1	
  
Greece’s Threat to the EMU: Is There an
Alternative Besides a Bailout?
Ryan Cho
November 21, 2011
Economics 475
  2	
  
• Abstract
Europe and the strength of its common monetary system has become a world crisis and
the strength of the...
  3	
  
that it would prevent future wars.1
Six countries decided to form a custom union that the Treaty
of Paris was writ...
  4	
  
France, Luxembourg, and the Netherlands had sought to achieve through the ECSC, political and
monetary conformity;...
  5	
  
• The Affects and Repercussions of a Country Defaulting on its Debt
Argentina is a country that has defaulted on i...
  6	
  
currency swaps will mature, and swell the country's already bloated deficit.”9
This shows Greece
never qualified t...
  7	
  
government debt was 129% of GDP, by 2010 145% and was granted €110bn but now in 2011,
its debt still has not stabi...
  8	
  
logical. Greece obviously does not understand or care about how the magnitude of the effects of
its incompetence c...
  9	
  
than the strongest financial countries giving handouts to poorer, less efficient countries, a change
in EMU policy...
  10	
  
enough to support the euro as its currency. A common monetary policy will either force drastic
measures, such as ...
  11	
  
money on a regular basis. It appears that the UK’s skepticism for a common currency was for
good reason. Monetary...
  12	
  
alive because the strong countries are willing to pay the debt of smaller countries and by the
funds of the IMF, ...
  13	
  
Works Cited
Balzli, Beat. "Greek Debt Crisis: How Goldman Sachs Helped Greece to Mask Its True Debt -
SPIEGEL ONL...
  14	
  
2010. Web. 19 Nov. 2011. <http://www.guardian.co.uk/world/2010/may/06/greek-debt-crisis-
economy>.
"The Single Eu...
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Final paper for "History of the European Union."

