How Bad the“Cart Before the Horse” Situation Can Get

The Financial World According to Inya” Column
by Inya Ivkovic, MA

The potential debt crisis in Eurozone is not only the first test of its unity, but it could be the very thing that will either define or dissolve the European Union. Of course, since we are talking about actual countries and people, and in Europe at that, failure is not exactly an option. What Europe is likely to do is muddle its way through the motions, probably for a decade or two, because this is what you do when you are of the Old World. However, no one has the patience to wait for Europeans as they indulge in a decade-long bout of soul-searching.

No sixth sense was required to predict the conundrum that the Eurozone is faced with now. Just before the union rallied around the monetary union in late 1990s, many economists around the world argued that it was the wrong priority on which to focus. But, as the euro took the world currency stage by storm, the naysayers were shushed, while citizens of countries participating in the monetary unity relished the ease of travel with no foreign exchange charges attached.

Now, the problems are resurfacing, some more serious than others. As George Soros said, to have a “fully fledged” currency, there has to be also a central bank and a treasury. There has to be an effective fiscal and monetary policy and the ability to help out ailing countries. In other words, what the EU needs is not only monetary unity, but strong economic unity as well, further supported by political unity. After all, this was the initial and ultimate reason for pooling together countries at often different levels of economic and political development. The first time the Old World rushed into anything, the end result was, as it has often been said, Europe putting its (monetary) cart before the (economic and political) horse. And now there is a price to pay.

After indulging in misleading and self-destructive wastefulness, Greece has demonstrated just how bad “the cart before the horse” could get. Greece’s situation is actually rather unique, even when compared to other European cripples, such as Portugal, Italy, Ireland and Spain, because Greece’s deficit reached 12.7% of GDP in 2009 and its national debt has swelled to about 125% of GDP and continues to rise. This is more than living beyond one’s means. Greece has actually become so lazy that it has piggybacked on its long Eurozone membership and lost nearly all of its competitive advantages and edges.

Last week, the streets of Athens were filled with public servants on another general strike. The Greek government has made some difficult promises and thought one way out would be to freeze pay for its public servants. Among the promises made to the EU is to cut the deficit from 12.7% to 8.7%. Sure, it is the right thing to do, as well as an impossible thing to do. Such deep cuts and radical reforms first make things worse before they get better, if at all. Just to keep its head above the water, the Greek government needs to find someone willing or crazy enough to lend the already overextended country 55 billion euros in 2010, and about half that amount by the end of the second quarter. Which has better odds: a snowball in hell or Greece in the bank?

As I have said earlier, failure is not exactly an option. Germany, reluctantly and grudgingly, is likely to put together with other stronger EU allies something of a Greek bailout package. However, I don’t see EU allies going overboard supporting Greece’s reckless spending habit. Chances are the bailout will come with heavy strings attached, including the EU practicing tough love, which may or may not be welcomed by Greeks. But beggars cannot be choosers and the Greeks better get used to its new classification, however unjust it may seem to them.

Why should North Americans follow what is going on with finances of sovereign countries in the Old World closely? Simply, we are all far too connected to ignore our weakest links. We need strong economic governance in every corner of the world if we want to live peacefully and happily in our own backyard.