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Will Greece bring the eurozone down?

There is a crisis in Europe at the moment as a result of the possibility of Greece defaulting on its debts. The euro has fallen in value and stock markets have dropped around the world during the last few days. Even the Chinese have expressed concern, because Europe is such an important market for them.

The Greek crisis will remain an EU problem.

Greece is a basket case, with unemployment having risen to 15.9% in the last quarter, compared to 14.2% in the same quarter last year. Yesterday, Greek two-year bond yields rose 1.6 percentage points to 28.6%, which makes it virtually impossible for the government to be able to afford to repay the interest on borrowings made on the open market.

What Greece does have going for it, is a global, as well as European, inter-linkage. The question is, can the EU afford to let Greece default on its loans, and perhaps exit the eurozone, or must it continue to pour money into what looks like a bottomless pit.

One of the main problems is in the construction of the eurozone itself. Whilst member countries have ceded monetary control to the European Central Bank, they have retained control over their own fiscal policy. They have the right to tax and spend as they wish. Greece has great problems raising taxes, due to endemic tax avoidance in the country. It has also borrowed and spent too much such that its total government debt is expected to reach 160% of GDP by the end of 2011.

This contrasts with the way a country like Germany has sensibly managed its finances, but is now continually called upon to bail out other countries which have been profligate in the way they have been run. Last year the International Monetary Fund and the European Union bailed Greece out by pouring 110 billion euros into the economy. It now looks as though a similar amount needs to be found again to keep Greece from defaulting on its loans over the next two years.

One of the main questions to be asked is how a fairly peripheral country such as Greece, which accounts for less than 3% of eurozone output, can be in a position to demand such extreme levels of help. Part of the problem is that French and German banks are holding 55% of the total EU exposure to Greek debt. If that debt becomes worthless it could cause a collapse of their banking systems. And, if Greece is forced to exit the eurozone and go back to the Drachma, all outstanding debt will be worth less than the paper it is printed on.

The IMF and the EU have pushed Greece into taking austerity measures, which has led to rioting on the streets of Athens. But, on the other hand, they cannot be seen to allow the Greek government to spend as it chooses and still give bailouts. What sort of message would that send around Europe.

The whole thing is a total mess. It is also a Catch 22 situation. The only way Greece can get out from under on its own, is to give up the euro and return to a heavily depreciated Drachma. However, the collateral damage from such a move on the financial sectors of other EU countries, would be so great, that they have to keep pumping money into Greece.

Can the UK be smug about all this? Not really. Although we can be grateful that we did not join the euro, if Greece goes under, then Ireland and Portugal may follow. If that happens, Spain may not be too far behind. This would have enormous implications for our trade and financial sectors and is not to be contemplated. Whether we like it or not, we have been dragged into the problem and therefore must be part of the solution.

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Posted in European Union, eurozone, International Monetary Fund

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