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  1. 1.   1   Greece’s Threat to the EMU: Is There an Alternative Besides a Bailout? Ryan Cho November 21, 2011 Economics 475
  2. 2.   2   • Abstract Europe and the strength of its common monetary system has become a world crisis and the strength of the Economic Monetary Union has come into question. In 2010 the International Financial Institution and the EMU approved a nearly trillion-dollar bailout, Greece being one of the major recipients. A year later, even with the tremendous funding by the IMF and the European crisis fund, some countries failed to stabilize their economies. The EMU is faced with a virtually unprecedented issue if Greece were to default on its debt. Greece would be the only country to suffer; Greece could very well be the catalyst for a world financial crisis. Contagion would likely occur for countries such as Italy, Spain, Ireland, and Portugal, which are already fearful about their debt situations and if Greece isn’t bailed out, no one may be bailed out, which could cause a chain of defaults. A custom union is logical theoretically, but it is now apparent there are underlying problems with the EMU and custom unions in general. Only an outside source can pay off Greece’s debt. Greece has shown a lack of responsibility to maintain a stable economy, low inflation, and other requirements to be a member of the EMU; meanwhile, countries worldwide are donating money to buy up Greece’s debt and Greece is reliant on this. Unless there is some kind of policy changes, whether it is the Greek government or the European Central Bank, there is reason to fear an implosion of the EMU and the beginning of a world financial crisis. • The Road to and the Goals of the EMU To understand the 2011 financial crisis regarding Greece, it is necessary to understand the development of the custom union and common currency that developed in Europe post World War II. The Treaty of Paris was signed in 1951 for both political and economic reasons in hopes
  3. 3.   3   that it would prevent future wars.1 Six countries decided to form a custom union that the Treaty of Paris was written for, the European Coal and Steel Community. Since coal and steel were such valuable commodities, the ECSC would allow for economies of scale and eased political tension because no country would need to wage war for coal or steel. Next, the 1957 Treaty of Rome was signed to further expand on the Treaty of Paris and created a common market for the free movement of capital and labor.2 The Single European Act of 1968 made amendments to the original treaties with the intent to further unite the member states and the original goals that the Treaty of Paris had sought to bring to Europe. The SEA aimed for stronger monetary integration, common foreign and environmental policies and also to expand research and development.3 By 1986, 12 of the most important countries in Europe were members of the European Union when the SEA came into effect, which “increased the role of the European Parliament (cooperation procedure) and widened Community powers.”4 Finally, the 1992 Treaty of Maastricht paved the way for the EMU to use a common currency, the euro. Theoretically, a common currency should be beneficial to further unite countries that previously had been enemies for years. Political stability and economical benefits aside, recent crises have shown weaknesses of a common currency and custom unions. The 2010 and 2011 bailouts show vulnerability of a CU • The History of the Euro In 1999, the EMU finally implemented the euro.5 Out of all the EMU states invited to use the euro, Sweden and the UK opted out because they were not ready to give up the sovereignty EMU members have to (ibid). The idea of a common currency can be traced back to the ideals of the 1951 Treaty of Paris and finally the euro encompasses the goals of Germany, Belgium, Italy,                                                                                                                 1  Class   2  http://europa.eu/legislation_summaries/institutional_affairs/treaties/treaties_eec_en.htm   3  http://europa.eu/legislation_summaries/institutional_affairs/treaties/treaties_singleact_en.htm   4  http://europa.eu/legislation_summaries/institutional_affairs/treaties/treaties_eec_en.htm   5  http://ec.europa.eu/economy_finance/euro/index_en.htm  
