Greece/EU/the Euro are not out of the Woods Yet

Posted by PITHOCRATES - January 30th, 2011

The Price for Greece to Avoid a Sovereign Default

Greece’s troubles ain’t over yet (see European Union talks on Greek debt as IMF flies in by Helena Smith posted 1/30/2011 on the Guardian).

The European Union is engaged in frantic behind the scenes talks to reduce Greece’s debt as international monitors fly into Athens this week. There is growing concern that the eurozone’s weakest state will be unable to end its worst crisis in decades, without a sovereign default.

A sovereign default?  Yikes.  That’s pretty bad.  That means things may be so bad that they may just have to start all over.  And just say ‘so sorry’ to all those debt holders.  Break that sacred obligation of a written contract.  Just like those written contracts with the public sector unions will be broken when they reorganize.

No nation wants to go down this path.  The Greeks certainly don’t.  So what will it take?  And can they do what it takes?

Economists also recognize that even if Athens enforced the fiscal consolidation programme demanded in exchange for the bailout to the letter, the country would have to generate a primary budget surplus of 5.5% just to keep up with debt repayments.

That, in turn, would not only require relentless austerity but years of sacrifice in a nation already racked by a widening gulf between rich and poor and the social tensions that unprecedented policies have brought.

The spectre of a Greek default has divided economists, with many arguing that it would trigger a chain reaction and have a catastrophic effect on Ireland, Portugal and Spain which are also struggling with heavy debts.

It is an uphill battle.  They got into this mess because of uncontrolled deficit spending.  They just couldn’t cut spending or raise taxes enough.  Now to prevent default, they will have to cut spending and raise taxes even more than they were willing to before.  Can the Greeks pull off this Herculean task?  Or should Ireland, Portugal and Spain be getting a little nervous?  Time will tell.

If East Germany could do it so can Greece

The Greeks have a friend in Angela Merkel, the chancellor of Germany.  Germany is the strong economy in the European Union.  And they have experience in bringing someone back from the brink.  The reunification of Germany after the fall of the Berlin Wall was not easy.  West Germany was a prosperous nation with a strong currency.  East Germany was not.  Rescuing Greece will be similar.  Restoring financial health to a weaker nation.  While protecting a strong currency (the Euro) that is key in the rescue (see Merkel’s Defense of Euro Forged in East Germany by Jack Ewing and Katrin Bennhold posted 1/30/2011 on The New York Times).

There are also practical lessons for Europe. Like Greece and Portugal, the former East Germany suffered from a crippling competitiveness gap yet it was locked into a strong currency, the German mark.

Mrs. Merkel has witnessed the enormous political divisions that can arise when taxpayers from one region are compelled to rescue residents from another.

And how bad did it get?

About 14,000 businesses were shut down and four million jobs lost in the first five years after formal reunification in 1990. Unemployment eventually peaked at more than 20 percent in 2005.

Since the fall of the Berlin Wall in 1989, two million of the 16 million people living in the east have moved west. Long-term unemployment and wage depression bolstered xenophobic parties like the National Party of Germany, which holds seats in the state Parliament of Saxony.

It won’t be pretty.  But it can be done.  If the Greeks can handle “relentless austerity.”  If the other EU members are willing to rescue the Greeks.  And if the Greeks can resist xenophobic fears of those trying to help them.

And while the Greeks face this austere future, the rest of us should think about reducing our own deficits.  Before we find ourselves saying, well, if the Greeks could do it, then so can we.

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