Last week, I talked about the risk that Europe might sleepwalk into a deeper and more widespread economic slump. As of now, the news is hardly more encouraging. Greece is headed for a June 17 election rerun that is now shaping up as a vote for denial of the austerity demanded by its Eurozone partners as the price for continued membership. While the tone of discussion has become slightly more pragmatic, the creditor countries still seem caught between the need to impose fiscal discipline on their profligate neighbors and the urge to punish debtor countries beyond what is economically possible.
My email is filled with bettors speculating on the rising probability of Greece leaving the Eurozone, as if that change would somehow end the festering crisis and let everyone get on with business. Faithful readers are no doubt tired of my recitation of the incentives that promote a broad common currency zone —remember why Germany pays the bar bill—however ill-advised the initial project may have been. Add to that list the additional problems of rebuilding the cross-border payment settlement system and the devaluation of claims that surplus countries have accumulated at the central bank.
Let’s imagine that Greece reintroduces the drachma, its currency prior to the euro. Optimists predict that a severely devalued drachma would power a boom in tourism and foreign investment in facilities to serve the tourist trade. Maybe, but I think about a sharply lower standard of living and social disorder that would likely follow, which is not the most inviting environment for tourists. Greeks have maintained their long tradition of aggressive political protest and I can’t expunge my memory of the brutal military dictatorship which ruled that country some 40 years ago. Would the wealthier countries of northern Europe tolerate political upheaval on their southern flank or would they continue to pay at least some of the bar bill to ease the transition, thereby prolonging it?
And then there are Portugal, Spain and Italy, which seem to be taking the tough steps to restrain their budgets and strengthen their economies’ competitive positions. However, far more money—along with far greater certainty of it being available when needed—will be required to insulate those countries and their banking systems from the contagion effects of Greece giving up on the euro and the Eurozone giving up on Greece.
There are no easy solutions and considerable potential for deeper problems. And speaking of problems which seem greater than the political will to deal with them, soon we’ll have to start talking about the U.S. budget, debt ceiling and the impending fiscal cliff ahead of us. Stay tuned.