The Euro Crisis (Continued): Time to make a choice?

It is now July 2012, almost three years since the chain of events that set in motion what is now called the Euro Crisis and surprisingly enough, the world is still waist deep in the middle of it. In my previous article I attempted to diagnose what was causing the breakup and why there was so little action taken, and regardless of whether it was for those reasons, just from looking at the EUR/AUD exchange rate it’s easy to see that the situation has been deteriorating continuously ever since the end of the global financial crisis and despite several attempts to change things, it has not really improved.

EUR/AUD Exchange rate, 2009 – 2012

Source: Bloomberg

The news articles in the day (1, 2, 3) ranged from mild dismissals that it would amount to nothing more than a small blip on the financial crisis radar to slightly concerned opinions, but only a few bet on the ‘domestic’ Greek problem turning into an event that regularly makes the headlines around the world. What’s interesting about Greece is that its debt levels have always been a problem ever since admission to the European Union back in 2001 (Graph by BBC), and it only managed to do so because of some statistical spoofing on its debt figures.

However much media attention is focused on Greece at the moment, a small amount of research will easily reveal that Greece is neither the cause nor the solution to the current crisis. Consider the following figures: the Greek national debt is around €350 Billion, but that’s nothing compared to the estimated €17 Trillion worth of public debt owed collectively by the EU nations. Considering that Greece’s GDP output composes a mere 2% of the overall EU output this should come as no real surprise.

The real worry if Greece does default is that public confidence in the whole Euro system collapses, which will raise the cost of borrowing for countries which aren’t quite as troubled as Greece, yet. Problem countries such as Spain and Italy, which owes extensive foreign debt may be then forced into default as their cost of borrowing rises and becomes unmanageable. Their default could bring about a serious meltdown in the European and global financial systems due to the fact that their economies combined amount to about 10 times the size of Greece, and it doesn’t hurt to point out that their debt is being held by other members of the EU.

Is there a solution to this mess? Yes and no. As Greece is nearing its third round of European Central Bank (ECB) bailouts which will bring the total sum to about €320 billion, it should be obvious that wait, bailout and repeat is no longer a viable sequence of responses. At the present, the two main schools of thought are unify or disintegrate, both of which carry their share of unpalatable side effects. It’s prevented a solution from being worked on for the past two years.

Let’s start with unification: this is effectively asking for member nations in the EU to surrender parts of their sovereignty so that the EU as a whole can function more like a single entity as opposed to a collection of nations bound by a single monetary policy. This would include the issuing of ‘Eurobonds’, marketable by any government and liable by all in the Euro zone – i.e. to have Germany pick up Greece’s tab. To make this fair, there would also need to be some sort of governing body overseeing the fiscal policies of each individual member state, seriously reducing the power of each government to control its own finances. The end outcome would be the political union of the members in the Euro zone, creating an entity under which national boundaries would become increasingly blurred – radical changes to be sure.

However much sense creating a union makes however, in the present situation it is politically impossible. Much of the debate over the crisis is to do with ‘who is to blame’: it’s been established that German people, on the whole, object to having to bailout Greece; why should they have to cover some another countries reckless spending? According to famed hedge fund manager George Soros, in a speech last month he pinpointed the present state of the crisis to this same reasoning: when the crisis first started Angela Merkel declared that Germany would not be responsible for other countries’ debts in the Euro zone. This lack of political will for a union is difficult to change in the present situation as much of the Euro zone countries are divided into creditors like Germany and debtors like Greece. The benefits of a union are no longer the same for everyone.

Which leads to the second, more politically practical option: breaking up the Euro. This is a natural extension of a process that is already underway in the EU, where every country is preparing against the potential collapse of the Euro which will eventually lead to a self-fulfilling prophecy. If Greece leaves the Euro, the advantage would be that it would be in control its own currency (the Drachma) which they can devalue as necessary. This would help maintain economic competitiveness and get them out of the position of being indebted in a currency Greece doesn’t control, which is what is causing the vicious cycle of austerity and a contracting economy at the moment.

The one real problem with this scenario is that no one can predict what the outcome would be as there are so many unanswered questions: will everyone ditch the Euro, or just the troubled countries? How would one reclaim outstanding obligations denominated in a currency that no longer exists? What would be the magnitude of these effects? Besides short term effects, who knows how long the fallout could last for and how the actual breakup would play out? In the event that it does happen it would also cause irreparable damage to the credibility of the European Union and its institutions. Despite the choice being on the table, it is one that the political leaders of the EU would not want to come to pass – who wants to be remembered as the one who lacked the political will to save the Euro zone?

There are answers to the crisis, but each one comes with more questions that also difficult to answer. Time is starting to run short and it may be down to some of the leaders of Europe to bite the bullet and agree to make a choice for the greater good. Maybe there is another option that has yet to be discovered. Unless decisive action is taken the situation risks crippling the European and Global economy.