Will the Euro Survive the Greek Crisis?

A decade ago, the introduction of the euro, the common currency of 16 of the 27 EU member states, was a political decision – not a monetary one. When the euro was introduced in 1999, Nobel Prize winner Milton Friedman wrote to his friend, the Italian economist Antonio Martino: “As you know, I am very negative about the euro and I am very doubtful about how it will work out. However, I am less pessimistic about it now than I was earlier simply because I never expected that the various countries would display the kind of discipline that was required in order to qualify for the euro.”

One decade later, the euro is in serious trouble. The problems result from the recent economic crisis which have badly affected the economy of Greece, one of the countries of the eurozone. Analysts doubt whether the government in Athens is able or willing to address Greece’s financial problems. If not, the other 15 nations using the euro will suffer the consequences, which is something they are not likely to accept.

Thomas Mayer, the chief economist of Deutsche Bank, warned last week: “The situation is more serious than it has ever been since the introduction of the euro. […] If the Greece situation is handled badly, the Eurozone could break down, or face major inflation.”

The problems of the euro affect the entire world. The EU currency was not introduced because of economic considerations, but because the European Union is pretending to be a genuine state and states are expected to have single national currencies. Hoping to become a powerful political force in its own right, the EU adopted the euro as the common currency of some 327 million Europeans, so that the currency’s economic power would prefigure the political power to be. The eurozone represents the second largest economy in the world. During the past decade, the euro became the second largest reserve currency after the U.S. dollar. With banknotes and coins in circulation for more than €790 billion, the euro has surpassed the U.S. dollar’s circulation. The euro appeared to be very strong, with the value of the U.S. dollar, the British pound, and other currencies dramatically falling in comparison to it – one of the causes of Greece’s problems. Tourism is a major economic sector in Greece. For tourists from outside the eurozone, such as the Americans and British, the country became too expensive as a holiday destination. Last year, when the world economic crisis also affected Europe, with a huge drop in the numbers of EU-citizens, such as Italians, that headed for Greece, the Greek economy collapsed and the Greek government was no longer able to pay the country’s public debts.

With Greece facing bankruptcy, the fears about Greece’s financial situation has led to a drop in value for the euro. Last week, the finance ministers of Germany and the Netherlands – the two eurozone countries which in pre-euro days had the strongest currencies in the EU: the German mark and the Dutch guilder – announced that they will not help Greece solve its problems. Polls indicate that 70% of the Germans oppose using their taxes to bail out other countries. Despite the EU propaganda line that EU citizens share a common European national identity, this is simply not true. As a leader in the Financial Times Deutschland noted earlier this month: “Spain believes in ‘more Europe’. Whether that’s the case for Germany as well one cannot be so sure any more.”

Moreover, the German economy has also been badly affected by the crisis. Last year, Germany’s GDP fell by 5%, the biggest drop since the war, with a drop of 15% in exports and 20% in sales of German manufacturers. The German people are not prepared to lift countries such as Greece, Romania, Spain, Portugal and Ireland out of the recession at its own expense.

There is also a lot of anger towards the Greeks in the other EU countries: for some years Greece seems to have covered up its bad economic performance by officially presenting better economic figures than was the case. The promise of the Greek government to reduce Greece’s budget deficit from 12.7% of GDP in 2009 to 2.8% in 2012, is being met with scepticism. Many doubt whether the government in Athens will be strong enough to resist the domestic pressure from the powerful trade unions against the radical deficit-cutting efforts which are needed, while others doubt that the Greeks will refrain from manipulating the economic data again.

Unwillingness to help the Greeks is huge within a eurozone currently facing an unemployment rate of 10% of the workforce, the highest figure since the single currency was introduced eleven years ago. Under EU rules, however, all the 27 member states of the EU, not just the 16 member states of the eurozone, are obliged to help the Greeks if the EU decides to bail them out. Article 122 of the EU Treaty, which went into force last December, states: “Where a member state is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the council of ministers, on a proposal from the European Commission, may grant, under certain conditions, Union financial assistance.”

