Blog > News Analyses > 21st Century Greek Tragedy: The European Debt Crisis |
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Introduction
When turning on the news, it is impossible to avoid the constant talks surrounding the US budget problems and the impending debt ceiling. Amid the discussion is an endless fear over the possibility of US default on its debt, and the ramifications such a default would have on the world economy.
Meanwhile, on the other side of the Western world, countries within the European Union, specifically Greece, Ireland and Portugal, find themselves well beyond possible default trepidations. Especially in Greece, the questions have shifted from “if they default” to “when they default”. While it has become increasingly clear that default is inevitable for the Greek economy, new worries have arisen concerning the consequences across the European Union, specifically within the currency zone.1
As a result, the major economies within the union, especially Germany and France, have attempted to help drive Greece through this crisis in the hopes that the Euro zone will not fall apart. However, the need for restructuring of debt and the resulting default have brought to question the overall effectiveness of a single currency zone, and have cast a shadow of doubt over its future.
Origins of the Single Currency Zone and the Greek Debt Crisis
After two major wars on their own soil, the major economic powers of Europe were well aware of the necessity of solidifying a peaceful and prosperous future. On a day now celebrated as Europe Day, May 9, 1950, the “Schuman declaration” was established and set the course for the eventual development of the European Union.2
According to this declaration, Robert Schuman, then foreign minister of France, “proposed that his nation and West Germany pool their coal and steel production.”3 Schuman claimed that this would make future wars practically impossible, since it would have drastic political and economic consequences. Soon after, a customs union was formed, creating a free trade zone among the European countries. Finally, “[t]he creation of the euro was proclaimed the logical next step in the process.”4
The overall benefits of a currency union were abundantly clear. Imagine being able to travel anywhere in the continent without fear of having the right currency. Importers and exporters would no longer have to fret about the intense exchange rates calculations. In essence, the policymakers felt that they were creating a new golden age for Europe, hoping to be the beacon for the rest of the world.5
Unfortunately, amidst all of the excitement of a new currency, they overlooked the major detriments. By agreeing to a single currency, countries were essentially giving up their sovereign ability to manage their own fiscal and monetary policy. As a result, the ability to solve a recession by “cutting interest rates and increasing the money supply” did not exist.6 If there would be a price or wage issue, a country would not have the ability to devalue its own currency, and would be at the whim of the union. This is the issue that Greece is currently facing as it tries to combat both a recession and debt service issues.
It would be wrong however to place all of the blame on the detriments of the currency union. Greek politicians and borrowers played a significant role in both the rise of the debt and the concealment of the actual debt numbers. The first problem concerned the actual interest rates of Greek bonds. Before joining the euro, Greek bonds were forced to pay excessively high yields due to the country’s shaky financial history. After joining the currency however, “national interest rates converged” and Greece issued bonds at same rate as Germany. Rating agencies clamored to increase their grade, and the Greek government was able to borrow at unprecedented rates.7
Unfortunately, the bubble eventually burst. As markets began to crash as a result of the Great Recession, the realities came to light. The situation in Greece was especially bad, as it was discovered that the previous government had effectively lied about its debt. “Suddenly it was revealed that Greece had both a much bigger deficit and substantially more debt than anyone had realized.”8
As a result, lenders bolted and Greece was left in a dire situation. Now, policymakers are scattered wondering what the results are going to be for the country. Restructuring and default are unavoidable at this point. The country’s continued use of the euro is in jeopardy. One of the biggest fears is the possibility of contagion across the EU. Many plotlines have been played out, and the EU has stepped in to try and ensure continued European affinity.9
Solutions
As time goes on, even though it would be traumatic for both the Greek state and European Union, the general consensus has become that Greece should default in some form. Originally, there was apprehension on allowing Greece to restructure their debt. Now, policymakers have become open to the idea of “soft” restructuring, which would involve “creditors voluntarily stretching out the maturities on their loans to Greece.”10 There are even talks that a “hard” restructuring may be both plausible and necessary, which would make Greece’s case similar to that of Argentina in 2001. 11 12
The idea of “soft” restructuring was originally offered by the French, who believed that bond holders should take an active role in helping Greece dig itself out of the proverbial hole. However, this idea was exacerbated by the rating agency S&P, who stated that any sort of restructuring, would be considered a “selective default” since “creditors would have to wait longer to be repaid and the value of Greek bonds would effectively be reduced.”13
By all means, both the banks and Euro zone are trying to avoid any sort of default because of the major ramifications. There is a major fear that it could lead to a complete collapse of the Greek economy and their inevitable exit from the Euro zone. In addition, it would also have a frightening effect on the European Central Bank (ECB) and other countries’ banks that had lent to Greece.
Finally, the existence of “credit default swaps” poses another major issue. Similar to the problem faced by Lehmann Bros. in the United States, default could possibly affect major insurance agencies across the globe. Since it could be assumed that “American banks and insurance companies have taken on the largest share” of insurance swaps, consequences throughout the world economy would be inevitable.14
As a result, a new plan was created by German policymakers that would involve bringing in the private sector to help sustain Greece. Essentially, the Germans have proposed that the Greeks institute a bond swap, where they would exchange their current bonds for ones that would take longer to mature.15 Of course, the major issue with this is the fact that it would just be prolonging the inevitable. In essence, some believe the German plan may just be a way to buy time in order to avoid default and get Greek finances in order.16
A United Europe
As the situation in Greece continues to unfold, the fear of default and its consequences remains throughout the European Union. While Greece represents a mere two percent of the overall EU economy,17 what if their default spreads to other more prosperous countries such as Spain or Italy? Such an event would be cataclysmic for the EU and would make this as much a political problem as an economic one.18
In addition, if Greece decides to go “Full Argentina” and drop the currency altogether, what would prevent other countries from doing the same?19 In the end, the best solution for all parties is the continued cooperation between countries within the EU to help Greece out of its current situation. This would not only help keep the Union together, but also prove to the world that Europe remains united and is committed to helping its members brave any major crisis.
1 “If Greece Goes…” The Economist. June 23, 2011
2 “Europe Day, 9 May.” Europa
3 Krugman, Paul. “Can Europe Be Saved?” The New York Times. January 12, 2011.
4 Ibid.
5 Ibid.
6 Ibid.
7 “Greece and the Euro: Was it Worth It?” The Economist. July 4, 2011.
8 Krugman
9 “If Greece Goes…”
10 “Tomorrow and Tomorrow.” The Economist. May 21, 2011
11 Ibid.
12 Krugman
13 Ewing, Jack; Thomas, Landon. “Europe Faces Tough Road on Effort to Ease Greek Debt.” The New York Times. July 4, 2011.
14 Ibid.
15 Spiegel, Peter; Jenkins, Patrick. “EU Stance Shifts on Greek Default.” Financial Times. July 10, 2011.
16 Cowen, Tyler. “Choices for Greece, All of Them Daunting.” The New York Times. July 9, 2011.
17 Ibid.
18 “The Cost of Europe’s Dithering.” The Economist. July 11, 2011.
19 Krugman