  4. 4.   4   France, Luxembourg, and the Netherlands had sought to achieve through the ECSC, political and monetary conformity; in addition, environmental and research and development policies were created in the process.1 The criteria to join the EMU as decided upon in the Treaty of Maastricht, is that a country must not have more than a budget deficit of less than three per cent of its GDP and 60% government debt of GDP. In addition, a country should have low inflation and interest rates close to the EU average.6 Greece was apparently qualified. • Likelihood and Effects of a Default Despite the persevering strength of the euro, the crisis amongst the countries in the European Monetary Union has affected all of the world’s markets. Greece has been the main focus of the EMU crisis because of how close it is to defaulting on its debt, now for a second time. The fact that Greek bonds are a common currency a default is a scary situation for those that hold Greek bonds, as Greece will likely never be able to repay them. Greece defaulting would have unpredictable affects on the world’s markets and it is likely that very few countries could benefit. Additionally, the IMF requires all countries to contribute to the fund, which hurts all countries around the world because it seems unfair for one country, or a handful of countries, to repeatedly be the major recipients of insane sums of money that the entire world contributes to. What makes the idea of a second bailout even worse is that Greece completely neglected to fix any economical problems with its 2010 bailout money, a staggering €110bn. Greece has shown its irresponsibility, which makes default seems like a realistic possibility. This scenario is virtually unprecedented because although countries have defaulted on debt before, those countries were not in a custom monetary union.                                                                                                                 6  http://ec.europa.eu/economy_finance/euro/adoption/who_can_join/index_en.htm  
  5. 5.   5   • The Affects and Repercussions of a Country Defaulting on its Debt Argentina is a country that has defaulted on its debt and can be a proxy for what could happen if Greece defaults. Argentina went through an economic crisis from the 1990s to the early 2000s.Venezuela was a major contributor to help Argentina recover from its default, analogously to how the EMU has approved bailouts in the past. By 2005, Venezuela has bought over $5 billion in bonds from Argentina.7 Judging by the current situation of the EMU and the job of the European Central Bank, gifted money from the EMU crisis fund is one of the few options left to save Greece. A possible affect on the world, analogously represented by Argentina’s default, “a default by Argentina to the World Bank and/or the IMF would therefore be somewhat unprecedented. A big question would be whether the IFI's would try to make a "pariah state" out of Argentina for defaulting to them, or would succeed if they were to try.”8 This would mean the International Financial Institution would have to buy up all of Argentina’s debt and possible take ownership of Argentina. But, “many people see the IFI's as having at least joint responsibility for bringing about the depression in Argentina (ibid).” Greece arguably should not be given the same empathy. Greece has already been bailed out once and has shown it is incapable to use money wisely, even given the gravity of the crisis that EMU has to act on. • How Greece was Able to Join the EMU However, Greece may not be entirely to blame for its debt crises. The United States can arguably be blamed for a potential default on Greece’s debt. For example, “Goldman Sachs helped the Greek government to mask the true extent of its deficit with the help of a derivatives deal that legally circumvented the EU Maastricht deficit rules. At some point the so-called cross                                                                                                                 7  "Chavez  keeps  up  South  American  energy  diplomacy,"  Reuters,  Wed  Aug  8,  2007   8  http://www.cepr.net/documents/publications/argentina_crisis.htm  
  6. 6.   6   currency swaps will mature, and swell the country's already bloated deficit.”9 This shows Greece never qualified to join the EMU in the first place. Additionally, Greece’s debt situation shows that Greece’s economy is too weak to support the use of the euro. Only by “the help of blatant balance sheet cosmetics… Greece was able to hide billions of dollars of debt by masking “gigantic military expenditures… and another time billions in hospital debt (ibid).” Only by using shady methods was Greece able to keep its government deficit to GDP under the required 3% and the government debt to GDP under 60%. “Greece's debt managers agreed a huge deal with the savvy bankers of US investment bank Goldman Sachs at the start of 2002. The deal involved so-called cross-currency swaps in which government debt issued in dollars and yen was swapped for euro debt for a certain period -- to be exchanged back into the original currencies at a later date (ibid).” Multiple sources are to blame for Greece’s debt crisis; United States banks, Greece’s willingness to mask debt, and the EMU’s lack of due diligence to ensure Greece met all the budget requirements are all to blame for the world crisis Greece has caused. • How Greece Became in Debt and Failed Using its Rescue Fund Greece’s first bail out in May 2010 was approved because of the growing fear of a “debt crisis that has engulfed Europe and threatened markets around the world.”10 The EMU “agreed on Monday to provide a huge rescue package of nearly $1 trillion in a sweeping effort to combat the debt crisis that has engulfed Europe and threatened markets around the world,” of which Greece was the beneficiaries of €110bn (ibid). While consumers were a significant reason for the US’s 2008 recession, the government is to blame for Greece’s debt crisis.11 In 2009, Greece’s                                                                                                                 9  http://www.spiegel.de/international/europe/0,1518,676634,00.html   10  http://www.nytimes.com/2010/05/10/business/global/10drachma.html?pagewanted=all   11  Class  
