Strains Across the Atlantic Coincide With Strains Across the Euro Zone

Oh, for the good old days when American Presidents would attend European Union summits. Gone.

Barack Obama, the hero of the adoring, anti-George W. Bush street crowds in Paris, Berlin and London has decided after two such summits that he would do better to tend to his diminishing popularity at home than to attend the May EU summit in Madrid, thereby foregoing the need to figure out with which of the three EU "presidents" he should hobnob—Herman Van Rompuy, the new, full-time EU "president;" José Manuel Barroso, the president of the European Commission; or the occupant of Spain's seat as the temporary, rotating president. EU officials haven't yet identified the official host.

This comes at a time of heightened tension in the EU, both political and economic. Political tension has been mounting for some time as French president Nicolas Sarkozy continues his attack on America's plans for structural reform of the banking system, and the use of the dollar as the world's reserve currency. In part this is a matter of conviction, in part the revenge of a scorned lover. Mr. Sarkozy had hoped to become Obama's closest ally, but was refused a photo op with the U.S. presiden during the D-Day ceremonies and, according to the Washington Post, was mightily offended when a letter from Mr. Obama promising close collaboration was misaddressed by the White House and sent to former president Jacques Chirac.

So much for Europe's belated discovery that Mr. Obama is not the friend in the White House for which they yearned during the reign of Bush the younger. More important is the economic strain created by the Greek crisis, which might be the forerunner of problems in Spain and Portugal, and Goldman Sachs calls the euro zone's "biggest challenge since the establishment of the single currency."

Nobel-Prize-winning economist Joseph Stiglitz is hoping Greece does not cut its deficit too quickly lest such fiscal austerity would throw Greece's economy into a deeper recession, deepening rather than lowering its deficit.

EU policy makers don't see it that way. They fear that Greece's failure to present credible plans to cut its deficit from 12.8% to 8.7% this year and to 2.8% by the end of 2012 might result in a default, and put pressure on it and similarly situated countries to abandon the euro. So they are increasing their control of Greece's finances in the (decreasing) hope of avoiding a bailout, which would create moral hazard, inviting Spain and Portugal (deficit, 9.3% of GDP) to seek similar help.

Over four million Spanish workers are out of work, and the jobless rate, closing in on, if not already at, 20%, is the highest in the EU. Cutting the budget deficit, now 11.4% of GDP, is politically difficult, and might cause what is politely labeled by eurocrats as "social unrest"—"riots", to the rest of us. The good news for Spain, which has the advantage of a low level of debt (55.2% of GDP), is that Goldman Sachs last week called its budget-cutting plan "realistic and credible."

The difficult situation in which these periphery countries find themselves has forced the European Central Bank to hold its key interest rate target at 0.25%, despite the fact that the core euro-zone economies are showing real signs of life. Business sentiment in the core countries is up and Germany's economy minister Rainer Brüderle has raised his growth forecast for this year to 1.4% from the 1.2% figure he suggested in October. Most private forecasters believe he is being excessively cautious, since they expect the world-wide recovery and a fallen euro to increase Germany's exports by 5.1%.

What remains unclear is the credit situation and the condition of the euro-zone banks. Although the proportion of banks tightening their lending standards is down, 42% "are still reporting some constraints on lending", according to Bank of America Merrill Lynch. Joerg Kraemer, chief economist at Commerzbank AG is a bit more gloomy. He reports, "The current stagnation of bank lending reflects at least partly the difficult situation of the banking industry." Which carries three unpleasant implications.

• Small and medium-sized firms, which provide 70% of private-sector jobs, will have difficulty expanding if they need credit, as most of them do.

• The condition of the banks is such that they are living in good part on the life support of extraordinarily low interest rates.

• If the pace of recovery quickens, the ECB, burdened by concerns for the banks and for the peripheral countries, will find it difficult to raise interest rates in order to contain inflationary expectations, which at the moment are quite low.

Meanwhile, EU politicians are trying to decide how to react to a U.S. president who ignored them during the Copenhagen climate-change meetings, and is proposing financial-sector reforms that are completely unacceptable to most European countries. And who doesn't care to mingle with their very own three presidents.