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A Modern-Day Greek Tragedy… A Tale of Sovereign Debt

Mythology. Philosophy. Reason. Greece has contributed much to the world; it was the birthplace of Western civilization… and now it may be the death of the euro zone. As the first euro area country facing default, Greece has captured the world’s attention, and sparked fears of a contagion among other weak euro zone countries. While Greece is a pinpoint in the global economic picture, (just .58% of the global economy, according to the World Bank) the possibility of a default jarred investors already shaken by Dubai’s debt crisis.   Now, European Union members have pledged to save Greece from default. What will a bailout mean for the European Union, in particular the euro zone? Even more, does the euro zone model work… and can it stand up against the pressure of a global economic crisis? 
 
The European Union & the Euro Zone


Source: European Central Bank
The troubles in Greece are nothing new: the country has spent half of the last two hundred years in default. So why has the current crisis rattled the markets and sent the euro on a downward spiral? Because nine years ago Greece joined the euro zone, and in doing so connected itself to fifteen other European Union countries through a common monetary policy: this means that sixteen countries share a currency, and a one-size-fits-all interest rate. Though these member states are tied together through the euro, there is no fiscal authority (or binding fiscal policy), so members are separated by individual budgets (and deficits). This is an obvious flaw in a shared currency: when one country stirs a global panic, all member states suffer a weaker euro.
  
Euro / U.S. Dollar
 

Greece has spent the last decade living (and spending) beyond its means, driving its deficit-to-GDP ratio to 12.7%; euro zone rules allow a maximum of 3%. Greece has spent its way into a corner, and the markets have responded. The cost of Greek bonds has risen dramatically, and accentuated the fear that a Greek default would lead to higher borrowing costs for some of its troubled neighbors. This fear of contagion has led to a painful choice: the euro zone will rescue Greece with a bailout, because if they don’t, everyone will pay the price. 
 


This bound-yet-separate economic structure has created a rift between the healthier, fiscally conservative countries in the North and their sickly, spendthrift Southern neighbors. This has been a concern since the inception of the euro zone: that sixteen countries beholden to one currency without a central fiscal policy authority would result in an imbalance with no easy fix. The real problem: Greece is only one of the PIIGS (Portugal, Italy, Ireland, Greece, and Spain) that euro zone members have to worry about. The big question: what will be the result of a Greek bailout? Will it create a “moral hazard”, with other weak nations failing to straighten up their fiscal acts, knowing that their neighbors will throw them a rope when things start to sour?
 
When a country faces a deficit crisis, it may expand the monetary base (print money), or devalue its currency to get a competitive edge on trade. Greece can do neither. It is literally caught in a trap, calling out for help. Its solvent fellow EU members (particularly Germany and France) have answered that call, not out of kindness, but to protect their currency…and because they are heavily exposed to Greek debt (and the debt of other weak EU countries). The alternative was to allow Greece to ask the International Monetary Fund (NYSE:IMF) for help; while the IMF has the ability to enforce strict conditions on Greece, it would have been a humiliation for the euro zone as a whole.
 
At the end of the day, the crisis in Greece calls into question the viability of the euro zone. Will Greece be forced out? Not likely. Will the euro zone separate? Some say it is inevitable. Or, at least in the immediate future, will this mess lead to a more collective and responsible approach to managing debt?   As the remaining scenes play out, remember…Greek tragedies were written to tell us something.


Disclosure: no positions