Blame Germany, Galbraith Says: "Extreme Brinkmanship" Imperils Europe

This weekend, the IMF and EU are expected to approve a bailout package for Greece now reportedly in the $160 billion range. In return, Greece's parliament is expected to approve a $32 billion fiscal austerity package.

The scramble to save Greece comes after months of on-again, off-again pledges of support from the EU and IMF, delays that caused market participants to doubt whether a bailout was coming. S&P's downgrades of Greece, Spain and Portugal earlier this week prompted "contagion" fears, reflected in a big spike in the cost to insure sovereign debts, as discussed here.

"They have to assist Greece," says James Galbraith, economist and Lloyd M. Bentsen Jr. Chair in Government/Business Relations at the University of Texas. Germany played "a game of extreme brinkmanship that pushed the euro zone to the edge of panic."

While some blame Wall Street speculators (nee Goldman Sachs) and Greece's massive government spending for the crisis, Galbraith says the situation was made worse by local German politics. A May 9 election in the German state of North Rhine-Westphalia is reportedly too close to call. A loss could cost Chancellor Angela Merkel's ruling Christian Democrat-Free Democrat coalition its majority in the upper house of the German parliament, and thus she wanted to extract a "pound of flesh" from Greece to overcome German opposition to the bailout, Galbraith suggests.

A Critical Flaw: The bigger issue here is the Greek drama has exposed the "critical flaw" in the design of the euro zone, he says. Specifically, Germany's reliance on exports (vs. internal consumption) makes it impossible for less-competitive nations like Greece and Portugal to export their way out of a recession, especially since all EU nations share a common currency and (restrictive) central bank.

"As long as the Germans don't admit responsibility for destabilizing the system...everyone else will be in an unstable situation from which they cannot escape," