(This is a guest post from the author’s blog.)
Europe’s hopes of containing the crisis dimmed as Spain became the third euro-zone nation to be hit with an S&P downgrade in just two days, following steeper cuts on Portugal and Greece.
Fears of a Greek contagion to other euro zone nations ratcheted higher on that news sparking a market selloff across the globe, sending the euro to fresh lows against the dollar, and intensified the pressure to finalise a rescue plan for Greece.
Blaming the Euro Currency Union
The ongoing Greek debt crisis has revived the old arguments that all national governments need monetary sovereignty. Financial Times columnist Samuel Brittan also recently suggested that if Greece has its own currency,
“…it can issue its own money; so it can pursue a fiscal policy attuned to domestic needs, without being dependent on the international bond market.”
All Better With The Drachma?
So, what if Greece had stayed with the Drachma, and never switched to the euro? Would this debt crisis be averted?
Unfortunately, as illustrated by the chart from the Council on Foreign Relations (CFR), in the six years before joining the euro, only 27% of Greek debt was issued in drachma. At the end of 2000, just before Greece joined the euro zone, 79% of its outstanding debt was already denominated in euros, and a mere 8% in drachmas.
Blame It On Profligate Spending
This could only lead to an inescapable conclusion as noted by the CFR,
“Even if Greece had remained outside the euro zone, its dependence on euro borrowing would only have increased. A falling drachma would merely have brought the current crisis to a head earlier by accelerating the rise in Greece’s debt-to-GDP ratio (think Iceland)….problem is excessive foreign borrowing, a problem with which Greece has struggled since the early 19th century.”
Meanwhile, a Greek official said the IMF is considering increasing the Greek loans to €100 billion to €120 billion ($132.5 billion to $159 billion) over three years, from the current €45 billion, but expressed doubts about whether the boost would happen.
The actions of the EU and IMF are sending a message to investors that it is not important that PIIGS nations have excessive and unsustainable public spending and fiscal deficits, because ultimately the countries of the euro zone who will resolve the problem.
There doesn’t have to be a rescue plan for Greece, as long as the markets believe in “the moneylender of the last resort” (the countries of the euro zone.)
In that sense, the debt-rescue-or-not saga of Greece could drag on for a while before some uncommon event forcing a concrete resolution out of the EU and IMF.
Business Insider Emails & Alerts
Site highlights each day to your inbox.