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The Greek Crisis and the Future of the Euro: Contagion from the Debt Crisis

Koji Fukuda
Professor, Faculty of Political Science and Economics, Waseda University

The problems that began with the Greek fiscal crisis are now shaking Europe and the rest of the world. The financial panic in Europe is also beginning to damage market confidence in the Euro. As a result of the G20 Cannes summit, Greece shelved plans for a referendum and confidence in the Papandreau Cabinet grew. However it was replaced by a coalition government led by Lucas Papademos, a former European Central Bank vice-president on 11 November 2011.Greece appears ready to accept a policy package put together by the European Commission and the 17 members of the Eurozone, with its parliament looking likely to approve it. All this makes it appear as though a crisis has been averted, but none of the fundamental problems have been solved. The Eurozone's third largest economy, Italy, now also appears to be in crisis, and like Greece, Ireland, and Portugal before it, has been placed under IMF observation. The new Prime minister of Italy, Mario Monti, an economist and a former European Finance Commissioner formed a cabinet made up of specialists rather than politicians on 16 November 2011. Fears that may trigger the collapse of the Euro or a world economic crisis also remain. What are the causes of the fiscal crisis and euro crisis currently faced by the EU? What are the risks for the EU, what direction is it trying to move in, and are there any solutions to these issues?

1. Background to the world economic and financial crisis and the Eurozone fiscal crisis

European integration was a historical experiment that preceded globalization in terms of history by half a century. Currency unification, in particular, relates directly to the EU integration project, which is aimed at enabling people, capital, and goods to cross international borders freely. The Euro, the single European currency, it was introduced in 1999 as a unit of account by banks, and with the issue of notes and coins in 2002, became a part of the everyday lives of the citizens of the countries participating in it. More than a decade has passed since then. At present, 17 of the 27 EU member nations have abandoned sovereignty over their own currencies, such as the once-powerful German Mark and French Franc, in favor of the single European currency, the Euro. The economic benefits of the introduction of the euro included (1) stability in trade and investment and the promotion of trade within the zone due to the end of exchange rate fluctuations, (2) a reduction in foreign exchange commissions, (3) from the perspective of the strategy of integrating markets within the zone, an increase in active profits due to factors such as the promotion of competition and economies of scale, (4) the promotion of economic growth through the improvement of the macroeconomic environment, the curbing of inflation and fiscal deficits, and lower interest rates.

Not only has the introduction of the Euro functioned as a political symbol of European integration and had the political and social effect of strengthening citizens' identity as Europeans, it has also helped to invigorate the European economy by reducing exchange rate risk and increasing flows of funds across national borders. On the downside, however, the impact of the Lehman Shock of 2008 has served to bring into focus the Eurozone's financial distortions, structural inconsistencies, and lack of economic governance.

2. The causes of the Greek fiscal crisis and its triggering of fiscal crises in other Eurozone countries

As a condition for joining the Euro, member states had to sign the Stability and Growth Pact, which required them to submit a medium-term (five-year) budget to the European Commission, keep their budget deficits within 3 percent of their annual GDP, and keep their total public debt within 60 percent of GDP. However, this system did not function well in reality. Countries with weak currencies like the Greek Drachma were allowed to join the Euro, which increased their credit standings, made it easier for them to issue deficit-financing bonds, and allowed them to enjoy stable prices and low interest rates. As a result, it became possible for Greece to attract investment from all over the world. This, along with the fact that securitization was becoming more popular and new financial instruments were being developed, caused the credit and real-estate bubble in Greece and other Eurozone countries to swell.