This decision is taken on a majority vote. Consequently Britain, which always refused to join the eurozone, might be forced to help save the euro. The British press has already reported that if an EU rescue fund for the Greeks matches the Greek budget deficit, and if the EU decides that member states have to contribute in accordance with their own share of the total EU economy, Britain might be forced to pay a £7 billion bill to bail out Greece – or perhaps even more, if other bankrupt eurozone countries, such as Spain are excused their share.

British Eurosceptics fear that if Greece, which represents 3% of EU GDP, is bailed out, other eurozone countries facing financial difficulties (Spain, Portugal, Italy) might claim the same treatment. This, they say, would saddle Britain with a bill of £50 billion to save a currency in which the Brits have never believed.

Even though European public opinion is opposed to a bailout plan for the Greeks, Irwin Stelzer wrote in The Wall Street Journal recently that he expects European politicians to present just such a plan. “There is so much political capital invested in the euro by the political class,” he wrote. “that even the stern and parsimonious [German Chancellor] Angela Merkel will in the end contribute to a bailout fund if necessary.”

However, there also are indications to the contrary. Greek politicians might feel that the only way to avoid civil unrest in Greece may be to drop the euro and re-establish their own national currency, the Greek drachme. This will allow the Greek government to devalue the currency in order to stimulate exports and economic growth – a political-monetary tool which Athens lacks if it remains in the eurozone. It seems that some people at the European Central Bank (ECB), which controls the euro, are in favor of such a move.

On Jan. 17, Ambrose Evans-Pritchard wrote in the London Daily Telegraph that at the ECB headquarters in Frankfurt the legal ground is being prepared for a euro break-up. A major problem, however, appears to be that once a country has accepted the euro it cannot get rid of it unless it leaves the EU altogether. “This is a warning shot for Greece, Portugal, Ireland and Spain. If they fail to marshal public support for draconian austerity, they risk being cast into Icelandic oblivion.” Apart from Britain and Denmark, two countries which obtained opt-outs in the EU treaties, all EU member states are obliged to join the eurozone or peg their currencies to it. Former IMF analyst Desmond Lachman is quoted in CityAM warning: “There is every prospect that within two to three years...Greece’s European membership will end with a bang.”

Evans-Pritchard reports, however, that the dominant view in financial circles in the City of London seems to be that “if a rescue [a bailout of Greece] turns out to be necessary, a rescue will be mounted.” This is a bet, says Evans-Pritchard, that Berlin will do “what it did for East Germany: subsidise forever. It is a judgment on whether EMU is the binding coin of sacred solidarity or just a fixed exchange rate system like others before it. Politics will decide.”

Which brings us back to Milton Friedman. When politicians decide to rule economic and monetary issues, the results are usually catastrophic.


Beginner's mistake


While I agree we should firmly object to any bail-out to Greece (or any other country), had I been an official in Brussels' pay, I would not have been too outspoken about the whole thing, the actual EU officials did, and it all happened: frenzy on bond markets, as Greek debt is considered riskier, the yield on Greek bonds has to increase so that the risk is offset. The Greeks have to pay 7.15 % interest rate on their debt as of today, at the current pace, the roll-over effect all have been anticipating will not take long before it becomes a fait accompli. EU officials are incompetents (nothing new here). Greece seems in a very dire situation indeed.

European taxparer will save the day

They will give cash to Greece for sure, socialist political project is more important than economic science. I don't see how the EU would force Greece to seriously reduce spendings, this is not philosophy popular in Brussels.  Brussels is all about spendings. Only right wing dictator could radically change Greek attitude but then the EU would stop trade with such undemocratic (non-socialist) state. 

Blueprint # 2

@ Blueglasnost

You make interesting observations.  However, why should possible future Greek bankruptcy "spur European leaders to re-think their monetary policies"? 

If and when the Greek government defaults on its debt, it will only make it harder for them to borrow in the future, which will force more discipline.   This is no reason for European monetary authorities to get involved.  Of course, it may induce the Greeks to leave the monetary union, and this wil be unwelcome to the European political authorities.   The latter will have to choose between grandiose dreams and a future of continuous blackmail.

Similarly, the US government should resist 'bailing out' (much bigger) California.