  7. 7.   7   government debt was 129% of GDP, by 2010 145% and was granted €110bn but now in 2011, its debt still has not stabilized.12 The government is to blame because “Corruption in Greece was one of the major causes of the debt crisis. It caused wasteful public expenditure and widespread tax evasion, ultimately leading to a bankrupt state… Due to political lobbying, the retirement age in Greece for public sector workers and a large number of private sector workers was 53. Upon reaching that age, individuals could receive a state pension equal to 90% of the previous salary for the rest of their lives. So an individual who lived for 80 years would only work for around 30-35 years of their lives. Early retirement and generous pension schemes were one of the primary factors that drove the Greek government into bankruptcy… A lot of public expenditure was devoted to policies that simply existed to buy votes for politicians… Many wealthy businessmen and professionals in Greece would not declare large portions of their income, thereby avoiding tax… one-third of the doctors had reported income levels low enough that they did not have to pay any tax at all… Clearly, a lot of income goes unreported and thus tax is not paid on it.” 13 By taking advantage of Greece’s lax tax regulation and generous pension system, consumers are partly to blame. But, the government is outrageously irresponsible to allow such actions to happen. The government should be the obvious catalyst of its debt crisis by its failure to collect taxes and failing to realize its economic policies are not possible to maintain, given the debt situation. Public expenditure to keep the politicians in office to allow tax evasion for personal and corporate gains is not only detrimental to Greece’s economy, but also counterintuitive to stabilize its economy. The politicians that public money is spent on are the people responsible for producing the debt crisis in the first place. The government obviously needs to change. The 2010 grant was to prevent another debt crisis and was wasted in only one year. Greece should be forced to change fiscal policies and reevaluate its government. Using the money granted by the crisis fund in order to promote the reelection of politicians that have caused this crisis is not                                                                                                                 12  Class   13  http://www.equitymaster.com/dailyreckoning/detail.asp?date=11/19/2011&story=5&title=Corruption-­‐and-­‐the-­‐ Greek-­‐Debt-­‐Crisis  
  8. 8.   8   logical. Greece obviously does not understand or care about how the magnitude of the effects of its incompetence could impact only on the EMU, but the world if Greece were to default. • Why the EMU should Bailout Greece The EMU should have a responsibility to bailout Greece, even though Greece failed to stabilize its economy the first time. Had the EMU been more careful before granting Greece membership into the EMU, it should have been discovered that crooked bookkeeping that Greece used to meet the EMU’s requirements. Greece certainly has shown it is irresponsible with money and while Greece may not deserve more, Greece is almost a scapegoat. Even though Greece is not the only country with massive debt, the EMU has done a good job to avoid looking weak to the rest of the world. By keeping other countries that are in fear of defaulting out of the view of the public, the euro and the EMU look stronger to investors and keep a higher credit rating. The amount of countries that are in outrageous debt may eventually need bailouts as well, but Greece is the country that the world has been focusing on and if Greece falls, contagion suggests others will fall as well. If there are so many countries on the brink of defaulting, there must be flaws with how the EMU operates and with its policies. Not only did the EMU fail to prevent Greece from using shady tactics, “In previous years, Italy used a similar trick to mask its true debt with the help of a different US bank.”14 The EMU did not look deeper into Greece’s finances; if the EMU had, Greece would have never been able to use the euro in the first place and there would be no Greek crisis to begin with that would threaten the EMU and the euro. The EMU should not blame Greece, only themselves. Now there is nothing for the EMU to do but buy Greece’s debt. • Problems With the 2010 Bailout Exemplified by the first attempt to solve the EMU’s crisis in 2010 by distributing money logic would suggest a different approach to solving Greece’s debt crisis should be taken. Rather                                                                                                                 14  http://www.spiegel.de/international/europe/0,1518,676634,00.html  
