Is the economic and financial situation in Western Europe largely under control , as many prominent Europeans contend ? Or is it poised to move into a new and more difficult phase ? The crisis feels unreal to some people in the same way that war felt phony to some Britons from September 1939 through spring 1940 . In contrast to previous crises in emerging markets , Europe hasn ’ t moved precipitously toward collapse . But the main element that lets the European crisis unfold in slow motion ― the existence and appeal of the euro ― also explains why a great deal of volatility lies ahead . The storm is gathering . In a classic emerging markets crisis ― Asia in 1997 - 98 or Latin America many times in the past ― there is a loss of confidence in the ability of local borrowers to repay their foreign creditors . Many debts are denominated in foreign currencies and , as confidence declines , the exchange rate drops , making debt payments that much harder . If interest rates are raised in an attempt to stabilize the currency , the borrower ’ s burden increases . If companies default , the solvency of local banks and governments becomes a concern . The resulting rush for the financial exits tramples on a great deal of wealth , and many ordinary citizens suffer disproportionately . The big difference with the European situation today is the euro . As the world ’ s No . 2 reserve currency after the dollar , euro assets are in demand by investors around the world . This means that almost all euro - zone corporate , household and government borrowing is in euros , making the classic downward emerging market spiral unlikely . If the euro depreciates , debt burdens don ’ t increase . In fact , euro depreciation mostly helps the real economy by increasing exports and making it easier to compete against imports . But a run is still possible within the euro area . If you have a euro deposit in a Greek , Spanish or Italian bank , you can transfer the funds to a German or other bank . A euro is a euro ; with some small transaction costs , you can move money to whichever part of the eurozone is more convenient or seems safe on any given day . This doesn ’ t happen in the U . S . Even if you were convinced that a state was about to suffer a severe financial disruption , deposits would still be backed at the federal level . Runs in the U . S . can occur , of course : In the fall of 2008 , there was a run out of money market mutual funds and away from the likes of Goldman Sachs Group Inc . and Morgan Stanley . But these were moves out of broad asset classes or away from specific institutions . In Europe , any run would be within the eurozone and across banks , not out of the euro or away from a pan - European asset class . It would be running uphill to escape whatever flood one imagines is coming to a particular country or bank . The shift now taking place in euro balances toward more Germanic areas ― besides Germany , this includes the Netherlands and Luxembourg , among others ― wouldn ’ t be a problem if the banks receiving funds were willing to hold the same portfolio of assets in peripheral countries as the banks that are losing deposits . But they aren ’ t . In addition to the lack of full financial integration ― meaning that German banks are , almost by definition , not as present in Italy as are Italian banks ― the unfortunate system of risk weights under Basel II plays a compounding role by encouraging European banks to lend excessively to local governments , making conditions ripe for this specific kind of run . The most important fallacy within the Basel framework is that “ AAA ” - rated securities and sovereign debt ( when less than “ AAA ” ) are regarded as zero - risk . In most instances , banks have the lowest risk weight on debt issued by their own government ― Greek bank lending to the Greek government , Italian bank lending to the Italian government , and so on . ( For more background on capital regulation and Basel in general , see this excellent paper by Martin Hellwig . ) An example , and one that deliberately avoids some of the more precarious financial institutions , is the balance sheet of the Belgian group Dexia SA . ( Here is the news release of second - quarter results ; start on page 11 . ) On June 30 , Dexia had total assets of just over 517 billion euros . But its total weighted risks ― assets that regulators say must have a cushion of capital underpinning them ― amounted to only 127 billion euros . Does Dexia have a lot of debt relative to equity ? If we evaluate the balance sheet as we would for any nonfinancial company , the answer is an unambiguous yes : Assets are 74 . 5 times total shareholders ’ equity . Yet according to the Basel II agreement ― and reinforced by the new Basel III deal that bank regulators negotiated last year ― Dexia is a well - capitalized bank because so many of its assets are regarded as essentially riskless . This logic assumes that the weights correctly assess government debt as having precisely no risk of default or loss of value . Even a 1 percent fall in the value of its zero - risk assets would almost wipe out Dexia ’ s shareholder equity . Under the risk - weighting system , we can safely presume Dexia holds a great deal of Belgian government debt . To be clear : Belgium does not have an immediate government solvency issue , although some flags have been raised . Dexia is just an example of how a flawed view of risk has created both macroeconomic vulnerability ― encouraging lending by local banks to weak economies like Greece and Portugal ― and the potential for disruptive bank runs within the eurozone . Such runs will tighten the credit available to troubled sovereigns and tend to push up the interest rates at which they have to borrow . As deposits flow from the troubled periphery to the Germanic core , there will naturally be a contraction in credit ― and growing concerns about liquidity of peripheral banks . Stress across the bank funding market can be counterbalanced only by European Central Bank loans . The ECB will increasingly be called upon to lend to governments that can no longer place debt easily with their own banks . The loss of liquidity for both banks and governments is just a symptom of an underlying malaise . Too much moral hazard crept into the European financial system and the run - up in debts was unsustainable . As I argued in a recent Peterson Institute for International Economics policy paper , written with Peter Boone , a visiting fellow at the London School of Economics , Europe must choose between restructuring debts in a systematic fashion or issuing a great deal of money , increasing the moral hazard and possibly creating significant inflation . So far this summer , European policy makers have headed further down the road to easing monetary conditions , while refusing to discuss the real causes of their situation with any degree of frankness . An anchor of global stability is beginning to slip . By Simon Johnson , Bloomberg Simon Johnson is a Bloomberg View columnist . The opinions expressed are his own . ― Ed .