Greek Bailout: Savior for Euro or Temporary Fix?

Markets can be savage and unpredictable, but they appeared satisfied Monday, April 12, after European leaders finally agreed to throw a financial-rescue line to Greece, offering the country up to $40 billion in loans at below-market interest rates to help the country meet its debt obligations. The euro swiftly rose 1.5% to $1.36 in the hours after the markets opened, suggesting that the bailout may have succeeded in restoring faith in both Greece and the euro zone — at least temporarily.

Politicians will be watching closely over the coming weeks and months to see if speculators back off for good. The markets have buffeted Greece — and other vulnerable euro countries, like Spain and Portugal — since January, presenting Europe with the most serious challenge to the euro in its 11-year history. And two much trumpeted but frustratingly vague announcements by European leaders in recent months failed to soothe doubts among investors that Greece would not default on its debt.

The latest deal for Greece — hammered out over a videoconference among the euro zone's 16 finance ministers on Sunday, April 11 — comes mainly in the form of a $40 billion, three-year bilateral loan with an interest rate of around 5%. This is somewhat higher than the 3% rate financial markets have offered Germany to finance its debts, but it's significantly lower than the 7.5% rate the markets demanded from Greece last week. An additional $20 billion in loans are likely to be offered by the International Monetary Fund (IMF). If the Greeks seek a bailout, the IMF loan would be used at the same time as the euro-zone loan.

Greece welcomed the deal, but Finance Minister George Papaconstantinou insisted that his government would continue both its austerity measures and commercial borrowing. "The Greek government has not asked for the activation of this mechanism, despite the fact that it is immediately available," he said. Papaconstantinou maintains that Greece could raise money itself, and he expressed confidence that the very existence of the package would allow Athens to access debt markets at sustainable rates. Greek Prime Minister George Papandreou was more forthright, aiming a barb at the speculators he blames for the country's financial woes. "No one, any longer, can play with our common currency. No one can play with our common fate," he said.

But elsewhere there has been more caution about the deal. Greece still faces a leviathan of debt: $400 billion, or about 120% of output. It has pledged to slash its deficit from 13% to 8.7% this year, including a 10% cut to government salaries, but the real pain will come in the next few years, when the majority of the government's recently passed austerity measures are implemented. "The medicine is working today, as far as markets are concerned," says Ciaran O'Hagan, an economist at the large financial-services company Société Générale in Paris. "But the onus is still on Greece to do the right things." O'Hagan warns that loans could create a moral hazard: governments will have less incentive to adopt responsible fiscal policies in the future if they assume they will be bailed out in tough times. "Europe's willingness to want to save everyone from everything raises new risks," he says.

And in the longer term, the loan offer does little to resolve some inherent tensions within the euro zone that economists say could return with a vengeance. Even before the euro was born, there were warnings that it was foolhardy to force monetary union on European countries without fiscal union and that euro-zone states would eventually have to surrender their right to tax their citizens to a common E.U. authority.

Some economists, like Nobel Prize winner Paul Krugman, say Greece joined the euro zone before it was ready. Financier George Soros has said that a fully fledged currency requires a treasury — which the euro zone clearly lacks — as well as a central bank. And Dominique Strauss-Kahn, managing director of the IMF, said this weekend, "The launching of the euro was only a first step. You can't have a single currency without having a more coordinated economic policy."

Within the E.U., there is hazy talk of firmer "economic governance" to sort out the euro's flaws. But Cinzia Alcidi, a research fellow at the Center for European Policy Studies, a Brussels-based think tank, is skeptical. "These ideas seem quite empty. It is quite unlikely to be the case that Germany and France will give up their fiscal sovereignty to some European body," she says. As for the weekend loan offer for Greece, Alcidi sees it as a Band-Aid solution. "It will perhaps postpone the problem for a year, but the threat of default will come back stronger than ever," she says. If that is the case, European governments will be nervously watching the markets for a long time to come.