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Greece's Risky Eurozone Maneuver

Author: Christopher Alessi
Updated: November 4, 2011

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For the first time in the two-year eurozone sovereign debt crisis, EU leaders have openly acknowledged that Greece could exit the single-currency union, potentially plunging the global economy back into recession.

The shift followed a short-lived scheme (WSJ) by Greek Prime Minister George Papandreou to put a referendum to the Greek public over a new debt rescue plan agreed on by EU leaders last week. Papandreou abandoned the idea after his finance minister and other Socialist allies quickly turned against him on November 3. Meeting at the G20 leaders' summit in Cannes, German Chancellor Angela Merkel and French President Nicolas Sarkozy made clear that the preservation of the eurozone was a more urgent priority than rescuing Greece (Guardian).

In turn, Papandreou called on the Greek conservative opposition to join him in forming a national unity government that would support the implementation of harsh austerity measures mandated by last week's bailout plan. Papandreou, who faces a critical parliamentary vote of confidence (BBC) on Friday, has resisted calls for his resignation, saying such a move would lead to snap elections (DerSpiegel) that could usher in anti-euro momentum and prompt Greece's exit from the eurozone.

If Greece abandoned the euro, there would be significant knock-on effects for other indebted eurozone sovereigns and exposed European banks. In turn, there would be a ripple effect throughout the global financial system, including to U.S. lenders. Greece's exit could also force the collapse of the entire eurozone. "The failure of all the attempts thus far would create an existential threat to the common currency," Michael Huther, of the Cologne Institute for Economic Research, told Der Spiegel.

The political ramifications could also end up reshaping post-war Europe, writes Reuters' Noah Barkin. "Beyond the harrowing financial consequences, the move would also be a crushing symbolic setback for Europe," he says. "After more than half a century of closer integration, it would open the door to a new era of disintegration."

But some analysts argue that Papandreou actually succeeded in keeping Greece in the eurozone by having forced the conservative opposition's hand. Papandreou prompted the opposition party "to commit itself to being pro-euro," Jacob Kirkegaard, a research fellow at the Peterson Institute for International Economics, told CFR.org. By proposing the referendum, Papandreou was able to facilitate an expectedly forceful response from Merkel and Sarkozy. The prime minister made the opposition understand that EU support for Greece is not unlimited. In doing so, Papandreou has a "much firmer domestic political foundation" for implementing the necessary austerity measures, Kirkegaard says.

But other analysts question whether Greece would actually be better off if it were to leave the eurozone. TIME's Michael Schuman says that if Greece were to drop the euro it would regain control over its economic destiny. Moreover, Schuman argues, the eurozone could use the billions it was spending on Greece to shore up the continent's banks and build a substantive firewall to protect indebted Italy and Spain. The Economist rejects this argument, saying that gains in competitiveness would be minimal because of wage and price inflation: "Greek firms would be bankrupted by their euro debts."

Background Materials:

"G20 Scrambles to Contain Eurozone Crisis," Wall Street Journal

"Caretaker Government in Athens?" Der Spiegel

"Italy Strains to Resist Debt Whirlpool," New York Times

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