The Wall Street Journal reported that Greece has ordered that its banks remain closed for the next week to the stem panicked cash withdrawals by depositors. This drastic move indicates that the five year long Greek debt crisis is coming to an end game.
After the financial meltdown occurred in 2008, the economic folly of Europe’s single currency, the Euro, became apparent. The European Union was created in an effort by Europeans to create a political climate that would lessen the likelihood of future wars on their continent. This desire was a reaction to the carnage that inflicted on Europe during two world wars in the 20th century. While the political idea was noble, little thought was given to the economic consequences that a central currency would lead to. Those consequences are now playing out.
The Euro was destined to create an economic calamity because the political union was not accompanied by a truly economic union. European countries maintain their own banking systems and Euro central bank was weak.
After the European Union and the Euro were created, the more efficient and stronger economies of North Europe, specifically Germany, obtained the lion share of benefit created by the Union. With nearly all European countries having a single currency, less efficient countries had their cost of labor increased in relation to more efficient ones. As a result, the poorer countries had a artificially strong currency that enabled them to consume increased amounts of the more efficient countries’, i.e. Germany. Through the Euro, Greece had to access to relatively cheap borrowing via an overall European credit rating that did not reflect the realities of individual countries. As a result, Greece and other Southern European countries borrowed more funds than they could afford to pay back and use these funds to purchase imports from Germany and other exporting countries.
When the recession hit, Greece and other countries were unable to make payment on their debt. This led to a battle between the creditor countries such as Germany and debtors like Greece.
For five years the Greece debt crisis has been a can kicked down the road. Creditors including, Germany, have been unwilling to forgive Greece’s debt, even though Greece is not a position to repay it. Had Greece continued to have its own currency, it would have devalued versus the German currency making its exports cheaper and more likely that it would have been able pay back its debt obligations. The single currency has curtailed this natural rebalancing mechanism of sovereign debt.
Greece has been operating under an austerity program for some years in an effort to pay down its debt obligations. That effort was doomed to fail since austerity does not address Greece’s uncompetitive position. Its current efforts to stop the panicked withdrawals At the Greek banks will also fail since this radical step will only create more panic in Greece and other southern European countries.
It is difficult to determine how the next few days will play out with the Greek crisis. There are basically two long-term solutions 1) Greece drops out of the European Union and reverts back to its own currency, while at the same time defaulting on its debt, or 2) Greece’s creditors, mainly Germany, writes off the loans. Either scenario has very painful economic consequences. Either would require a realignment of the Euro and the European Union to correct the economic deficiencies of this unnatural union.
Greece is a relatively small economy. Had it not been for the Euro, its default would have had only minor consequences for the world economy. However, similar to international banks that were allowed to become too big to fail, the European Union’s single currency has made the consequences of even smaller economies European countries defaulting too big to fail.
Given the hard choices for Europe, look for the politicians and bankers to do whatever is possible to kick the can down the road. This means that it is likely they will give Greece more loans to continue the illusion that the country is not defaulting on its loan obligations. However, that bit of alchemy would only push the crisis off for a short period of time.