Several weeks ago, Washington Post blogger Dylan Matthews wrote a helpful summary of the differences between the debt crises in various Eurozone countries -- specifically Portugal, Ireland, Italy, Greece, and Spain or PIIGS. Of those countries, Greece, which was particularly profligate during the boom years and can't plausibly pay off its debts, is in the most dire shape. But all of them are teetering, the banks and countries that lent them money are heavily exposed, and fixing the problem would likely require healthier economies in northern Europe to bear the losses. If things start to unwind -- if Greece defaults and leaves the union, the other PIIGS countries will likely domino and Europe will be plunged into the economic abyss.
The other option is for healthier Euro countries to basically provide Greece with massive amounts of assistance for years -- an option that's not politically palatable.
Barry Eichengreen, a U.C. Berkeley economics professor who recognized flaws in the structure of the Euro before this crisis, says the doomsday scenario can be averted, but only via a series of complicated steps that European leaders don't seem entirely prepared to make.
"Preventing more chaos requires fixing the flaws in Europe's financial system. First, weak banks need to be strengthened with capital injections," he told TPM in an email. "Second, it then becomes possible to restructure Greece's sovereign debt, writing it down to maybe a third of face value; removing the debt overhang can help get growth there going again. Third, a firewall needs to be built to prevent Greek problems from spreading to Spain and Italy. This can be done by either a leveraged EFSF [the European Financial Stability Facility, a recently created bailout entity for Eurozone countries] or the ECB [European Central Bank] buying Spanish and Italian debt. Four, Europe needs a more growth supportive monetary policy to get the denominator of the debt/GDP ratio rising."
Doing this is much, much easier said than done.
"[T]here's disagreement about sharing the costs," Eichengreen added. "French banks don't want to dilute their shareholders by raising more capital, and they have the ear of the French government. German taxpayers don't want to leverage the EFSF because they worry that the result will be a downgrade of the German government's credit rating. There are 17 euro zone countries. It's herding cats."
The German government agreed Thursday to bolster the ESFS. That's encouraging news but many analysts say it's insufficient to contain Greece's collapse on its own.
If those analysts are right and no further steps are taken, the U.S. is exposed via trade and finance. "Europe back in recession hurts US exports, since they buy less. Worries about the Euro lead to a stronger dollar/euro exchange rate, which further hurts U.S. export competitiveness. US banks and money market funds have exposure to Europe, so their balance sheets are damaged if Europe goes under."
This has led economist Nouriel Roubini to conclude it's not just a question of if the U.S. will tumble back into recession, but of how deep it will be.
The U.S. economy's already in terrible shape, and the Euro crisis is the single biggest downside risk facing it. In addition to the hardship it will cause millions of people around the world, if the economy shrinks and unemployment spikes, it will make President Obama's political challenges more severe than they already are.
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