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October 3, 2011

The latest proposal for resolving the Euro-zone debt crisis is a sketchy plan that entails Greece restructuring its debt with writedowns around 50% and recapitalisation of the affected banks. The European Financial Stability Funds (“EFSF”) would increase its size to a proposed Euro 2-3 billion from its current Euro 440 billion. This would enable the fund to inject capital into banks and also support Spain and Italy’s financing needs to reduce further contagion risks. Illusion is giving way to reality.


Greece acknowledged over the weekend that it won’t meet its debt targets. it is becoming increasingly obvious to the financial markets that the politicians in Europe is not on a path to resolving its burgeoning sovereign/bank crisis. It is insisting on imposing austerity on debt burdened countries, which will only shrink their GDPs, making their debt hangovers even worse.

Europe is in the midst of its variant of the great debt crisis that hit the United States in 2008. Jeffry Frieden reminds us in the US:

the boom became a bubble and the bubble burst; when it did, it brought down the nation’s major financial institutions – and very nearly the rest of the world economy. The United States is now left to pick up the pieces in the aftermath of its own debt crisis....Europe’s debtors went through much the same kind of borrowing cycle. in the United States, the boom was not sustainable. When the global financial crisis began in October 2008, the European debtors were largely frozen out of financial markets. As their economies spiralled downward, they faced grave difficulties in servicing their debts. The problems of Europe’s debtors were not just worrisome for the debtors themselves. Most of their debts were owed to Northern European banks and investors, and the crisis threatened the very solvency of major European financial systems

The rationale for Europe’s ongoing debt bailout is that a collapse of Greek or Portuguese finances could harm the rest of the euro-zone financial systems. If Bank of America was too big to fail, then so was Greece.

Friden adds that in Europe as in America, the real question is how the costs of this devastating debt crisis will be distributed. Who will pay – creditors or debtors? Taxpayers or government employees? Germans or Greeks? More realistically, what combination of sacrifices will be politically tenable, both across countries and within countries.

| Posted by Gary Sauer-Thompson at 10:42 PM |