 percent or more across Europe and parts of Asia as investors increasingly wonder if Portugal, Spain and even Ireland may not be able to borrow the billions of dollars they need to finance their government spending.

“It’s like Lehman Brothers and Bear Stearns,” said Philip Lane, a professor of international economics at Trinity College in Ireland, referring to the Wall Street failures that propelled the financial crisis of 2008. “It is not so much the fundamentals as it is the unwillingness of the market to fund you.”

Standard & Poor’s cut Greece’s debt to junk level on Tuesday, warning that bondholders could face losses of up to half of their holdings in a restructuring. The agency also downgraded Portugal’s debt by two notches.

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As interest rates on Greek debt spiral upward again, the question facing Europe is no longer whether Athens has the political will to cut spending and raise taxes to curb its gaping budget deficit, but whether Greece will run out of money before it gets the chance to do so.

With the rate on 10-year Greek bonds reaching as high as 7.5 percent on Thursday, up from 6.5 just three days ago, the cost of insuring against a Greek default hit a record high.

The message from the market could not be clearer: artfully worded communiqués from Brussels will no longer suffice. To avoid bankruptcy, analysts said, Greece needs a bailout from Europe, and fast.

“This is no longer about liquidity ”” it’s a solvency issue,” said Stephen Jen, a former economist at the International Monetary Fund who is now a strategist at BlueGold Capital Management in London.

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The euro is under attack like never before, as the promises on which it was based turn out to be lies. Hedge funds are speculating against Greek debt, while euro-zone politicians work behind the scenes to cobble together rescue packages. But fundamental flaws in the monetary union need to be fixed if Europe’s common currency is to survive.

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