Greece, Germany, and the Uncertain Euro

April 24, 2015

It has become increasingly more difficult to keep track of where Greece and Germany stand in regards to agreeing on how to deal with Greece’s disaster of an economy. While the outcome remains uncertain, a good recap seems appropriate in understanding how this whole mess came about and what the implications of a fall out might be.

 

The Euro

 

The euro was created in 1999 by the European Union as a common currency for those of its members with stable economies for the purpose of better trade and to further European integration with the hopes that such an act would increase the EU's stability as a governing body. In order to adopt the euro, countries were encouraged to adhere to a set of guidelines involving maximum inflation rates, budget deficits, and public debt. The process of aligning economies involved balancing out the value of a current currency with the value of the euro. For example, when Greece aligned its economy with that of the euro, it had to work to bring up the value of the drachma because the euro was initially more valuable, whereas Germany downgraded from a more valuable deutschmark. As the euro gained momentum, global investors began to see the eurozone as a single entity with the financial influence and economic power of other global powers such as the U.S., which allowed it to obtain a better credit rating than many of the individual countries had previously experienced. As a result, investors increased levels of direct investment in Europe because an investment there was no longer backed by a tiny, singular country, but by 12 developed economies. Some data suggests that since its establishment, the euro has increased investment in the eurozone by 62%.

 

Germany

 

In regards to global competitiveness, Germany enjoys a status as the 6th largest economy in terms of purchasing power. At the time of the European Union’s inception, Germany had only recently come together as a unified state. As such, the EU was created at a time when Germany was experiencing immense levels of integration so it followed nicely that outward integration was also feasible. Furthermore, Germany’s infrastructure was not only conducive to the adoption of an integrated currency, but the population supported it. Unlike countries with weaker economies such as Greece or Portugal, Germany had joined the euro with a stronger economy and therefore experienced an economic downgrade as opposed to the higher credit ratings enjoyed by less economically established nations. In an effort to maintain price stability with the implementation of the euro, the Stability and Growth Pact was passed in 1998 under which a member country was obliged to take corrective actions if it was running a large deficit or face economic sanctions. Ironically, between 2002 and 2003, both France and Germany experienced deficits in defiance of the Stability and Growth Pact, but they were eventually able to reestablish competitiveness and set their economies back on track.

 

Greece

 

Greece joined the euro in January 2001 after working hard to bring its drachma in line with the Euro by cutting inflation and interest rates. With the implementation of the euro, many peripheral countries such as Greece, Ireland, and Portugal enjoyed early prosperity because the euro was worth more than their individual currencies; however, that prosperity was taken advantage of by these same countries and quickly spiraled out of control. Unfortunately, a closer look at Greece’s budget in November 2004 showed they hadn’t actually met the terms and conditions needed to adopt the euro. To try to cut its deficit, Greece adopted what became known as an austerity budget that included various new taxes to compensate for the debt it had acquired largely in part due to hosting the Olympics in 2004. To add further pain, in light of the global economic recession in 2008, France and Germany pushed for tighter credit lines, which in turn put the peripheral countries in danger of running excessive debts that they were now unable to borrow on. As more investigation was done, Greece’s books revealed a country in even worse shape than was initially estimated, such that over the past few years, Greece’s credit rating has been downgraded multiple times making it more expensive for them to borrow the money they so desperately need. Of course, before the rest of Europe hands them the money, they want to see improvement in the form of increased taxes and a leaner budget. Economically, this plan has not been all that successful due to the fact that a large portion of Greece’s population was employed by the government and had to be laid off to trim down the budget making them unable to pay the needed taxes.

 

Now What?

 

Central to the argument that Germany will likely not let Greece default is the fact that while all the euro member states share part of the risk of having a unified currency, at present, Germany has the most to lose. While other countries continue to tumble into debt, Germany’s influential economy remains the strongest in Europe and is the provider of the majority of the bailout money and the European Union’s budget. Of course, the counter-argument would point out that should the euro fail, Germany would incur losses like all of the other nations, however, unlike the other nations, Germany is not currently struggling financially and in danger of default. As such, Germany would most likely survive if the euro were to eventually break up. Some economists argue that with such an increased dependency, in a worst-case scenario the world could end up seeing a financial break down similar to that of the Lehmann Brothers, but on a more global scale. At the same time, that is a worst-case scenario and many would argue that Germany has the power and financial security to prevent that from happening.

 

Bulmer, Simon and William E. Paterson. “Germany in the European Union: Gentle Giant or Emergent Leader? International Affairs 72.1 Jan. 1996: 9-32. JSTOR. Web. 7 Nov. 2011.

 

Lane, Philip. “The Real Effects of European Monetary Union.” The Journal of Economic
Perspectives 20.4 (2006): 47-66. JSTOR. Web. 28 Sept. 2011.

 

Schuman, Michael, Catherine Mayer, and Tristana Moore. “Why Germany Can’t Save Europe, Much Less the World.” Time Inc. 178.13 (2011). Academic Search Elite. Web. 7 Nov. 2011.

 

“The World Factbook.” cia.gov. CIA World Factbook, n.d. Web. 22 April. 2015.

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