Imagine a typical Indian joint family. The grandparents, 5 brothers, their respective wives, grand children etc etc. Typically every member in the family earns and contributes towards the house hold expenses.
Consider a situation wherein, the eldest brother is the highest earner in the family and the youngest is the worst spender. The youngest brother lets says earns Rs.10,000/- but mismanages his finances to a large extent maybe because of his lifestyle…lets say his monthly expenses are at Rs.25,000/-. This means he is spending 150% of what he actually earns. In such a situation, what would happen to the younger brother over a period of time? It is obvious that the younger brother would borrow more and more to support his lifestyle and eventually the rate of interest on his borrowed amount bec...omes enormous.
One fine day, creditors will be at the door step asking for their money back. Now once creditors come knocking at the door, the problem is no longer the younger brothers anymore. It’s the problem of the entire family. What would the family do?
There are few solutions for this problem….
Solution 1) Ask the younger brother to pay up.
Problem with this is that he does not have any money…he will probably borrow fresh money to repay his current debt. But the new creditors will know his lousy past hence would expect a much higher interest rate to lend to this risky person.
Solution 2) The family together comes to a consensus and bails out the younger brother.
Problem with this is that the eldest brother and his family will get the biggest hit as they are the major economic contributors to the family. Even if the elder brother’s family agrees to bail out the younger brother, then they would expect the younger brother to change his lifestyle and lead a more controlled lifestyle. In other words they would expect the younger brother to adopt austerity measures.
Solution 3) They can simply ask the younger brother to leave the family and deal for himself. This solution has a social issue. The family will no longer be respected in the society and they may also set a bad example to other joint families.
Tricky situation isn’t it? Each solution poses a new problem. How do you deal with it?
Well, this is exactly what is happening in the Eurozone. Let me reveal the characters to you..
Joint family: European Union.
Elder brother: Germany.
Youngest brother: Greece.
Long term rate of Interest if one wants to lend fresh money to Greece: 22%.
Greece is at very alarming state, their debt to GDP stands at a very scary rate of 143%! It is very similar to the younger brother’s situation. Unemployment rate is at 24% (as of March 2012)…what’s more disturbing is to know that their unemployment rate was at 14% just 1.5 years back. This only means to say that the catastrophic economic situation is spreading, and it’s spreading really fast! Long term interest rate i.e the rate at which one would lend money to Greece is now at about 22%! This only shows the kind of fear creditors have when it comes to lending to Greece!
So what are the possible ways Greece can come out of this situation?
Solution 1) They can borrow more money.
Problem is that no one is willing to leand them the required money, even if they do, Greece will find it very difficult to service their debt since the interest rate is at 22%. This is as good as buying more cancer cells to your already malignant body!
Solution 2) They get a bail out from EU.
Germany, the major economic powerhouse of the EU will have issues with this. Why would the German taxpayers help the Greek’s and encourage their financial mismanagement? Even if there is a bailout, then they would expect a lot of austerity measures, which means the Greek Govt will have to curb its public spending by a great degree. As such, the Greek economic situation is in a bad shape with high unemployment rates and a sluggish business environment. Imagine a major austerity drive in this situation? Not good at all, this means to say there wont be major public projects hence this would fuel the unemployment situation.
Solution 3) The EU or Greece itself decides to leave the Eurozone.
This can be extremely scary. The first thing, Greece will do if they branch out is to have their own currency. Obviously this currency will be devalued against the Euro. This means that the entire bank savings (denominated in Euro) the Greek’s have will suddenly be worth much lesser. Greek citizens may not desire this; hence they can start pulling out their funds from banks. This can potentially lead to bank failures, business failures and other catastrophic event, all of which can culminate to hyper inflation.
When civil society reaches the brink of frustration, when you start doubting if there will be food to feed your kids society can lose its sanity. Situations like this can have a contagious effect. Remember, its not just Greece, there is Portugal, Italy, Spain etc! If Greece gets disowned, Portugal may fear they may get disowned as well, Italy may fear the same. This paves way to radical thoughts. Hyper inflation, radial thoughts were some of the major drivers to the World War!
Conclusion
Either of the solution Greece adapts the eventual outcome can be very scary to the Greeks. Factors that matter are far too many. Disowning Greece from EU can be really dangerous. There has to be political will to bail them out in a structured manner. EU should stick together and deal with the mess; this means a tighter integration in European Union could be just around the corner.
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