Euro : how to escape the domino effect

Published on the Malta Independent¸ issue 07 August 2011

Recently¸ financial news has been inundated with stories of falling stock exchange levels amid calls from debt-stricken eurozone countries asking for bailouts. European shares have fallen sharply as fears grow about their debt levels and the health of the US economy. This is not Armageddon but it looks like the omens are not favourable for the euro (at least in the short term). The big picture concerns not only the cost of bailing out individual eurozone members but it is really and truly about the prospects of the euro. The saying goes that as soon as more countries ask for a bailout¸ contagion spreads across the entire region threatening a domino effect.

Nostalgically¸ we can recall that on 1 January 1999¸ 11 European countries took a bold step forward by entering the euro club. At the stroke of midnight¸ the national currencies of these 11 countries became denominations of a single currency. Clearly¸ the launch of the euro was a truly historical event¸ not only in view of the complexity of the task and its careful preparations¸ but mainly in that it promised to bring in far-reaching economic and political consequences for the participating countries and for the international monetary system as a whole. It was seen as a powerful financial tool to streamline markets and reduce costs across its members.

Now¸ 11 years down the line¸ we can safely say that it did increase cross-border competition and improve market integration. Members saw a visible improvement in the efficiency of the markets for goods¸ services and capital. Perhaps it was not a perfect solution but it certainly helped in many ways to reduce transaction costs¸ improve price transparency and lower price pressures. It was no panacea for the champion currency¸ the dollar¸ but it swiftly gained popularity particularly in financial trading markets. The sheer size of the euro area economy¸ which is comparable to the US economy¸ should augur well for it to gain more strength and ensure price stability. Alas¸ not all the 27 members opted for the single currency and¸ typically¸ Britain has always strongly resisted entry. Now that the honeymoon is over we have started to see cracks in the system.

The first patient in the sick bay was the ubiquitous Greek nation. Last month ‘s eurozone summit saw Germany ‘s Angela Merkel treading a fine line between showing European solidarity and keeping her voters happy. It is a sad story that saw the Greeks being granted the first tranche of a €110 billion bailout in May last year; since then its debt has soared to €340 billion¸ nudging 160 per cent of gross domestic product and rising. But the medicine did not work sufficiently well and the patient needed further monetary assistance. Brussels prescribed another bailout of a similar size to keep it afloat until 2014. The ultimate aim is to relieve Greece’s debt burden¸ currently at €340 billion¸ to reduce it to about €255 billion¸ in the hope of boosting recovery prospects. That represents another €85 billion in loans on top of the first bailout of up to €120 billion.

Under the plan¸ the private sector will provide €135 billion over the next 30 years through a variety of measures including a debt buy-back programme. As well as the buy-back scheme¸ private sector creditors will