One proposal gaining prominence would have countries cede some control over their budgets to a central European authority – an idea that would have been unthinkable even three months ago.
World stock markets, glimpsing hope that Europe might finally be shocked into stronger action, staged a big rally. The Dow Jones industrial average rose almost 300 points. In France, stocks rose 5 percent, the most in a month.
More relevant to the crisis, borrowing costs for European nations stabilized. They had risen alarmingly in recent weeks – in Greece, then in Italy and Spain, then across the continent, including in Germany, the strongest economy in Europe.
The yields on benchmark bonds issued by Italy and Germany rose, but only by hundredths of a percentage point. The yield fell 0.1 percentage point on bonds of France, 0.14 points for those of Spain and 0.22 points for Belgium.
Allowing a central European authority to have some control over the budgets of sovereign nations would create a fiscal union in Europe in addition to the monetary union of the 17 countries that share the euro currency.
Some analysts have said that would be a leap toward creating a United States of Europe. More delicately, it would force the nations of Europe to cede some sovereignty and agree to strengthen ties with their neighbors.
“The common currency has the problem that the monetary policy is joint, but the fiscal policy is not,” German Finance Minister Wolfgang Schaeuble said in Berlin.
The monetary union has existed since the euro was created in 1999, but the European Union – which includes the 17 euro nations and 10 others that use their own currencies – has no central authority over taxing and spending.
Countries such as Ireland, Portugal, Spain, Greece and Italy overspent wildly for years and racked up annual budget deficits that have left them with monstrous debt.
A fiscal union could prevent excessive spending in the future. More important, it would be a step toward addressing today’s debt crisis: It could provide cover for the European Central Bank to stage a massive intervention in the European bond market to drive down borrowing costs and keep the debt crisis under control.
Enforced budget discipline might ease the central bank’s concerns about the concept known as moral hazard – essentially, that bailing out free-spending countries would only encourage them to do it again.
A fiscal union would also pose a practical problem: how to make such a body democratically accountable.
Another option is for the 17 nations in the euro group to sell bonds together to help the countries in the deepest trouble because of debt. Germany has resisted such a plan, because it would raise borrowing costs for it and other nations with good credit ratings.
While Europe buzzed over the possible solutions, finance ministers of the euro nations prepared for a summit beginning Tuesday evening in Brussels, to be joined the following day by ministers from the rest of the European Union.
Italy readied an auction of bonds designed to raise €8 billion, or about $10.6 billion – and steeled itself for the high interest rates it will have to pay.
In Washington, President Barack Obama huddled with European Union officials, and the White House insisted Europe alone was responsible for fixing its debt problems.
While Obama offered no specifics on how the U.S. might help, he said failing to resolve the debt crisis could damage the U.S. economy, which has grown slowly since the end of the recession in June 2009 and still has 9 percent unemployment.
“If Europe is contracting, or if Europe is having difficulties, then it’s much more difficult for us to create good here jobs at home,” Obama said at the conclusion of the day-long summit.
The euro appeared to be in increasing danger. Experts said the currency could fall apart within days without drastic action, with consequences rivaling those of the 2008 financial crisis.
“Everyone knows that if the eurozone crashes the consequences would be very dramatic and in the race after that there would no winners, just losers,” said Finland’s finance minister, Jutta Urpilainen.
For countries that decided to leave the euro group and return to their own sovereign currency, the conversion would be wrenching.
If Germany broke away, for example, its national currency could rise in value quickly because the German economy is stronger on its own than the European economy as a whole. But a stronger German mark would damage the German economy because Germany depends heavily on exports, and it would cost more for everyone else to buy German goods.
As for weaker countries that decided to leave, depositors would probably yank money out of their banks, fearing a plummeting currency. Savers would not want their euros replaced with, say, feeble Greek drachmas.
If countries tried to repay their old euro debts with their own currencies, they’d be considered in default and struggle to sell bonds in global financial markets. Corporations would face the same squeeze.
Overall, economists at UBS estimate, a weak country that left the eurozone would see its economy shrink by 50 percent.
Currency chaos and defaults by governments and companies would weaken European banks and also cause them to stop lending to each other. Because banks are connected globally, a credit freeze in Europe would spread. As it did in 2008, a credit freeze would cause stock markets to sell off worldwide, and another deep recession would probably follow.
Wolfgang Munchau, a columnist for the influential Financial Times newspaper, wrote Monday that the common currency “has 10 days at most” to avoid collapse. He called for decisions on a fiscal union and the creation of a powerful common treasury.
Unlike the United States, which has centralized institutions in Washington for raising taxes and spending money, the euro nations have 17 independent treasuries with little oversight from Brussels, the headquarters of the EU.
That would change under the fiscal union proposal being aired ahead of another summit of EU leaders that begins Dec. 9. Ten nations in the EU do not use the euro currency, most notably Britain.
While not explicitly backing a fiscal union, Germany and France have promised to propose measures that will make the 17 euro countries operate under strict and enforceable rules, so that no single country can wreak continent-wide damage.
Already, the Organization for Economic Cooperation and Development, an international group devoted to economic progress, was warning that the global economy was in for a rocky road in coming months.
In its six-month report Monday, it said the continued failure by EU leaders to stem the debt crisis “could massively escalate economic disruption” and end in “highly devastating outcomes.”
The latest turmoil came last week, after Germany tried to auction $8 billion worth of its national bonds and could only persuade investors to buy $5.2 billion. It was a sign that even mighty Germany was not immune from the debt crisis.
Investors around the world will watch the Italian bond auction Tuesday. If it receives a similarly poor reception, more European countries would be in danger of being locked out of the international bond market.
Exactly how a fiscal union would take shape in Europe is an open question.
Schaeuble, the German financial minister, said the proposal would require passage only by the 17 countries that use the euro currency. The other 10 countries in the EU, such as Britain, Poland and Sweden, could adopt it if they wanted to.
But analysts said such a move would take a long time to come to fruition.
“We do seem to be moving slowly towards more of a fiscal union but at a pace that may result in all the components being put in place after a complete meltdown of the financial system,” said Gary Jenkins, an economist with Evolution Securities.
Many think the ECB is the only institution capable of calming frayed market nerves. But Merkel, the German chancellor, has continually dismissed the prospect of a bigger role for the ECB.