“We must all hang together, or assuredly we shall all hang separately.”-Benjamin Franklin
Last weekend, Helmut Kohl, frail and confined to a wheelchair, implored his countrymen not to abandon his lifetime goal — a united Europe.
Kohl said, “I am convinced more than ever that European unification is a question of war and peace for Europe and for us, and the euro is part of our guarantee of peace.”
Kohl was pleading with his countrymen to prevent the impending bankruptcy of Greece, a country with an economic gross national product comparable to the state of Michigan.
Kohl should have enjoyed his last hurrah. On Monday, global markets enjoyed their greatest rally in more than a year after European leaders and the International Monetary Fund floated a nearly $1 trillion bailout package to stop the spreading debt crisis.
A two-part solution
What steps did eurozone leaders take? The rescue package had two parts:
Eurozone leaders provided a roughly $146 billion bailout for Greece. Two-thirds of the funds will come from the other 15 countries in the eurozone, the rest from the IMF. This aid package is conditioned on Greece bringing down its deficit to 3 percent of GDP by 2014.
The European Union provided a $955 billion bailout to stanch the burgeoning sovereign debt problems of Portugal, Spain, Italy and Ireland. This consisted of $558 billion in loans from the eurozone governments; $76 billion from a new eurozone fund created to help countries facing balance-of-payments problems or other “exceptional occurrences”; and $321 billion from the International Monetary Fund.
he problem
Why did the problems of Greece threaten the world economy? Greece is essential to Europe. It is a member of the European Union, which consists of 27 countries, and the eurozone, which consists of 16 countries. Countries in the eurozone have the euro as common currency and a common monetary policy.
Greece plays the same pivotal role in Europe as Lehman Brothers did in the United States in 2008. Greece’s bankruptcy would have caused a contagion because its failure would have fatally infected the credit markets. Stated differently, sovereign entities and lending institutions would lose faith in each other’s creditworthiness.
The future of Greece
Does Greece now have clear sailing?
Even after the bailout, Greece is facing major headwinds. According to The Economist magazine, its debt will grow to 149 percent of GDP by 2014. Mohamed El-Erian, chief executive officer of Pacific Investment Management Co., doubts Greece will comply with all the austerity measures required to get its financial house in order.
John Lipsky, the International Monetary Fund deputy managing director, disagrees with El-Erian. Lipsky said that fears of Greek default are overblown. The IMF forecasts Greece will cut its budget deficit from 13.6 percent of GDP in 2009 to 3 percent by 2014. Greece’s economy will enjoy moderate economic growth in 2012, he said.
The future of Europe
The bailout package has changed the premise of the European Union. Until now, its leaders assumed that each nation would manage its own finances. Going forward, EU members will take unprecedented responsibility for each other’s fiscal troubles.
In order for the eurozone to survive, all its members need to maintain sound fiscal policies. The conflict is between countries that impose rigorous fiscal standards versus those that are wayward. Countries such as Germany, the Netherlands and Austria operate within tight budgetary constraints. On the opposite end, Greece, Portugal, Italy and Ireland suffer from big budget deficits and high public debt. The latter will need to impose severe wage restraints and structural reforms.
In conclusion, we need to reframe the discussion of “too big to fail.” Political leaders such as Kohl recognized the long-run consequences of failures of seemingly small entities such as Greece and Chrysler. They understood that no entity is an island unto itself. Instead, they acted forcibly to stop the spreading debt crisis.
Originally published in the Sarasota Herald-Tribune
