While the world has been transfixed with Japan,Europe has been struggling to avoid another financial crisis. On anyRichter scale of economic threats, this may ultimately count morethan Japan’s grim tragedy. One reason is size. Europe represents about20 percent of the world economy; Japan’s share is about 6 percent.Another is that Japan may recover faster than is now imagined; thathappened after the 1995 Kobe earthquake. But it’s hard to discuss the“world economic crisis” in the past tense as long as Europe’s debtproblem festers—and it does.

Just last week, European leaders were putting thefinishing touches on a plan to enlarge a bailout fund from an effectivesize of roughly €250 billion (about $350 billion) to €440 billion ($615billion) and eventually to €500 billion ($700 billion). By lending tostricken debtor nations, the fund would aim to prevent them fromdefaulting on their government bonds, which could have ruinousrepercussions. Banks could suffer huge losses on their bond portfolios;investors could panic and dump all European bonds; Europe and the worldcould relapse into recession.

Unfortunately, the odds of success are no better than 50–50.

Europe must do something. Greece and Ireland arealready in receivership. There are worries about Portugal and Spain;Moody’s recently downgraded both, though Spain’s rating is still high.The trouble is that the sponsors of the bailout fund are themselves bigdebtors. In 2010, Italy’s debt burden (the ratio of its government debtto its economy, or gross domestic product) was 131 percent; thatexceeded Spain’s debt ratio of 72 percent. Debt ratios were high evenfor France (92 percent) and Germany (80 percent).

As these numbers suggest, there’s no automaticthreshold beyond which private investors refuse to buy a country’s debt.Germany and France are considered sound investments, deserving lowinterest rates, because their economies are judged to be strong. Butinvestor perceptions and confidence can dissolve in a flash. If privatemarkets lost faith in, say, Italy or Belgium, even the enlarged bailoutfund probably wouldn’t be big enough to rescue them. The whole scheme isabout debtors lending to debtors. It could collapse if investorsconclude it’s unworkable, dump bonds, and demand higher interest rates.

What would happen then is anyone’s guess. Defaults?A banking crisis? Some countries abandon the euro? (This sounds simple;in practice, it would be immensely complex.) The European CentralBank—the continent’s Federal Reserve—buys vast amounts of governmentbonds? The International Monetary Fund organizes a bailout, financedheavily by China, to rescue Europe?

Europe has arrived at this dismal juncture drivenby three forces: (a) large welfare states that were too often financedwith debt; (b) the financial crisis that led to recession and has pushedsome countries (Ireland, Spain) to aid their banks; and (c) theperverse side effects of the single currency, the euro.

The euro’s role is especially ironic. Adopted in1999—and now used by 17 nations—the euro was intended to promoteprosperity and political unity. Countries could enjoy similarly lowinterest rates and the convenience of common money. It seemed to workfor awhile. But low interest rates in countries like Greece, Spain, andIreland encouraged unsustainable booms or housing bubbles that, whenburst, aggravated recession and budget deficits. Now unity has turned todiscord. Countries that back the debt bailout—particularlyGermany—resent the possible costs; countries being bailed out resent theharsh austerity that’s imposed as a condition of aid.

There is a fragile debtor-creditor consensus thatcould crumble, posing yet another danger to economic recovery. It’sunderstandable that the scale of human suffering, physical destruction,and nuclear hazards in Japan compel our attention. But we ought toremember that the greater menace to global stability and prosperity lieshalfway around the world.