To the Winners: Carry the Losers

As Greece comes close to defaulting on its national debt, the structure of the European Union as a whole is about to be challenged. It has widely been reported (WSJ, FT) that the member countries of the EU, led by Germany and France, have stepped up to prevent a Greek collapse. Such a move was made to protect the value of the European common currency. In the event Greece were to default, the value of the Euro would likely follow downward harming the finances of all EU members.

The safety net created by the EU countries for Greece was an action to protect their common monetary base. However, this move may have severe political consequences for each individual country and the continental system as a whole. What is of yet to be seen is how citizens in countries like Germany and France react to their tax dollars (or issued debt) being used to prop up spending in Greece - and possibly Ireland, Portugal and Spain. Likely, these moves will become increasingly unpopular unless the finances of their practically bankrupt neighbors can be quickly repaired.

The EU nations will likely demand new austerity measures along with increased taxes on countries they are forced to bail out. Unfortunately, as reported this morning, these measures are incredibly unpopular in Greece. It seems a strange situation where the populace of the beggar nation is protesting budget cuts while asking for protection from their creditors. Such actions will likely breed resentment and anger in the populations of the countries that are bailing them out. There can be seen a situation where a Greek government trying to fix their finances falls to a more 'generous' one. Meanwhile the governments in their neighbors may see defeats by more conservative parties who take a harder line on helping to support overly indebted neighbors.

Along those same lines, could this type of event ever occur in the United States? Obviously, the federal government will not see such problems as it could monetize its debts. However, individual states could see such situations. Places like California, New Jersey and New York, with large deficits could potentially run out of funds and access to debt markets. If this were to happen, there is little question that the Federal government would step in and bail them out. But, would these states act to fix their budgets or would they just continue on their paths and hope things get better? If they fail to change their policies there would be large amounts of resentment by the other states in the Union and severe political consequences.