PIIGS to the Slaughter Can the Euro Zone Cope with a National Bankruptcy?

As speculators attack the euro, Europe is facing a growing threat of national bankruptcies. The consequences would be dramatic for the whole of the continent, especially German banks, which are highly exposed to risky debt. EU politicians are willing to pay almost any price to help the beleaguered countries. By SPIEGEL staff.

On Wall Street, they call Bill Lipschutz the "Sultan of Currencies." He once turned the legendary investment bank Salomon Brothers into the world's largest foreign currency trading operation. Today Lipschutz runs his own hedge fund, which specializes in currencies.

"I still approach the market the same way. I still approach it as a 24/7 market," says Lipschutz. He trades almost constantly, even at home in his apartment in New York's trendy NoHo district, where there are monitors everywhere. Every night, Lipschutz gets up at two or three in the morning to see what is happening on the European markets.

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Photo Gallery: The Euro Under Pressure

Europe is indeed currently the hottest topic on the global financial markets. The value of the battered euro has been falling since the Greek government confessed to the actual scope of its debt -- and since it became clear that things are not looking significantly better in the other PIIGS countries (the acronym refers to Portugal, Ireland, Italy, Greece and Spain).

There has never been this much uncertainty. No one knows whether the Greeks will manage to solve their problems, whether and how other countries will come to their aid, whether the crisis can be confined to Greece or whether it will spread like wildfire among the PIIGS -- and end up tearing apart the European currency union.

All of this translates into excellent opportunities for foreign currency traders and speculators. They can either bet on a decline of the euro or a bailout for the Greeks in the form of a rescue effort by other euro zone countries. In the first case, the price of Greek government bonds will hit rock bottom, and in the second case it will rise.

These are the kinds of conditions that make it possible to make a lot of money quickly -- but with devastating consequences, because speculators amplify trends and increase risks. If they bet on a Greek bankruptcy, it will become even more difficult, and expensive, to attract fresh capital. This could lead to a national bankruptcy or the feared conflagration -- or even the collapse of the euro.

Problem Cases

The financial industry is back to its old tricks, playing with the greatest possible amount of risk. In the past, it speculated with the debts of American homeowners and, as a result, triggered the biggest crisis in the world economy since the Great Depression of the 1920s. Now it is gambling with the debts of entire countries.

After the failure of investment bank Lehman Brothers, it was governments that saved the financial markets from collapse. Now the governments are being attacked -- with the cheap money their central banks pumped into the market to keep the financial sector afloat.

A new Lehman, triggered by speculation in government bonds, would be disproportionately more dangerous, because it would affect the entire world economy. And who would rescue the economy then?

It is no coincidence, however, that the speculators have not zeroed in on the dollar, the British pound or the yen. Although the United States, Britain and Japan are also groaning under the burden of their debt, the euro is much more vulnerable, for both historic and political reasons.

The weak southern countries, members of the so-called Club Med, have always been seen as problem cases. They have lived beyond their means and neglected the need to be competitive, they have built up -- partly in full view, partly cleverly hidden -- enormous mountains of debt, and they have avoided hard-hitting reforms. These conditions existed before they became members of the euro zone, and they did not improve afterwards.

The other euro countries looked the other way. Initially, before the establishment of monetary union, they looked away because they didn't want to jeopardize their political goal of a European common currency. Later, it was because they themselves were benefiting from the euro. The German export economy, in particular, was able to expand continuously, unhampered by troublesome revaluation and appreciation that would have made its exports more expensive.

Vindicating the Critics

The euro has been a success story until now. During the recent financial crisis, the common currency proved to be a blessing at first, particularly for the smaller countries. But as debt levels increased, the problems, previously suppressed, became more and more evident, including the debt-based economy in the Club Med and the imbalances in terms of competitiveness.

Even before the common currency was introduced in 1999, Nobel economics laureate Milton Friedman was warning that the euro would not survive its first economic crisis. He predicted that the euro zone could break apart after just 10 years.

Ever since the Greeks were forced to admit that their national debt was much higher than originally claimed, the critics of a common European currency have felt vindicated. They had always warned that the northern countries would eventually have to vouch for the debts of the south, that the differences in economic development within the euro zone were too great and that a common currency could not function without a common economic policy.

At the time, politicians ignored the concerns of many economists. Now they realize that this may have been a mistake. The European agreements that define the legal framework of the currency union do not include any provisions to account for the kind of crisis the euro is currently experiencing. For that reason, there are no instruments available to combat such a crisis.


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