February 5, 2012

Why Is Greece Still Part of the Euro?

The EU has turned into a club of rogue members

Protesters in front of the Greek Parliament last year. (Photo: AP) Protesters in front of the Greek Parliament last year. (Photo: AP)

The European Union (EU) isn’t what it wants you to think it is. It wants you to believe that it’s a disciplined institution committed to economic growth and financial stability. Yet, everything it’s done as of late is opposite of that.

In fact, a closer look at the EU's reckless behavior shows how it's morphed into an organization guided by rogue members who have converted it into a first class circus.

As European leaders grapple with another rescue program for Greece, it’s amazing that Greece is still even permitted to be part of the euro. What are the EU’s economic standards? And what does it mean for the eurozone?  

The EU’s History

The EU was created after World War II to foster economic and political cooperation among key European nations. Today, the EU consists of 27 European countries, which account for roughly 20% of global exports and imports. The EU is the world’s biggest exporter and the second largest importer. 

Introducing a common currency known as the euro (FXE) is perhaps among the EU’s greatest feats. The euro was introduced to world markets on January 1, 1999. 

Rules for Membership

Entering the EU as an official member comes with privileges and rules. One expects that a member who is allowed to join the EU, follows those rules or risks expulsion.  

Here’s what the EU itself says about these guidelines:

“The potential economic stability and growth of the European Union should be developed through the implementation of adapted national policies. The Council recommends that Member States align their macroeconomic and microeconomic policies taking into account changes in European society and fluctuations in the international situation.”

All of that big talk sounds nice, until you realize that Greece (GREK), an EU member who’s on the verge of defaulting on its debt, has been in violation of these very standards for quite some time. If Greece truly “implemented” national policies to create economic stability and growth, would it be in the dire situation it is today?

A History of Broken Rules

In a report to Member States going back to 2005, the EU tacitly acknowledged Greece was in violation of its economic rules, particularly in piling up too much debt.

After issuing a challenge to Greece and other members in violation of the rules, the EU issued the following request to Greece:

1. To ensure that the government debt ratio is kept on a sustained declining trend at a satisfactory pace by maintaining high primary surpluses;

2. To take appropriate measures in response to the possible existence of an excessive deficit; move towards achieving a medium-term close to balance or in surplus position by ensuring an improvement in the cyclically adjusted budget balance of at least 0.5 % of GDP per year, including through effective control of government current primary spending;

3. To use public resources more effectively with the aim of improving labour productivity and enhancing the working capacity of the unemployed;

4. To continue reforms of the social security system, and, in particular, the pension system , in order to avoid budgetary strains in the future due to the problem of the ageing population.

What was the EU’s final conclusion on Greece’s compliance with these very clear standards? In each of these four areas, the final assessment was “insufficient.” All along the EU knew about Greece’s violations but took no concrete steps to effectively address them. 

A History of More Rules

Like most governmental and regulatory organizations, a lack of compliance with the existing rules typically leads to the invention of more rules.

In Europe (VGK), this led to the birth of something called the Broad Economic Policy Guidelines (BEPG). “Wider coordination is achieved through economic policy discussions between Member States and EU institutions,” stated the EU commission. The BEPG are non-binding guidelines for each Member State aimed at promoting macroeconomic stability, sustainable finances, structural reform and the smooth functioning of EMU. According to its creators, “The BEPG set the standard against which national and European economic policy-making can be measured.”

While the EU did a great job of dreaming up standards like the BEPG, it has consistently failed to enforce them. That’s how Greece’s debt-to-GDP ratio is on pace to top 160 percent by the end of this year. And it’s also why Greece is still allowed to be part of the eurozone currency club.

The Euro’s Future

Greece's debt crisis is a result of massive spending and consumption along with increased wages and government benefits, following its adoption of the euro. In November 2009, Greece got caught manipulating its balance sheet to hide its insurmountable debts. How did the EU’s leadership react?

Instead of booting Greece from its currency union, instead of enforcing the EU’s wonderfully crafted rules, instead of showing everyone there's very serious consequences for breaking the rules, and instead of setting a good precedent for other members, like Greece, in violation of the rules, the EU looked the other way and Greece remains a member in good standing.

And while Greece is getting all the headlines, massive debt restructuring in Ireland (EIRL), Portugal and Spain (EWP) are next. And don’t forget about Italy’s $2.6 trillion of runaway debt. The EU has turned into a club of rogue members.   

Maybe the EU’s new standard for membership should be the Groucho Marx Standard. When Marx was being pressed to join a private club back in the 1950s he said, “I refuse to join any club that would have someone like me as a member.”

What’s next for the euro and where will the big move be?

The ETF Profit Strategy Newsletter and Weekly Picks gives a short list of mega investment themes, including trading spots for the euro.

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