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Issue brief: Global finance

The Electoral Issue:

The European Union's monetary union is threatened by the debt crisis in countries like Greece, Italy, and Spain. If those countries collapse, European banks which hold their bonds would suffer huge losses, causing economic turmoil that would shrink the market for U.S. goods. American banks could also suffer losses making it harder for them to lend.

The Challenge:

Use leverage to push the Eurozone to either bail out debt-laden countries or excise them from the currency union in a way that minimizes the fallout for the global economy.



Greece's public debt burden is about 160 percentof the country's annual gross domestic product and still growing. The country's economy is shrinking, with a predicted 5.3 percent contraction in 2012 according to the OECD, and their prospects for future growth remain dubious, casting doubt on their ability to pay down their debt. Because Greece is part of the Eurozone (the countries in the European Union that have adopted the Euro as a common currency), their debt problem is a problem for the whole continent.

If Greece is forced to leave the Euro, foreign governments and private lenders holding Greek bonds would be left with a worthless I.O.U. Germany's exposure to Greek debt, to take just one example, is estimated in the tens of billions of dollars. Other nations in debt crises would see their borrowing costs rise sharply as bond markets reacted to the Greek default, potentially making the problems in Italy, Spain, and others that much more difficult to solve.

The EU has provided $240 billion in bailout loans to help Greece pay its creditors, and private creditors agreed to write off more than half of Greece's outstanding debt. In return, the EU has demanded rigid austerity from the Greek government - raise taxes, cut spending, reform pension and labour markets. It has proven a bitter pill for the Greeks to swallow, leading to widespread demonstrations and unrest. Elections earlier this year empowered a new government that campaigned on a promise to honor the austere terms of the bailout but has since resisted the austerity program, forcing Germany and other EU leaders to stress Greece's obligations to the international community and the non-negotiability of the bailout terms. The problem will not be resolved until Greece either leaves the Euro or rights the fiscal ship. The uncertainty of the outcome is already dampening the global economic recovery.

Italy & Spain

In 2011, Greece was the 34th largest economy in the world. Italy, however, was the world's 8th largest economy and Spain was the world's 12th largest. So while a Greek collapse would be bad, a collapse in Italy and Spain would be far worse. And while these countries' debt burdens do not reach Greek levels of imminent danger, they are very large, creating a pressing problem with no immediately apparent solution.

The Spanish and Italian economies are too large for the rest of the Eurozone or the IMF to finance a sufficiently large bailout. The austerity demanded of Italy and Spain by other European countries, principally Germany, has been resisted by Italian and Spanish policymakers and citizens. If Greece is pushed out of the Euro due to debt concerns, many fear that their exit would only shift the onus to Italy and Spain, creating a domino effect and leaving policymakers unsure of where the fiscal contagion can finally be halted.

German Reluctance

Germany, the largest economy in the Eurozone, is also among the most fiscally sound countries in Europe, providing the Germans with a strong degree of credibility in their demand that other countries take actions to reduce deficits. German leaders worry that a bigger bailout or closer European fiscal integration would basically force hard-working German taxpayers to pay for problems other countries created with their own irresponsible fiscal and labor policies - a transfer of wealth from the responsible countries to the irresponsible ones. The result has been assistance with painful strings attached: Germany has pushed Greece, Italy, Spain and others into an austerity regime that they may not be prepared to sustain.

The Germans are reluctant to be flexible and reduce the pressure on debt-laden countries because they worry that only a rock and a hard place will force these countries to truly fix their debt problems.

American Impotence

Confounding all of these problems is America's almost nonexistent role in solving them. Some analysts have posited that the person with the greatest control over the outcome of the 2012 American presidential election is neither Mitt Romney nor President Obama, but German Chancellor Angela Merkel, whose maneuvering on the European debt crisis could either stave off or set off a global financial catastrophe. American leaders, for the most part, can only sit on the sidelines, helplessly watching an unfolding problem from across the ocean and using only suggestions and summits to nudge the Europeans in the desired direction. Domestic political pressure also prevents the Americans from taking more direct action - American taxpayers have no interest in bailing out Europe.

Next page: Proposals


Cut Greece Loose

Sometimes the only way to stop the contagion is to amputate the limb. If Greece's budgetary problems prove too tough to surmount in spite of bailout funds allocated by the EU and the IMF, they may be forced to exit the Eurozone.

There is no clear process for a country leaving the currency union, which was designed for expansion, not contraction. Cutting Greece loose, while potentially very disruptive, could stem the bleeding and save the Euro, giving the Eurozone time to wrestle with other problematic countries. It may also be Greece's best hope for an eventual recovery - a new Greek currency would rapidly devalue (by as much as 80%, according to the IMF), and the Greek economy could shrink by as much as 10 percent. But after several tumultuous years, the devalued currency would force Greeks to buy domestic goods and increase Greece's export capacity, allowing growth to flourish.

Challenges: We do not know what would happen if Greece leaves the Eurozone, but the consequences could be very destructive. While Greece went through a painful restructuring, jettisoning the Euro and re-adopting the drachma, the rest of the world would be forced to share the pain. The very existence of a monetary union could be thrown into doubt as policymakers and investors refocus on problems in Spain, Italy, and other debt-laden members of the E.U.

Bailout & Austerity

On top of the $240 billion the EU and the IMF have already loaned to Greece, the European Union is in the process of setting up the European Stability Mechanism, essentially a bailout fund (roughly $784 billion) to which EU members contribute money that can then be loaned to cash-strapped member states. Between this and the bailout loans already allocated, some policymakers hope that the debt crisis can be contained - that with a mixture of loans and austerity, the Greeks, Italians, and others can be gradually nudged into stabilization.

Challenges: More bailouts may be simply kicking the can down the road. If there is not enough money to sufficiently relieve debt-laden member states, additional bailouts only serve to delay the inevitable resolution that will come from either a European fiscal union (see explanation below) or a Greek exit from the Eurozone.

Fiscal Union

The Eurozone is a monetary union - all countries share the same currency - but it is not a fiscal union, meaning each country retains sovereign authority over its budgetary practices.

According to some analysts, this was the original sin of the Eurozone - an architectural flaw that was destined to produce exactly the kinds of problems we're seeing today. Debt laden countries drag down the common currency, but the lack of a common budgetary authority prevents the Eurozone as a whole from addressing the fiscal policies of weak links. To address the problem, some policymakers are pursuing some form of fiscal union that would submit the taxing and spending policies of each member country to a central authority, ensuring that each country remains within the limits of acceptable deficit levels and preventing countries from living too far beyond their means.

Challenges: A fiscal union would require Eurozone countries to cede a substantial measure of national sovereignty to a continental authority. It could also force wealthier and more fiscally sound Eurozone nations to subsidize the less wealthy and more indebted nations. German taxpayers already leery about the prospect of loaning money to Greece and other nations might balk even further at the prospect of a fiscal union that cribs their own sovereignty for the sake of less prudent nations. The imposition of a fiscal union is largely a question of political will - can leaders across the continent agree to trim their national agency for the sake of the common currency?

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