Overreaching headlines aside, the Eurozone is a bit of trouble. Greece has been bailed out in an attempt to avoid a sovereign default. Those in the know think the Greeks are unlikely to be the last country in the Eurozone to require a bailout and the conditions the IMF are expecting Greece to conform with are likely to have unintended far-reaching consequences that we can’t possibly understand at this point. A lot of people I talk to seem to be of the opinion that the Greeks got themselves into this mess and that bailing them out serves little purpose. This is probably true though for reasons far more complicated than that.
A guest post over at Naked Capitalism outlines 11 points supporting the idea that the Eurozone will likely break down over the Greece bailout. One of the key points revolves around a basic accounting principle: if one entity has a deficit, some other entity must have a surplus. Fiscal accounting is essentially a zero sum game and this is very important in the Greek case. When thinking about this, it’s important to realize that Greece, being a member of the EU, does not control its own sovereign currency. Thus, for Greece to run a deficit, there had to have been complicity from within the EU, specifically from Germany. It’s the fiscally conservative Germans benefiting from their strong export driven economy who provide the opportunity for the Greek government to run a deficit.
This part about sovereign currency is important. Historically, countries that control their own currency have been able to inflate their way out of debt, at least to some degree. In Greece’s case, the country is unable to do this because their currency is the euro and is outside their control. Therefore, they essentially have two options: default or bailout and accept the draconian retrenchment terms the IMF is demanding. As the article above mentions, it is unlikely that these terms are created with the considerations necessary regarding the simple accounting fact above, e.g. if Greece successfully imposes financial austerity measures on its people (a HUGE if at this point, one that isn’t getting enough attention), this necessarily means that the export societies of Germany and other Eurozone countries will retract due to the cutbacks in spending in Greece and others.
On top of that, these austerity measures will likely have a deflationary effect on the Eurozone. The bailout of Greece is aimed at government debt and the austerity measures are aimed in the same direction. Based on the same simple accounting concept I talked about above, if Greek government debt obligations are reduced through austerity measures, the Greek private sector will see their debt obligations grow leading to more private defaults and less growth in the Greek economy. Shortsightedly demanding to lower government debt with no consideration of the interconnectedness of the government and private sector spending will lead to further pullbacks and lack of growth in Greece.
In the end, the issues that we are seeing with Greece and the like illustrates several problems with the Eurozone as it is currently existing. If the Eurozone collapses, as the article seems to think possible, the ramifications will spread out over a much bigger area than just Europe. My crystal ball is cloudy when it comes to the results of a Eurozone collapse but I can’t help but think it will be highly detrimental to our country as well. We should watch carefully how things play out in Europe since it’s quite possible we may have to deal with similar circumstances in the near future here at home as profligate states like California begin to encounter the same issues the Greeks are running into.