  9. 9.   9   than the strongest financial countries giving handouts to poorer, less efficient countries, a change in EMU policy, such as the goals and policies of the European Central Bank, would be a better long-term alternative for stability. Greece had a major spike in its interest rate; up to a frightening 12% on its bonds and so the IMF and the 2010 crisis fund provided funding to stabilize Greece and others in the EMU.15 Initially, this was a success for Greece, its interest rate dropped significantly. But, in only a couple months time the interest rate on Greek bonds dropped from 12%, down to a reasonable number, then skyrocketed and continued to climb to an unimaginable 27% (ibid). This sharp rise in interest rates revealed the instability of Greece’s economy to pay off its debt, even after being given a staggering €110bn euros. Europe’s decision to help Greece was empathetic, but the EMU should learn from how poorly Greece managed its first bailout cash without fixing the debt crisis. Still the EMU is offering yet another cash bailout to Greece. • Why Greece is Stuck in an Economic Struggle While it is arguable that Greece is not entirely to blame for its failure to stabilize its economy even though it was given extraordinary amounts of money, Greece has no monetary sovereignty to make changes that could reduce its deficit. “Like many countries, the Greek government relies on borrowed money to balance its books… The snag is, this traditional market response is complicated by Greece's membership of the single-currency euro club. This means it cannot stimulate growth by devaluing its currency, and nor can it cut interest rates any further, which would help, because these are decided by the European Central Bank in Frankfurt.”16 As discussed in class, the lack of monetary sovereignty makes it virtually inevitable for Greece to stabilize its economy without outside intervention. Greece’s economy merely is not strong                                                                                                                 15  Class   16  http://www.guardian.co.uk/world/2010/may/06/greek-­‐debt-­‐crisis-­‐economy  
  10. 10.   10   enough to support the euro as its currency. A common monetary policy will either force drastic measures, such as kicking Greece out of the EMU, or continuous bailouts if Greece managed to burn through €110bn in one year. • What is to be Done with Greek Debt After months of discussion, the EMU decided that banks would take a 50% haircut loss and the EMU would provide funds to prevent Greece from defaulting.17 Greece allowed the citizens to vote on whether or not Greece should accept the deal offered by the EMU, but the vote was eventually canceled.18 Frankly, it does not make any sense why Greece would default, causing unimaginable affects on European and the world’s markets. Contagion may come into effect and other countries, such as Italy, Spain, and Ireland, would require financial aid. Greece defaulting could likely cause a domino effect on all countries in the EMU, which would make an already disastrous situation even worse for the perceived strength of the EMU. • Contagion: Panic of EMU Members Also in Economic Troubles Failure to bailout Greece would cause panic for other countries because they would fear they would not be bailed out just like Greece. “What many investors fear is that the only way out of this vicious circle is for Greece to walk away from its existing debts and try to go it alone – potentially triggering a wave of similar defaults in other indebted European countries, and jeopardizing the euro itself.”19 The countries that are next in line for potential bailouts are Spain, Italy, Portugal, and Ireland.20 A series of defaults would threaten the stability of the EMU and outside investments on EMU member bonds. If contagion were to occur because of Greece, the EMU would be an example of how countries need monetary sovereignty, or need to be given                                                                                                                 17  http://topics.nytimes.com/top/news/international/countriesandterritories/greece/index.html   18  http://www.nytimes.com/2011/11/04/world/europe/greek-­‐leaders-­‐split-­‐on-­‐euro-­‐referendum.html?pagewanted=all   19  http://www.guardian.co.uk/world/2010/may/06/greek-­‐debt-­‐crisis-­‐economy   20  Class  
