2011: Europe still stuck in a rut

BERLIN, Germany — Bless the Estonians. As folks in the tiny Baltic state pop champagne corks at midnight today, their official currency will become the euro.

That’s right, Estonia is joining the eurozone, even as plenty of citizens in the existing 16 euro states talk about abandoning that listing ship. Estonia, population 1.3 million, is even gallantly offering loan guarantees of up to 130 million euros ($171 million) to the common cause of the Irish bailout, whose total price tag is 85 billion euros ($112 billion).

The eurozone debt crisis, it is safe to say, will carry through to 2011. Indeed it will dominate 2011.

Other issues will come and go. Some brief respite will arrive, for instance, when Britain’s Prince William marries Kate Middleton on April 29. Or when, as looks increasingly likely, Italy’s embattled Prime Minister Silvio Berlusconi is forced to call an election if he can’t scrape together a majority in parliament early in the new year.

But the story of 2011 will be the euro, more so even than it was in 2010. While opinion is divided as to whether the common currency will survive — at least in its current form — most economists believe that further bailouts in the style of Greece and Ireland will be needed.

The question is: Which country or countries? If it is Portugal, the problem is managable. If it is Spain, the eurozone will be tested to the breaking point. As the eurozone’s fourth largest economy — and twice the size of Greece, Ireland and Portugal put together — Spain is too big to fail but would be phenomenally expensive to bail out at up to 500 billion euros ($660 billion) — even with help from plucky Estonia.

If Spain goes, Italy and Belgium could be next.

Will Spain muddle through? Deutsche Bank’s respected chief economist, Thomas Meyer, believes Spain will be all right, though he thinks Portugal will need help sooner rather than later.

Others aren’t so confident about Spain. Either way, what everyone agrees on, Meyer included, is that Europe’s leaders will in the next few months have to commit themselves more fully than they have so far.

This is the greatest test of post-war European integration. Failure could mean the break-up of the euro, in which the continent has invested so much political and economic capital. The ideal of European brotherhood would struggle to recover.

At the last European Council summit in Brussels, leaders agreed to establish the framework for a future permanent eurozone rescue fund by March. The mantra of recent meetings in Brussels has been that Europe is “ready to do whatever is required” to save the euro. But it is clear countries remain deeply divided over what needs to be done.

It will mean sacrifices: greater fiscal discipline in the case of debt-ridden countries, and perhaps consideration from healthier countries such as Germany of solutions such as common European bonds, which share debt risk across the eurozone members.

This in turn will require exceptional political leadership. Can countries like Greece, Ireland, Portugal and Spain keep persuading their disillusioned citizens that they need to rein in spending even if those citizens riot in the streets? Can Germany convince its increasingly optimistic citizens that they should pay to bail out less disciplined countries?

It all assumes that the current crop of decision-makers have the political capital at home to do what’s in the best interests of the union — and this might be a problem.

Angela Merkel, who has dominated proceedings, has been watching her popularity slide for a year. Key state elections in 2011 could deliver her remaining authority and credibility a decisive blow if they go badly for her conservative party, as polls predict.

An election drubbing in March in the large, industrial state of Baden-Wurttemberg, which Merkel’s party has held since 1953, could fatally weaken the chancellor.

Spanish regional elections in March could likewise cripple Prime Minister Jose Luis Rodriguez Zapatero if his party fares badly. Zapatero pushed through unpopular reforms necessary to reassure markets that his country won’t default on its debts. An electoral debacle for Zapatero’s party could tip Spain toward a bailout.

Ireland, too, faces elections in the first few months of the year and opposition parties are campaigning to renegotiate the terms of the country’s bailout.

French President Nicolas Sarkozy, meanwhile, will chair the G8 and G20 for the first half of the year, giving himself a platform to launch his bid for re-election in 2012. His lack of prominent leadership on the euro question reflects the subtle shift in EU power along the old German-Franco axis toward Berlin.

The big election question that should be answered over the next year is whether socialist Dominique Strauss-Kahn will return from the IMF and try to wrest the presidency from his old foe.

Sarkozy has major problems to overcome, not least an unemployment rate of 10 percent and a record 25 percent for young people. It won’t help that his former mentor, Jacques Chirac, will face a corruption trial in March.

Looking east, EU-Russian relations are widely thought to be at a critical stage. They are off to a bad start going into 2011 with European leaders slamming the conviction of Mikhail Khodorkovsky, Russia’s former richest man, and Russia’s predictable complaint about the West’s meddling.

Nevertheless, closer cooperation between the EU and Russia will be a key topic for the next year. European Commission President Jose Manuel Barroso recently predicted Russia would be welcomed in the World Trade Organization in 2011 after it ironed out its remaining trade differences with the EU.

Russia and the EU have also signed a “partnership for modernization.” Russia will be pushing in 2011 for visas to be waived to streamline business with the EU.

Tensions between western Europe and the newer eastern members of the bloc may flare up.

Hungary will be the country to watch. The former communist state is due to take over the EU’s six-month rotating presidency on Jan. 1 — just the third former eastern bloc country to assume the job after Slovenia and the Czech Republic, a sign of the gradual shift of power from west to east.

The assumption of the presidency coincides with Hungary’s enaction of a new law that other EU members fear may be used to curb press freedom and has sparked talk of the “Putinization” of Hungary — a slur that also has been thrown at Ukraine. Luxembourg Foreign Minister Jean Asselbron even said the law “raises the question of whether such a country is worthy of leading the EU.”

But Hungary doesn't need a bailout. In 2011, it looks as though few members will fit the image of a perfect EU state.