Final paper for "History of the European Union."

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Greece’s Threat to the EMU: Is There an
Alternative Besides a Bailout?
Ryan Cho
November 21, 2011
Economics 475

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• 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
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
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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

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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

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• 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

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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
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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
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13
http://www.equitymaster.com/dailyreckoning/detail.asp?date=11/19/2011&story=5&title=Corruption-­‐and-­‐the-­‐
Greek-­‐Debt-­‐Crisis

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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

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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
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16
http://www.guardian.co.uk/world/2010/may/06/greek-­‐debt-­‐crisis-­‐economy

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
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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
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.

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