  11. 11.   11   money on a regular basis. It appears that the UK’s skepticism for a common currency was for good reason. Monetary sovereignty is more important than the EMU may have thought. • Necessity for Policy Change Instead of mending the recent financial problems, the EMU needs fix the root of the problems. The EMU has to realize that gifting countries money is not an effective way to solve problems. Greece can pay off its debt, but Greece cannot control its monetary policy. Changes with policies regarding the European Central Bank might be the only way to allow countries to stabilize themselves without constant bailouts. Germany, the main opponent against the central bank’s main job, keeping inflation down, will likely veto any changes to the central bank’s policies. It seems like Germany has two choices; allow changes with the central bank’s monetary policies, or continue to pay for other countries debt. If Germany has no problem carrying the burden of other countries debt and is fine bailing out countries when they need it, because Germany is the strongest economy in the EMU, Germany should have great power to make some of the most important decisions. If keeping inflation down is that important to Germany, then as long as Germany takes major burden by funding bailouts constantly, the EMU could function this way. • Conclusion - The Importance of the Greek Crisis and its Affects on the World Unless something changes, the euro is in danger. Since Germany has such a strong stance against any inflation, policy changes regarding the European Central Bank are unlikely. Until there is no other choice than EMU member states to integrate fiscal policy in addition to monetary policy, or come up with another clever way to allow countries to stabilize themselves, countries requiring bailouts will continue to require bailouts. France and Germany are able to sustain themselves, but smaller countries cannot. Judging by the past few years, the EMU is only
  12. 12.   12   alive because the strong countries are willing to pay the debt of smaller countries and by the funds of the IMF, which all countries worldwide contribute to. If this changes, only time will tell if the EMU and the euro will continue succeed. Greece has proven irresponsible with its 2010 crisis money; but since Greece has no monetary sovereignty, it can’t really do anything to strengthen its economy without continuous bailout money. A series of defaults by EMU member states would cause a worldwide market shock, and Greece would only be the beginning. Maybe Greece should just opt out.
  13. 13.   13   Works Cited Balzli, Beat. "Greek Debt Crisis: How Goldman Sachs Helped Greece to Mask Its True Debt - SPIEGEL ONLINE - News - International." SPIEGEL ONLINE - Nachrichten. 2 Aug. 2010. Web. 18 Nov. 2011. <http://www.spiegel.de/international/europe/0,1518,676634,00.html>. Donidio, Rachel, and Niki Kisantonis. "Greek Leader Calls Off Referendum on Bailout Plan." New York Times. 3 Nov. 2011. Web. 18 Nov. 2011. Dossani, Asad. "Corruption and the Greek Debt Crisis." Equitymaster.com. 19 Nov. 2011. Web. 19 Nov. 2011. <http://www.equitymaster.com/dailyreckoning/detail.asp?date=11/19/2011&story=5&title=Corr uption-and-the-Greek-Debt-Crisis>. "The Euro. Who Can Join and When? - ECFIN - European Commission." EUROPA - European Commission - Homepage. 1 July 2011. Web. 19 Nov. 2011. <http://ec.europa.eu/economy_finance/euro/adoption/who_can_join/index_en.htm>. "Greece News - Breaking World Greece News - The New York Times." Times Topics - The New York Times. 11 Nov. 2011. Web. 19 Nov. 2011. <http://topics.nytimes.com/top/news/international/countriesandterritories/greece/index.html>. Hornos, Conrado. "Chavez Keeps up South American Energy Diplomacy| Reuters." Business & Financial News, Breaking US & International News | Reuters.com. 08 Aug. 2007. Web. 18 Nov. 2011. <http://www.reuters.com/article/2007/08/08/us-venezuela-uruguay- idUSN0835483220070808>. Kanter, James, and Landon Thomas Jr. "E.U. Details $957 Billion Rescue Package - NYTimes.com." The New York Times - Breaking News, World News & Multimedia. 09 May 2010. Web. 19 Nov. 2011. <http://www.nytimes.com/2010/05/10/business/global/10drachma.html?pagewanted=all>. Roberts, Dan. "Greek Debt Crisis | How Did the Greek Economy Get into Such a Mess? | World News | The Guardian." Latest News, Sport and Comment from the Guardian | The Guardian. 6 May
  14. 14.   14   2010. Web. 19 Nov. 2011. <http://www.guardian.co.uk/world/2010/may/06/greek-debt-crisis- economy>. "The Single European Act." EUROPA – EU Website | Choose Your Language | Choisir Une Langue | Wählen Sie Eine Sprache. 26 Oct. 2010. Web. 18 Nov. 2011. <http://europa.eu/legislation_summaries/institutional_affairs/treaties/treaties_singleact_en.htm>. "Treaty Establishing the European Economic Community, EEC Treaty - Original Text (non- consolidated Version)." EUROPA – EU Website | Choose Your Language | Choisir Une Langue | Wählen Sie Eine Sprache. 26 Oct. 2010. Web. 19 Nov. 2011. <http://europa.eu/legislation_summaries/institutional_affairs/treaties/treaties_eec_en.htm>. Weisbrot, Mark, and Alan B. Cibils. "Argentina's Crisis: The Costs and Consequences of Default to the International Financial Institutions." Cepr.net. 19 Nov. 2002. Web. 19 Nov. 2011. <http://www.cepr.net/documents/publications/argentina_crisis.htm>.

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