The epic saga of Greece and its membership in the European Union is approaching its dénouement. Absent additional concessions from its European creditors, Greece stands to default on its debt payments and most likely depart from the 13 nation Eurozone and embark upon a painful period of economic restructuring. Even if a last-minute deal is struck to avoid default, the terms on offer are so onerous and would only forestall the inevitable for a limited time.
With an economy smaller than that of 50 other countries, the fate of this tiny Mediterranean nation nevertheless matters to the global economy thanks to the interconnectedness of the international banking system. Perhaps more interestingly, it stands as a stark reminder that no amount of well-intentioned bureaucratic financial engineering can suppress inexorable market forces indefinitely.
The concept of a European economic union was born of good intentions. Rising from the ashes of World War II, a nascent cooperative arrangement to trade coal and iron blossomed into the European Economic Community (often called the Common Market). Intended both to create a competitive trading bloc and to reinforce commercial relationships in an effort to obviate military conflict, the Common Market evolved into the European Union, which in 2001 launched a common currency that replaced the provincial monetary units of the individual member countries. Also envisioned but unaccomplished was the additional necessity of unifying the fiscal and budgetary regimes of the member states. This failure (stemming in part from the understandable unwillingness of nations to forego their own sovereignty) invalidated a fundamental premise of the union: that no one can leave.
Flotation of exchange rates is a necessary mechanism in global trade. Stable, productive nations with low debt levels and moderate interest rates tend to enjoy stronger currencies. Think Germany, the dominant EU member and economic powerhouse. Weaker countries with high debt burdens, low productivity and stifling bureaucracies (think Greece) are still able to trade if their currencies fluctuate in value to adjust for the differences in purchasing power.
With its adoption of the Euro, Greece no longer has its own currency. Until the Great Recession, global markets assumed that the stronger members would continue to prop up weaker ones long enough to finally achieve a more comprehensive fiscal unification. In effect, the laggards have benefited from a free ride, while the European Union has tarried in reforming its banking system and pushing forward with greater consolidation across borders.
Now the free ride is finally ending. Years of profligacy, tax evasion and institutionalized inefficiency propped up by mountains of cheap debt implicitly guaranteed by the EU have finally brought Greece to the tipping point. Additional life support (more debt) offered by the European Central Bank remains contingent upon a regimen of imposed austerity that makes economic recovery virtually impossible. With an unemployment rate of 25 percent (50 percent of young people) and an economy that has shrunk by one fourth, Greece needs strong market medicine, not more EU sugar pills.
As of this writing, Greece appears to be headed for a default on its debt and exit from the EU. Upon readopting its own currency (the Drachma), the desperate country will subsequently default on its obligations and enter a terrifically painful period of restructuring and reform. But if the nation chooses to make tough decisions now, credit markets will efficiently work their magic and soon allow Greece to rejoin the world economy. History has repeatedly demonstrated that markets, not machinations from Wise Men in Brussels, can offer Greece a way forward.
Christopher A. Hopkins, CFA, is a vice president and portfolio manager for Barnett & Co. in Chattanooga.