More likely the end of the EMU (European Monetary Union) as we know it now. The Euro will survive, but the membership and underlying rules are likely, perhaps even must change. From the outset, it was an experiment in an oddly matched marriage and with multiple partners. Mismatch: While monetary policy is absolutely managed by one central European bank, fiscal policy is left to each partner. This has opened the opportunity for cheating, but perhaps also the necessity. Fiscal and monetary policies are generally need to be complementary if not coordinated. Further, economies seeking/needing faster growth have been wed to more established ones. The later would be favored by tighter monetary policy and greater vigilance against inflation. The former needs looser monetary policy and emphasis on faster monetary expansion. This discussion could further highlight the mismatch by discussion of historical or even cultural differences as well as favored industries in each country. Countries as Greece and Spain reflect one Euro reality while Germany and the Netherlands are examples of the other. Germany and the more established economies have generally won out when priorities between growth and price stability were debated. In other words, part of the problem created in economies as Greece, Portugal or Spain can be traced to EMU monetary policy opting to favor the needs of the more established economies over theirs – just witness the latest rate hike by the European central bank when a looser monetary policy would have been more favorable to those EMU economies currently struggling. (Do not misunderstand though - Greece, Portugal etc are largely responsible for their own problems due to a variety of factors from mismanagement to structural inefficiencies). So Why Not Allow Greece etc to Default – Contagion? Frankly it has as much to do with broader consequences as it does with concern for Greece itself. Contagion is the term, but it actually has multiple meanings here. • European banks holding Greek debt (UK, German, French etc) would suffer significant losses threatening their liquidity position, equity reserves and viability; • If Greece defaults, the cost of debt (interest cost) would go up for all or most EU members, making rolling over the debt for some untenable and which could set off another domino effect; • A bad precedent could be established either way – further concessions to Greece would encourage Spain, Ireland, Portugal, perhaps Italy to also seek more favorable terms on their “austerity measures.” On the other hand, default by one could trigger default by other “weaker economy” countries and then banks and other private insurance holders of such debt – another domino effect or “contagion.” Some on “Wall Street” have started to refer to the Greek debt crisis as another Lehman Brothers – meaning that the risk of even growing domino or cascading effect could drag the whole global financial system into another seizure and sharp recession. Ultimately the global financial system could be at risk if contagion is not contained. Simply put, Greece needs an enhanced bailout as much to save British, German or French banks as to save Greece from default. Of course, some see this about preserving not only the economic but also political image of the EU. What Solution? It is possible to pontificate on the subject indefinitely; but practical solutions will have to be ultimately enacted. There will be a further “bailout” of Greece, Portugal, Ireland and perhaps others – as mentioned to save banks holding such debt and to save face. The IMF and states as China and the US have a stake. Again, this is not entirely unfair. With a mismatched monetary and fiscal policy, many of the solutions offered now actually may be making the situation worse. IMF conditionality attached to “bailouts” is reducing economic activity and tax revenues. In the pre Euro days, political leaders of countries like Greece or Portugal would have encouraged significant national currency devaluation to complement the IMF imposed austerity measures, but with the ‘single currency” that relief is not available. I’m convinced that this makes austerity measures a half medicine under the single currency, which in fact may be harmful rather than remedial. I met and have known Greece PM George Papandreou (PHOTO ABOVE) from his time as fellow at Harvard while he also was then a Parliament opposition member. He is intelligent and sincere, (at least as politicians can be). Greece’s fiscal crisis was created by the current opposition party when they ruled and frankly cheated. And, most informed political leaders in the EU knew then that Greece was cheating to squeeze into the EMU, with or without Goldman Sach’s swaps games. Perhaps some EU leaders then were more interested in inflating the image of the Euro and the EMU rather than addressing substantive concerns. PM Papandreou though is in a no win position. He has formed a new government as he tries to maintain a Parliament’s confidence. It would be ironic to now deliver the opposition back in charge, those politicians that cheated and created the problem a decade or so earlier, putting aside any of my personal familiarity. The Example of Poland & Zloty The solution is not flattering, but straightforward. Some economies do not belong to this EMU. Maybe it will be necessary to establish a second tier Euro, or more likely some countries will have to revert to national currencies, Drachma, Peso etc. A look at Poland provides a glimpse of how a more in need of growth economy can relatively flourish as member of the EU but not EMU. The greater flexibility in monetary policy to complement fiscal policy is welcome for a relatively healthy economy as Poland. Hungary, which has been facing relatively higher adversity as Greece and Portugal, greater monetary flexibility is also the lesser of evils and especially when needed to complement IMF or similar loan conditionality. No Appetite for Anything More “Unified” or “Single” There is one more potential solution – for the EMU to fully coordinate both monetary and fiscal policy under unified authorities. That is not likely for practical and symbolic/political reasons. The EU and EMU are still too differentiated to further unite fiscal policy. Also, perhaps ironically, after the exercise in failure to coordinate, European political leaders may be even more leery now of anything that carries the label of “unified” or “single.” Related Reports at “International Financial Crisis Channel” - diplomaticallyincorrect.org/c/international-financial-crisis By Ambassador Muhamed Sacirbey Facebook – Become a Fan at “Diplomatically Incorrect” Twitter – Follow us at DiplomaticallyX