What to do about Greece

The announcement Monday by the Greek Prime Minister George Papandreou that he would be calling a referendum on the bailout package agreed to by Eurozone leaders for Greece, put global financial markets into a tizzy and sent tempers flaring among the German and French leadership.

This came after the markets had got a powerful lift when over the last two weeks it seemed that the details of a plan to recapitalise European banks, restructure Greek debt, and increase the bailout fund, were close to being finalised.

The prospect that Europe was close to resolving its financial crisis was such good news that United States stock markets registered the biggest gains for an October month, in decades.

With that temporary injection of confidence now dissipating, we are likely to see a return to the kind of uncertainty that has plagued financial markets and undermined US and European economic recovery since the beginning of 2011.

Having angered Europe and faced with a critical vote of confidence today, Friday, Papandreou has now abandoned plans for the referendum.

But up to his turnaround on Thursday, the probability that the referendum could have been as late as January was seen as exacerbating the liquidity crunch that has hurt Europe's major banks and heightened volatility in global financial markets. Several of these banks have had their credit ratings downgraded in recent weeks reflecting their exposure to Greek sovereign debt and that of Italy, Spain, etc.

The highly interconnected nature of financial systems globally means that the effects of the crisis in Europe will not only undermine the euro and the Eurozone economies, but will spread worldwide. This is already showing up in the demise of MF Global, a US commodities and derivatives brokerage house which had made large investments in European bonds.

It is the biggest bankruptcy on Wall Street following the failure of Lehman Brothers in September 2008.

The crisis in Europe has intensified because the process of decision making about the bailout and restructuring measures has dragged on, because Europe has constructed a monetary union without the political and fiscal arrangements needed for such an integration.

The restructuring and bailout measures will involve a deepening of the coordination mechanisms between member countries. But financial markets remain apprehensive about the long-term viability of the Eurozone if individual countries still retain sovereignty over fiscal affairs.

The way in which Greece ran up its massive sovereign debt and was able to disguise the real fiscal and other economic data, is indicative of the structural flaws of the current arrangements that underpin the European Monetary Union.

And while Greece may be the most chronic case of indebtedness, other countries of the so-called PIIGS group - Portugal, Ireland, Italy, Greece and Spain - are seen as suspect by investors.

The inserted diagram sent to me by a friend in Europe illustrates the dilemma facing politicians and other decision makers in the region.

business@gleanerjm.com