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A Breach in the Eurozone Dike

PRINCETON – While all eyes have been on the European periphery, has the core been cracking? The Bundesbank has lowered its forecast for German annual GDP growth in 2013 to 0.4%. The Central Bank of the Netherlands expects Dutch GDP to shrink by -0.5% this year – following a contraction of about 1% in 2012.

The eurozone crisis may be entering its third stage. In the first stage, beginning in the spring of 2008, the locus of the North Atlantic crisis moved from the United States to the eurozone. Banks in the eurozone came under pressure, and interbank tensions increased.

In the second stage, starting in the spring of 2009, the crisis spread to the sovereigns, as investors grew increasingly worried that propping up banks would strain government finances. In turn, sovereign weakness made the banks appear riskier, and the banks and their home governments became joined at the hip.

Throughout the crisis, it has been widely assumed – at least so far – that the eurozone core would remain solid, and would continue to write the checks for the periphery’s distressed governments and banks. That assumption appeared plausible. A “two-speed” Europe was the new normal.