Greece's sovereign debt trap is the biggest crisis in the 11-year history of the eurozone. And it could soon become the most serious crisis in the history of the European Union.
The heads of eurozone nations this week unveiled their latest plan to aid Greece: a pledge to lend Athens €22bn (two-thirds from eurozone governments and a third from the International Monetary Fund) if it cannot roll over its debts on the open markets.
But it remains unclear whether this plan will be enough to calm the bond markets which have been desperately selling Greek government bonds, pushing up Athens' cost of borrowing this week to double that of Germany. Greek bond yields fell slightly yesterday, but the real test of the plan's credibility is likely to come when Greece has to refinance €20m in the coming weeks.
A more ambitious plan of assistance for Greece foundered on the resistance of Angela Merkel. The German Chancellor certainly cannot be accused of being out of touch with her domestic electorate. Recent surveys show that a majority of people in the eurozone's biggest economy oppose any form of bailout to Greece. But this is short sighted. It is in Germany's self-interest to ease the pressure on its southern neighbour. German banks hold a significant amount of Greek government debt. The lower the price of these bonds, the bigger the losses they face. The bigger the losses, the tighter the credit squeeze those banks will be forced to impose on the stuttering German economy.
Furthermore, if Greece falls, there is a risk of contagion among other eurozone members with weak public finances. Spain, Ireland, Portugal and Italy could be the bond markets' next target. This would certainly not be in Germany's economic interests. Southern European nations, including Greece, have been significant buyers of German manufactured goods in the past decade. Germany needs those customers to be solvent if it is to enjoy a healthy economic recovery itself. Incidentally, though Britain is not a eurozone member, a Greek rescue is also firmly in our national economic interest. Europe is our biggest trading partner by far. The chances of a strong recovery here in the UK are heavily dependent on a robust continent-wide rebound.
Ms Merkel spoke this week of a new treaty to ensure future eurozone stability. This is certainly needed given the manifest failure of the EU's Growth and Stability Pact to impose fiscal discipline on Greece in the boom years. But unless the present crisis is neutralised, there might very well be no future eurozone to stabilise. What is needed is a much clearer indication from Greece's neighbours that they will lend Athens whatever funds it needs to avoid default over the coming years. This will replace a vicious circle with a virtuous one as foreign investors bring down interest rates to reflect a lower sovereign default risk and Athens finds the cost of managing its debt burden less onerous. Such short-term guarantees must go hand in hand with a credible commitment to correct the continent's gaping economic imbalances which have contributed to this crisis.
Of course, there is an alternative: allow Athens to exit the eurozone, default on its debts and instantly boost its international competitiveness. But this would in all likelihood mean the end of the euro. Europe's leaders need to ask themselves a stark question: is this what they want? If the answer is no, they need to end the prevarication, hold their noses and do what is necessary to prevent it from happening.