For the past several weeks, large-scale and at times violent demonstrations and strikes have erupted in Greece and Spain, fueled by unemployed youth (which in Greece stand at 36 percent and in Spain at 44 percent), students, and public-sector workers. These outraged "Indignants" strongly oppose deep public spending cuts and believe that they are being made to pay a very dear price for the mistakes of government officials, bankers, and bondholders. The initial public acceptance of significant austerity measures as a requirement for national financial solvency in the early days of the European financial crisis has come to an end.
There are two ways to look at the European sovereign debt crisis and specifically the Greek debt crisis today: through a rational economic and monetary lens or through a highly political and emotive lens. But to understand the crisis, in full, you must view the situation through both, guaranteeing a distorted and confusing image about where this crisis is going and how profoundly it will change the future of Europe's economy and politics.
Understanding Greece
The rational approach to understanding the Greek crisis is the assumption that a country cannot sustain a debt-to-GDP ratio of over 140 percent (soon to approach 150 percent) with weak or negative economic growth (-4.8 percent Q1 2010, -2.8 percent Q4 2010, 0.8 percent Q1 2011) by austerity measures (Greece has lowered its deficit by 2 percent of GDP) and privatization measures alone (the Greek government is hoping for €50 billion from asset sales). To emerge from this crisis as quickly as possible, nearly all economists agree that Greece must devalue its currency, return to economic growth, and begin to pay down its debt. However, as one of 17 members of the European Monetary Union (EMU), Greece is unable to devalue its currency, the euro, and the EMU has no provisions for a member to temporarily leave and return to its national currency, in this case, the Greek drachma. Greece is also unable to independently restructure its debt as this would be considered a default, which would severely impact the Greek economy, as well as the other vulnerable economies in the eurozone, namely Ireland, Portugal, and Spain. A downturn in these periphery economies could set off a European banking crisis, which, in turn, would likely cause a second global economic shock.
So, the only option that Greece and Europe have at the moment is to further reduce Greek public spending (the parliament must vote next week on €28 billion in additional spending cuts); sell as many state assets as possible, which is no easy feat as the Greek land registry system is incomplete, making it difficult to quickly sell assets whose ownership is in question; and for the "Troika" - the European Union (EU), the European Central Bank (ECB), and the International Monetary Fund (IMF)-to keep lending Greece money so that it can stay financially afloat. Unfortunately, this prescription does nothing to change Greece's debt-to-GDP ratio, which is the very source of the problem. In other words, Greece is like a bucket with a big hole in the bottom of it, and the European bailout package is like water. You can keep filling the bucket up with water, but unless you patch the hole-or restructure the debt-the water keeps going right out the bottom. Some European governments are beginning to have doubts about the political sustainability of continuing to pour water into the Greek bucket. Unfortunately, no one is seriously addressing the question of how to patch the hole.
Why can't Europe seem to solve this crisis? In terms of economic scale and scope, Greece's economy is small, representing less that 2 percent of the GDP of the 27-member European Union. But this isn't simply about Greece. It's also about the other European nations that have exceedingly high debt-to-GDP ratios, such as Italy, Belgium, and the United Kingdom, and it's about Europe's currently less-than-healthy banking system. This is why it is vital that the European Union, and specifically the eurozone countries, create mechanisms, processes, and institutions that can adequately address systemic financial crises across Europe. If Europe cannot get Greece right, it has little hope of stopping financial contagion from spreading to other major European economies. It is the contagion effect that is behind the talk of the potential dissolution of the euro, even though that outcome would be cataclysmic to Europe's economy and its future prospect of integration.
