Professor Wolfgang Buehler

Banks and investment funds holding Greek debt must decide by today whether to cancel half of the money they are owed. This is a key component of a joint IMF and EU plan to keep Greece from defaulting.

Requests for the euro-zone to boost funds to fight the crisis have been loud and clear since the G20 meeting in Mexico, however little seems to have been achieved. Germany and other Northern European countries are still reluctant to increase the volume of the European Stability Mechanism, a permanent rescue fund to bailout members of the Euro zone.

This fund has a major signalling function that Europe is ready to fight possible contagion effects from Greece to other weak European countries. The German parliament vote last week to accept a bigger European bailout fund refers to Greece alone and has the purpose to buy again more time to give Greece a chance to recover. It will support European banks with a heavy exposure of Greek government bonds, and to ring fence the consequences of a Greek default. The European support of Greece comes with some unparalleled control measures impacting on the sovereignty of Greece, which the country has already found hard to accept. And yet Greece still has to accept further austerity measures.

Over the past two weeks, the European Central Bank, the Bank of England and the Bank of Japan have both increased their programs of expanding the money supply by buying their own governments’ bonds. Morgan Stanley has also forecast that the US Federal Reserve bank will be printing money again before the end of the year.

If the euro is to stay alive in the long run there have to be major changes. Easing liquidity and credit conditions are only short-term measures – there is no structural change in the banking system which is Europe requires. What we need is a plan to support real growth in the weak European countries, especially in Greece, Portugal, and Spain. If these countries decide to stay in the euro-zone, the Government sector has to shrink, and production costs have to decrease.

These austerity measures will have a huge impact on many people; the social and political consequences cannot be foreseen, and it presents a stark risk to political stability. It will be a major challenge to support these countries as they restructure their economy. It is similar to the way the USA had to revitalise Europe’s economy after the Second World War. There are still huge economic problems ahead – and for the Greek people that means more austerity, more wage cuts, and more unemployment.

Investors have until this afternoon to join an unprecedented debt swap worth up to 107 billion euro known as private sector involvement, which was agreed in February after months of tough negotiations. Concern that investors will not be willing to agree to the swap has caused sharp falls in stock markets around the world.

I feel it is crucial to avoid a disorderly default by Greece with a contagion effect that might spill over to the US and Australia. Mind you even Australia will probably feel the impact of the problems in the euro-zone. For example if exports to Europe as a whole go down by half that would decrease Australian exports by about 5% because Europe takes about 10% of Australian exports. Plus, we would then have what is called a ‘second order’ effect, whereby China would also see an impact because it exports a huge amount of goods to Europe. Consequently the demand for minerals to Australia would also drop.

Geographically we may be a long way from Europe, but there are close economic ties.