Comment: There is much speculation as to whether the European Monetary Union will survive in its current state.The common argument is that a monetary union without a fiscal one cannot survive over the long term.The inclusion of a fiscal union would, for example, comprise of a centralized body that managed both the collection and expenditures of taxes. This would be similar to the federal government’s role in the United States.While the verdict regarding the union is far from being final the economically weak member countries such as Greece and Portugal now are dependant on a consortium of bodies including the European Community Bank (ECB), International Monetary Fund (IMF), and a collection of the stronger European countries (Germany, France and possibly England). Without the assistance of these three groups Greece appeared to be on the brink of being unable to pay all the interest or principle on government debt. Historically defaulting on debts has been catastrophic for countries (most recently Argentina, 2002 and Ecuador, 2008). Should Greece default bond holders would likely take a significant haircut or loss on their positions. After a default Greece would find it hard to borrow from the international community.

With the announced “bailout” plan the ECB has begun to purchase European debt from banks in hopes limit any contagion from a Greek default. According to the Financial Times as of September 2009 foreign bank claims on Greek debt was $302.5 billion with the greatest exposure being held in France ($75.5 billion), Switzerland ($64 billion) and Germany ($43.2 billion). These figures have changed, but the exposure around Europe and by extension the world still exists. With many countries already recapitalizing banks through tax funded measures another round due to a default by Greece would be untenable.

Greece now faces a position in which it needs to raise revenue and cut expenditures. When Greece joined the European Monetary Union in 2000 the nation was able to borrow at a lower cost due to being a part of a supranational entity. While debt to GDP was already high when the country joined additional money was borrowed and this eventually led to a debt to GDP ratio of 115% by 2009. The borrowing caused large fiscal deficits under the Socialist party in power and in a country in which the public sector accounts for about 40% of GDP wages increased dramatically. Various estimates now show that Greece wages will need to come down by around 30% to be in line with the rest of Europe. As part of the bailout Greece has also stated that tax rates will increase. These measures while seemingly necessary to make Greece companies competitive on a global scale will likely plunge Greece into a deep recession if not depression.

Ultimately Greece can continue to implement austerity measures by raising taxes and cutting expenditures or carry out what was unthinkable just a few years ago, leave the EU. The consequences of this action would be dire, likely lead to default and almost certainly lead to a long depression. There would be runs on banks as people moved their money out of Greece to safer countries, borrowing costs would increase for many years to come and Greece would be no longer enjoy the benefits of being part of the European Union.