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Spanish Prime Minister José Luis Rodríguez Zapatero, looking glum after his socialist party, the PSOE, had the worst regional election results in 30 years, Madrid, May 23, 2011
On Monday, the euro dipped to record lows
against the Swiss franc and two-month lows against the US dollar on a day when
yields on Spain’s 10-year sovereign debt jumped to highs not seen since
September 2000. Italian 10-year bond yields also rose. Investors dumped Spanish bonds after a very poor performance by the ruling
Socialists in regional elections. Miguel Angel Fernández Ordóñez, the central
bank governor, said Spain should not accept the high cost of debt and must forge
ahead with its economic reforms.
Markets also reacted on Monday to a Friday night announcement from Standard &
Poor’s about Italy's credit rating when it cut the outlook on the sovereign
A-plus rating to negative because of concerns about the economy.
Dr. Peter Morici: Greece is in crisis again.
Athens should restructure its debt and abandon the euro to reassert control over
its finances and economy - - Video interview with France's Christine Lagarde at
the bottom of page.
Just one year after wealthier EU governments and International Monetary Fund
extended €110 billion in emergency financing, Greece is unable to meet the aid
plan’s deficit reduction targets and grow fast enough to make its debt payments
The European Central Bank and IMF insist that Athens can meet these targets, but
raising taxes or cutting spending further would only slow growth even more, and
likely cast Greece into a deep recession from which it could not recover.
Now, Greece is slipping from a liquidity crisis into downright insolvency. Bond
investors are demanding yields 20 percentage points higher on Greek debt than on
comparable German debt. Rolling over existing bonds, as those come due, will be
prohibitively expensive, and the collapse of Athens’ finances seems inevitable.
Unless Greece gets significant concessions and loans at preferential rates from
the EU and IMF, it will be impelled to ask private creditors to accept bonds
with longer maturities and paying lower interest rates than the bonds they
currently hold. As the market value of those securities would be much lower than
the face value of Greece’s current outstanding debt, such a restructuring would
constitute a “soft default.”
Exacerbating the crisis, the ECB has threatened to cut off support for Greece’s
private banks if Athens restructures its debt. The ECB reasons that the banks’
holdings of Greek debt would make them a bad risk, but it does not extend such
thinking to German and other European banks holding Greek government paper.
The European Central Bank and IMF remain firm that no such restructuring is
necessary, but cutting government spending or raising taxes enough to pay higher
interest rates as debt rolls over would be self defeating. The recession that
would result would reduce debt servicing capacity, not improve it, and endanger
political stability as social services were slashed and unemployment skyrocketed
The alpha and the omega of Greece’s debt crisis—and those that could follow in
Portugal, Ireland and other distressed states—are the anomalies in EU
institutions that make difficult financing pensions and other social benefits in
Greece and other poorer EU economies.
The 1992 Maastricht Treaty significantly harmonized product and safety standards
and methods of taxation across the continent and was supposed to remove untold
barriers to growth. It didn’t, because European strict labor laws and business
regulations discourage individual initiative and investment, and the EU’s much
advertised single market raised expectations among voters in poorer countries
that pension and social benefits would be on a par with Germany and other rich
The single currency, the euro, introduced in 1999, was heralded the next great
elixir but it too failed to rev up growth, because it addressed a problem that
didn’t exist and created a new major barrier to the effective management of
Prior to the euro, the European Currency Unit linked at fixed rates the national
currencies of many of today’s euro zone countries. The ECU was accepted as
payment in international commercial transactions—the primary void the euro was
supposed to fill.
However, each country could print its domestic currency and occasionally devalue
against the group as its circumstances might require. With the euro that
flexibility was taken away from poorer countries like Portugal, Spain, Greece,
Germany, like New York, greatly prospers by participating in a huge single
continental market, but Brussels cannot tax Germany to subsidize Greece’s
welfare state in the same way Washington taxes New York to subsidize
With all that wealth to itself, Germany provides generous pensions, gold plated
employment security and jobless benefits, short work weeks, and the like.
Meanwhile governments in Greece and other poorer EU states struggle to keep up,
pile up lots of debt and can’t scale back too much without risking political
upheaval, because their populations won’t accept they cannot enjoy the same
perks as the Germans.
If Greece still had its own currency, it would still have had to cut spending
and increase taxes—but not by nearly as much as the EU aid pact requires—because
Greece could also devalue its currency against those of richer EU economies to
make exports more competitive, accelerate growth, and increase debt servicing
Now things have gone too far. Greece’s debts are too large and are denominated
in euro, not the Greek drachma.
The only real solutions are for Greece to restructure its debt—both sovereign
and private creditors should take haircuts; abandon the euro and reinstate the
drachma; and rethink its welfare state. Like Americans, the Greeks will have to
work longer to retire and accept other less generous social benefits, but they
could reassert control over their economy.
The alternatives are endless EU bailouts—something the German and French voters
are doubtful to allow—loss of Greek sovereignty, and economic collapse.
Greece Must Deliver: Lagarde:"Greece has to deliver," French Finance Minister Christine Lagarde told CNBC when discussing the euro zone debt crisis and measures Greece has promised to take to tackle the crisis:
Professor, Robert H. Smith School of Business, University of Maryland,