In September 2008, however, the U.S. housing bubble burst, and in 2009 the financial and economic crisis there spread to Europe including Greece. In 2009, hedge funds and investment banks targeted Greece and triggered a fiscal crisis. When buying government bonds, many investors entered into credit default swaps (CDS) as a form of insurance, and it was these credit default swaps that the hedge funds turned their attention to. A CDS involves one party (the seller) agreeing to pay another, (a government bond holder), compensation in the event of default, i.e. a situation in which the bond issuer is unable to pay the interest or principle. The seller therefore takes the place of a bond guarantor. However, credit default swaps are just another financial instrument used by institutional investors, and hedge funds and investment banks were able to earn profits in two ways, from short selling government bonds and buying/selling credit default swaps. With this going on, a new government took over in Greece in October 2009. This government was led by George Papandreau, who declared that past data on fiscal deficits had been falsified. The previous government had initially said that the budget deficit for fiscal 2009 was 3.7 percent of GDP, but in fact it was 12.5 percent. Immediately this was announced, the markets registered their distrust of Greek government bonds, while ratings agencies downgraded them several times, which led the Greek crisis to deepen further.

At first glance it might appear that all that needs to be done is to remove Greece from the Eurozone. However, as can be seen by the fact that countries like France and Germany have purchased large quantities of Greek government bonds, the Eurozone nations have basically been holding each other up by buying each other's deficit-financing bonds. If Greece defaults, major French and German banks will be hit hard, and there is therefore a risk that the financial systems of countries like France and Germany might themselves also collapse. Because the real estate bubbles in the countries with ballooning fiscal deficits, commonly referred to as the PIIGS (Portugal, Ireland, Italy, Greece, and Spain) have burst, their current account deficits and external debts are rising. At the same time their domestic fiscal and structural reforms have not progressed well and their industrial structures are rapidly deteriorating. As a result, the problem needs to be dealt with at EU level. Although the only way for the PIIGS countries to get rid of their fiscal deficits is by adopting extremely austere fiscal policies, their citizens are refusing to remain silent. When their governments bow to EU demands and attempt to implement reforms aimed at achieving fiscal austerity, demonstrations and strikes are held, which sometimes escalate into riots. This would seem to indicate that it will be very difficult to bring the Eurozone's debt problems under control in the near future.

3. The issue of financial assistance and the future of the Euro and "EU Economic Governance"

In 2010 the European Financial Stability Facility (EFSF), which could provide loans of up to 500 billion Euros, was established so that when a fiscal crisis occurs, the EU could provide immediate financial assistance to the countries or banks affected to help them survive the emergency and to provide time for fiscal rehabilitation.. Based on this system, a framework for providing financial assistance to countries such as Greece and Ireland was also set up. Additionally, the total amount of money the EFSF could lend was soon increased to 780 billion Euros (around 82.7 trillion Yen), and the goal is to expand this to 1 trillion Euros. Japan has also helped Europe by purchasing 2.675 billion Euros (around 280 billion Yen) through its Special Account for Foreign Exchange Fund. However, Europe is still unable to raise sufficient funds, partly because at the recent G20 summit several emerging countries were unwilling to cooperate in the rescue. EFSF loans are provided under harsh terms, with the countries receiving them having to maintain discipline in their use of the Euro, cut pension payments, and greatly reduce costs in other areas. In addition, the EU and the European Commission have established a system, called "Economic Governance", to strengthen the monitoring of the economic and fiscal policies of member states. In 2011, the EU Economic and Financial Affairs Council set up the European System of Financial Supervisors (ESFS), a body aimed at improving financial supervision by overseeing the banking, insurance, and securities sectors. A system, referred to as the European Semester, was also established to serve as a preliminary monitoring cycle for the budgetary and structural policies of member states. Under this system, the medium-term fiscal plans of member states will be pre-evaluated at the EU level in an effort to continually monitor the fiscal situations of each country and manage emerging crises. In addition, since 2010 the ECB has purchased large quantities of the government bonds of countries in crisis such as Greece and Ireland, though this has been criticized as leading to a decline in confidence in the value of the currency.

The main theme at the G20 Cannes Summit held in early November, 2011 was the ripple effect from the government debt crisis in Europe, and attention was focused on whether Greece would be able to implement the policy package put together by the EU and the Eurozone member states. In addition, because of the massive revulsion among the Greek people to fiscal austerity measures such as reducing the number of public servants and cutting wages and pensions, there are a lot of concerns surrounding the implementation of the package. However, it is a fact that the Greek crisis has served to put systems in place for strengthening the Eurozone, and in that sense it can be said to have contributed to the process of European integration.

