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Greece: How Bad Could it Get?

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With great fanfare and reluctance, the nations of the European Union appear to be heading towards their own $1 trillion bailout plan. It's not for banks, or homeowners, but for entire nations. Markets held their collective breath over the weekend. President Obama politely, but insistently, kibitzed. Predictably, the deal got done just in time for markets to open in Asia.

A number of columnists and bloggers wrote of their worst fears. Nobel prize winning economist Paul Krugman worried that Europe would not summon the political will to action, which would lead to Greece leaving the Euro Zone. The blow-back, Krugman thought, would resemble Argentina giving up on its currency peg to the US dollar: a period of uncertainty followed by relative calm.

Steve Kyle at AMERICAblog went further, pointing out that bigger EU countries like Spain have similar problems to Greece, and had already curbed many of the entitlement excesses that supposedly landed Greece in its mess. The Euro Zone could slough off a small economy like Greece leaving the currency union, but not a large country like Spain.

Kyle also pointed out some of the differences in response to crisis of the strong US central government versus the weak EU central government. When a region of the United States gets into crisis -- say the Gulf Coast counties facing disaster from the oil spill -- a number of things happen automatically: some money flows in from unemployment benefits and reduction in tax collections. More things happen quickly as military and civilian federal agencies activate existing programs to provide special aid. In the EU, by contrast, any such measures require special one-off decisions: they are slow, controversial, and probably less effective.

Kyle worried that this could get even worse as EU member nations reflexively look to their own interests first. This could lead to even more instability within the Euro Zone. It is already leading to further tightening of already scarce credit.

But that is not the most nightmarish scenario. Suppose that, with or without the new bail-out, that the credit crunch gets even more severe. With economic activity strangled, tax collections would go down, particularly in weaker EU nations. Despite austerity measures, these nations could run further deficits. Which would further tighten credit. Which would lead to more division and austerity. Which would lead to further deficits ... which could, like the volcanic ash, cross oceans to infect Asia and America.

Austerity could become an accelerator of a full-blown global Depression, much in the way that rounds of nationalistic protective tariffs helped fuel the Great Depression of the 1930s. Economists do not agree on tariffs as a cause of the first Great Depression. They mostly agree that measures like the Smoot-Hawley Act and its international counterparts helped the Depression spread, made it more severe, and caused it last longer.

At times of crisis, Americans prefer strong action from their central government. In quieter times, the Hamilton-Jefferson tension between strong central government and the prerogatives of state and local government return to the stage. Thomas Paine's line from the Revolutionary War echoes down through our history: "We must all hang together or surely we will all hang separately."

Europe is learning that lesson. The trillion dollar negotiation could still come unraveled. One hopes that fear of the nightmare just outlined will keep things on track. Perhaps instead of leading to the unraveling of the Euro and the EU, this crisis could solidify both.