Playing Chicken.

Architects of the Euro-zone sought a stronger, more prosperous, and more harmonious union.[1] The inauguration of the Euro in 1999 began a period of low interest rates for member countries. Low interest rate led to heavy borrowing by both public (Greece) and private (Spain, Ireland) sectors. When the world economy slowed down after the American financial crisis, debt-service became a problem.

The architects had not then—and have not yet—resolved all of the problems. One worm in the apple is that the single currency serves 19 sovereign states. Those states do not pursue uniform economic policies. Nor do all national cultures celebrate the same values.[2] German hostility to budget deficits closed off large-scale counter-cyclical spending as a policy tool. Instead, states were to pursue limiting deficits as a share of Gross Domestic Product (GDP).

The pursuit of austerity policies has had different effects in different countries.[3] The GDP of Germany has risen about 10 percent from 2009. The GDP of Portugal, Spain, and Italy are all down about 10 percent. The GDP of Greece is down more than 20 percent. The decline in GDP has increased the burden of the government debt financed by taxation. Government debt as a share of GDP has risen from about 30 percent to about 70 percent in Spain; from 90 percent to about 110 percent in Italy; and from 60 percent to about 120 percent in Portugal. Greek government debt as a share of GDP has risen from about 110 percent to about 170 percent. (Thus, austerity has pushed Italy and Portugal into the same territory from which Greece began.) This raises the danger that bigger, more severe crises lie over the horizon.

The the creditor countries could pursue expansionary policies that might fuel demand for goods from the debtor countries. Once again, different national politics and cultures come into play. The northern creditor countries don’t want to abandon the policies that they associate with their own success, least of all to bail out the improvident.[4]

The concept of the Euro-zone was that—like Mr. Lincoln’s theory of the Union—the members had formed an indissoluble bond.[5] The Greek crisis threatens that idea. If Greece was to be forced out, then any other country that got into serious financial difficulty in the future might suffer the same fate. Countries at risk would have to pay extremely high risk premiums for financing public debt. The whole Euro-zone could unravel from the bottom like a sweater. Crisis after crisis would gnaw at a union that seeks the benefits of stability.

Hard-liners have not said so, but it might turn out to be a way of finally enforcing the economic doctrines of the northern creditor countries on the southern debtor countries.[6] Any country that did not wish to pay high risk premiums to lenders would have to pursue “sound” finances. That, in turn, could force a reform of social and economic policies.

The Greek “Syritza” and Spanish “Podemos” parties have drawn strong support for demands to end austerity and for debt repudiation. Many American observers seem to think that the Germans and other creditors should be happy to get robbed by the Greeks and other debtors for the greater good. The long Republican counter-attack against high taxes since the Reagan Administration shows something different. People who feel victimized will fight back. Right now, the focus is on angry Greeks and Spaniards. In the future it’s likely to be angry Germans.

[1] Eduardo Porter, “Local Politics Are Fracturing European Unity,” NYT, 3 February 2015.

[2] Flexibility, thrift, and probity, for example.

[3] See the charts in Porter, “Local Politics.”

[4] The limited historical knowledge of many economic commentators leads them to make frequent references to the post-First World War inflation as a formative experience. They ignore the “cigarette economy” that flourished after the Second World War and the heavy burdens carried by West Germans after absorption of the defunct German Democratic Republic in 1989. Germans today have a far more vivid set of memories shaping their behavior.

[5] Stephen Fidler, “Europe Weights Costs of Casting Greece Aside,” WSJ, 6 February 2015.

[6] As Voltaire quipped after the Royal Navy executed Admiral John Byng, “They shoot one to encourage the others.”


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