Japan has also been experiencing a historically unusual economic environment, with the Yen appreciating for a long period of time, and it is now also faced with serious tasks such as rebuilding after the earthquake and tsunami in eastern Japan, cleaning up after the disaster at the Fukushima nuclear power plant, and addressing the risks of an super-aging society. Like Europe, therefore, it has also been suffering since 2000; the disposable incomes of all working age groups have declined. A key reason for this has been the impact of the reforms carried out under Prime Minister Junichiro Koizumi's administration between 2001 and 2006, which expanded irregular employment and reduced regular employment. Workers have been pushed into an unstable and vulnerable economic situation, which has left them unable to plan for their futures and made the decline in the birthrate and the aging of society even more rapid and more serious.

The outcome of EU economic governance and the euro crisis is inseparable from the project to unify the EU's economies and currencies, and overcoming the crisis will be a long process. This is because doing so is beyond the problem-solving capabilities of the individual member states. The time therefore seems to have come for global governance, i.e. economic and financial governance based on worldwide cooperation involving multiple stakeholders, including the EU as a unit. The world economy has globalized, and dealing with this requires the establishment of some kind of international framework for ensuring that corporations and investors, who may solely seek economic profits, exercise social responsibility, and the regulation and coordination of their activities at the global level mechanisms, which might take the form of defaults or sanctions, need to be put in place to prevent "moral hazards". The establishment of societies that acknowledge and reward steady effort is the key to a sustainable and stable future.

Koji Fukuda
Professor, Faculty of Political Science and Economics, Waseda University

Born in Mie Prefecture in 1953. Currently a Professor on the Graduate School of Political Science and Economics, Waseda University, and a Doctor of Political Science. Also Director of the Waseda Institute for EU Studies, Organization for European Studies, Waseda University, and Representative of EUIJ Waseda (see http://www.euij-waseda.jp/). Also a member of the Board of Directors of the European Union Studies Association - Japan, and a Vice Chairman of the Japan Academy of the Common Good Studies, and a Director of the Japan Society of Risk Management for Preventative Medicine. Graduated from Waseda University, gained a doctorate from Doshisha University Graduate School, served as a Visiting Researcher at the College of Europe in Brugge(1992-93), and then served as a Professor on the Faculty of Law, Komazawa University, before assuming his current position. Area of specialization includes Global Governance and International Public Policy, International Public Administration, European Public Policy, and European integration. His major publications include Multi-level Governance in the EU after the Global Financial Crisis[Tagenka Suru EU Governance] (Waseda University Press, 2011), New Aspects on International Administration: Issues and Perspectives [Shinpan Kokusai Gyouseigaku - Kokusai Koueki To Kokusai Koukyou Seisaku] (Yuhikaku, 2011), Constructing a European Public Sphere and International Cooperation in the EU [EU/Oushuu Koukyouken No Keisei To Kokusai Kyouryoku] (Seibundoh, 2010), European Union Studies: European Governance after Lisbon [EU/Oushu Tougou Kenkyu] (Seibundoh, 2009), Cross-border Health Care in the EU: Recent trends in Movement of Health Service Professionals, Patients and their Implications [EU/Kokkyou Wo Koeru Iryou] (Bunshindo, 2009), The EU and Global Governance [EU To Global Governance] (Waseda University Press, 2009), The Administrative Structure and Policy Processes in the European Communities [EC Gyousei Kouzou To Seisaku Katei] (Seibundoh, 1992), "Accountability and NPM reforms in the European Union: Implications for UN reform," in S. Kuyama and M.R. Fowler, eds., Envisioning Reform: Enhancing UN Accountability in the Twenty-First Century, (United Nations University Press, 2009), and Koji Fukuda et.al., eds., European Governance After Nice (Routledge, 2003).