By Fareed Zakaria, CNN
It is ironic that Greece - a tiny economy that is a mere 2.2% of the Eurozone and not even among the top 25 economies in the world - has produced so much turmoil. But there has always been a fundamental flaw in the design of the Eurozone. Europe created a single currency without adequate fiscal policy coordination. Very competitive economies like Germany were joined together with uncompetitive economies like Greece.
Nevertheless, I remain cautiously optimistic. This is because, despite what many critics say, Germany is playing its cards right. Many argue that Germany should come up with a dramatic solution to the debt problem. Chancellor Angela Merkel is not leading, critics charge. I disagree. Germany has a good reason for being sluggish. It is trying to force countries like Greece to enact meaningful reforms.
The German concern is that if they come up with some dramatic solution to the euro crisis, such as guaranteeing everybody’s debt, financial panic would end but countries like Greece and Portugal would feel no pressure to undertake necessary reforms. These countries would not get their budgets in order; they would let their fiscal houses continue to crumble; they would not become competitive.
All of Germany’s leverage would evaporate the moment it wrote the check to its neighbors. Indeed, a couple of weeks ago, Germany watched as the European Central Bank responded to a financial scare in Italy by intervening. The situation stabilized. Then the Italians immediately began watering down their commitments to enact economic reforms. This is Germany's nightmare. It's what they're working so hard to avoid. Understandably, Germany is trying to force as much real reform out of debtor countries as possible before writing checks or making guarantees.
Germany is doing this not just for sound economic reasons. There are also political motivations. Angela Merkel couldn’t do it any other way. The German taxpayers would revolt if she suddenly guaranteed the debts of countries like Greece. They would feel like they were falling into the same trap that caused the problem in the first place. For these reasons, you’re not going to see dramatic action from Germany.
What you’re going to see instead is some complex solution that places pressure on Greece and other countries to reform while at the same time reassuring markets that Germany will not let the euro fail. This is understandable and sensible, but it will not satisfy the markets, which want a simple, clean solution. For this reason, the Germans are flirting with disaster. What is likely to emerge is a complex, incremental solution. The markets will have to learn to accept it.
The part that I worry about is that even after all of this, Greece is probably not salvageable. It has too much debt and, fundamentally, it is not a competitive economy. It doesn’t make anything anyone wants. This is not true of Spain or Ireland. Spain and Ireland are quite dynamic economies that got hammered by the financial crisis. So the real question is whether there is some way to ring-fence Greece from the rest of Europe. Perhaps then there’s a scenario in which the Germans guarantee all remaining debt.
The truth is: Greece has defaulted before. There’s a book out that says that since it’s independence in the 1830s, Greece has been in default for 50% of its national existence. The difference is that now the Germans are willing to bail the Greeks out. That’s what’s new.
