It has been over a year since I have written about the fragile condition of the European Union’s financial system. The financial crisis of a possible Greek default has been papered over since then, but now it is coming to a head again.
Greece again is teetering on the brink of default. Last Friday, Greek debt was so unpopular that interest rates on one-year notes spiked to 98 percent. No country grows so vigorously that its government can afford double its creditors’ money in one year, and certainly not a bankrupt government like Greece’s.
For the last couple of years, the governments and big banks of other EU countries have been bailing out the Greeks in the hope of averting a Greek default that would spark a chain reaction of defaults throughout the EU. In doing so, the would-be rescuers were throwing good money after bad. They have only delayed, not prevented, a Greek default.
Greece’s finances have deteriorated beyond the point of no return. The Greek government tried to impose “austerity” and tell the Greek people that the days of the government-provided gravy train (retirement at 50 on cushy salaries, etc.) were over. Greece’s many entrenched special interests dug in. No government was going to burst their bubble! The inevitable result is that the Greek gravy train is crashing into the immovable wall of financial reality.
Greece will be a mess, but in today’s interconnected world, the pain will be felt far beyond Greece. The entire European Union will be shaken to the core and the survival of the euro currency is in play.
The key player will be Germany, the linchpin of the EU. Germany has the largest, strongest, and most financially stable economy. It literally is the only country that might possibly be able to bail out the Greeks. Will the Germans do so?
Let’s consider Germany’s situation: For the last two decades, Germany has been carrying the financial burden of rebuilding its eastern, formerly communist-controlled region. So devastated and economically backward was the former German Democratic Republic (what Americans called “East Germany”) that it has required a huge internally funded bailout to get it “caught up” to the western region.
Now the German people are being asked to fund a hugely expensive bailout to keep Greece and, indirectly, the euro currency viable. At first glance, we might think that they wouldn’t even consider it. Why should they—the industrious and productive—pick up the tab for the self-indulgent splurging of a people who have shown that they are not willing to tighten their belts and live within their means?
Actually, there could be trillions of reasons why Angela Merkel’s German government might extend additional bailout money to Greece. If German banks do not provide many billions of additional credit and assistance to Greece, the resulting Greek default would impose colossal losses to German (as well as French, Italian, et al.) banks. The financial dominoes could start to fall; defaults and bankruptcies would spread, plunging Europe into depression.
In other words, as costly as a bailout to Greece would be, the costs of not bailing out Greece could be even higher—in the near term. The key here will be whether German leaders adopt a shorter-term or longer-term perspective.
Proponents of a German bailout (generally not Germans themselves, but other high officials of the EU who are not bashful about telling sovereign governments what to do) argue that the only real solution is for EU members to surrender more sovereignty and enter into a fiscal union (i.e., a common tax-and-spend budget policy) to match the monetary union they share via the euro currency.
Indeed, fiscal union makes sense in that it clearly isn’t viable for countries to share a common currency and still have independent fiscal policies. But if Merkel and her colleagues consent to a greater level of European integration, they would be essentially agreeing to having a portion of their wealth transferred year after year—indefinitely—to subsidize their less productive neighbors, such as the Greeks, Portuguese, Spanish, Italians, etc. Rather than accept this yoke, the Germans may decide to cut their losses by refusing to bail out the Greeks, taking some painful lumps now, but coming out of the crisis in a position to enjoy the fruits of their own labor.
This ongoing European drama is of immense importance here at home. American banks have huge exposure to European banks. Financial convulsions in Europe will inevitably reverberate here. Hang on to your hats.