Similarly, the US government should resist 'bailing out' (much bigger) California.

Yes, but you are thinking like an economist, and not a politician. If California defaults they (i.e., most citizens of the state for they are mostly liberal) would not mind being "taken over" by the federal government. And a "bail out" would allow the federal government more control over what was once a sovereign state: something the current administration would not mind, at all. Whether there is political will in the other states to oppose a "bail out" is an important question. I suspect such a move would essentially ruin any prospects for the current administration to be re-elected. But stranger things have happened.


I meant "re-think their monetary policies" in that a possible defaulting of Greece on her debt could prompt other European leaders to withdraw from the eurozone in order to be able to devalue if they restore their own national currencies, that would be a welcome change (from both an economic and political point of view), although it can be debated whether the state should be entrusted with such policies. Hayek's writings on central banking are highly interesting on this topic. As far as I am concerned, I think Greece stands on the brink of bankruptcy, and sharp perusal of national assets and liabilities shows she could default very soon indeed. I definitely agree on California, the "Golden State" should not be bailed out, cuts and austerity as well as a more thrifty behaviour (and not taxpayers as we have seen bail-outs only serve to hand out bonuses to those who do not deserve them, i.e.: JP Morgan) ought to restore some measure of economic equilibrium. Let 'em fail and teach others a lesson everyone should know by now (that you cannot spend more than your income in the long run, it is not economics but common sense).

An interesting blueprint

It will be interesting to see what happens in Greece, the situation might provide us with a blueprint for years to come as many other countries are faced with similar dire situations. Greece's debt is skyrocketing, and is over 100 % of GDP (Italy's is as well). As Mr Belien pointed out, the government seems unwilling to do anything or about, any move would be highly unpopular and would likely meet with fierce (left-wing) opposition. Cuts on a tremendous scale are badly needed, I would stake on inaction as the surest course, the government simply has not got the guts to remedy their plight. Milton Friedman was right all along.

If Greece is expelled from the eurozone, whether it be of its own volition or through coercion, others might follow. Spain is faced with a situation so lamentable as to test any reasonable mind. They have been relying on heavy EU subsidies for years, and they could not prevent that situation still. The likelihood of Greece defaulting on her debt is high, very high indeed. I doubt the Germans, or the French, for that matter would consent to bailing out such a failed state, leeching off revenues from the EU as a farmer would milk a cow. The eurozone will be shown for what it has always been: one of this century's biggest swindles; merging so different countries into a single-currency area (explain how you would reconcile Germany's world-leading exports with Spain's fragile economy relying on housing?).

Greece has many options:

(a) devalue their way out of recession by boosting exports and tourism.

(b) massive quantitative easing to wipe out the debt through inflation.

(c) savage budget cuts.

(d) raising taxes.

Options (a) and (b) are impossible, for the euro is controlled by the Frankfurt-based ECB, which also controls the amount of liquidity in circulation, option (b) would be highly harmful to the wider economy as it could lead to hyperinflation, an unsteady economy (due to prices changing too rapidly for anyone correctly to adjust) and damage other economies as well. Option (c) is unlikely due to governmental reluctance and pressure from hare-brained lefties. Option (d) is also unlikely, and would also bring about negative consequences, not least a slowing activity due to higher taxes and a decrease in incentives, taxes could be raised only marginally, and that would not suffice, anyway, nor would it be desirable as it would be as if we doled out more dope to an addicted person (the Leviathan, if you get my drift).

So Greece will descend into bankruptcy within one or two decades. It will prove many economists wrong, and it that crisis bears good odds to spur European leaders to re-think their monetary policies, perhaps by splitting up the eurozone. Only future will tell.   


A girl dressed as a boy or vice-versa?

The Belgian Microcosm

As Belgium is a the model for European political integration, so too is it for European economic policy, common currency included.  The top performing economies of the EU are handcuffed to the losers, whose only concern is prolonging the arrangement.  It is an unfortunate consequence of the postwar era that northern work ethic is in the employ of southern avarice.  Of course, it goes without saying that any institution bankrolled by Germany and controlled by France is a travesty.