Eurozone Action on Greece Fails to Defuse the Ticking Global "Debt Bomb"

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European leaders said yesterday (Thursday) that they were prepared to take a "determined" action to stave off the worst crisis in the euro currency's 11-year history. But their plan was short on details and is unlikely to totally dispel fears of a possible default by Greece.

European Council President Herman Van Rompuy said assistance for Greece would be forthcoming. But his speech lacked specifics about exactly what form that assistance would take and he offered no timeline for when aid for Greece would be initiated.

The statement seemed to be primarily aimed at reassuring markets that the EU wouldn't allow Greece's ballooning deficit to spark a debt crisis.  It simply ordered Greece to clean up its accounts and gave the International Monetary Fund (IMF) a monitoring role.

"Markets seem to be happy that they are doing something. The problem is if they come out with an ad hoc temporary solution for Greece then people wonder what happens when the next country comes into trouble," Nick Kounis, chief European economist at Fortis Bank Nederland NV in Amsterdam, told Bloomberg News. "This whole thing needs to be institutionalized."

The EU summit was initially intended to rough out a 10-year economic strategy, but was quickly redirected to deal with the Greek debt debacle - the latest manifestation of a growing global "debt-bomb" crisis that has already hit such countries as Dubai. ... and that could eventually put the United States in its cross-hairs.

Still in the depths of recession, Greece is plagued by a spending deficit that rose to 12.7% of gross domestic product (GDP) last year, far in excess of the 3% ceiling permitted to countries in the union. It's also saddled with debt amounting to 113% of GDP, which prompted Moody's Corp. (NYSE: MCO) to downgrade its debt to A2 from A1 on Dec. 22.

The government needs to sell $73 billion (53 billion euros) of debt this year, the equivalent of about 20% of GDP, Bloomberg reported.  The heavy debt burden and government deficit have spurred fears of a sovereign default. Spreads of medium-term Greek debt over comparable German paper widened to nearly 4% recently.  Yesterday, Greek bonds rose and the euro fell after the deal was announced.

The agreement to support Greece was brokered by Greek Prime Minister George Papandreou and European Central Bank President Jean-Claude Trichet, but was most likely crafted by German Chancellor Angela Merkel.

Germany, the bloc's biggest and most stable economy, would likely have to provide the bulk of any bailout, which would be hugely unpopular with that country's thrifty voters.

The statement's lack of teeth reflects the delicate nature of direct aid for Greece.

The foundation of the Eurozone rests on the concept that each of its 16 member nations will manage their own monetary policies, with oversight from the EU's executive arm.  A financial bailout of Greece would imply that a rogue nation with bad spending habits will be rescued from the consequences.

But letting Greece default poses risk, as well.  The stability of the currency would be threatened and even the existence of the union itself could come into play.
One solution to resolve the whole issue would be to revoke Greece's EU membership.

But such a drastic measure could also put the euro at risk and was quickly ruled out by Trichet, the ECB president, who called the notion "absurd" when questioned on the matter last month.

However, Trichet also said that the ECB wouldn't be rushing to Greece's aid with any "special treatment."

That's not a surprising stance: If the ECB offers special treatment to Greece it would btedly come under pressure to offer similar bailouts to the other EU members including Portugal, Ireland, Italy and Spain, which together with Greece have been given the dubious acronym of "PIIGS."  Those debt-ridden countries have already been forced to swallow tough spending cuts to reduce their deficits.

But the lack of specifics in yesterday's EU statement left some analysts feeling rankled.

"The only thing EU officials have clarified is that they will 'safeguard financial stability', without actually saying how and in what way they would help Greece, or any other country in difficulty if necessary," a London-based share trader told The Wall Street Journal.

The global debt problem is not isolated to Europe, however. To pay for stimulus programs and other debt obligations, governments worldwide are expected to borrow a staggering $4.5 trillion this year.

If any of those governments should default on their debt, investors will demand higher interest rates on the global bond markets. That would lift the cost of capital for businesses and individuals, constituting a major blow to the global economic recovery.

As Contributing Editor Martin Hutchinson explained in a recent article for Money Morning, a default would drastically alter the investing landscape for years to come.

"When the international debt bomb blows," Hutchinson wrote on Feb. 4, "it will be China and other Asian exporters that will reap the benefits. They have the huge foreign exchange reserves needed to do so. As a result the global balance of power and money will lurch still further in their direction."

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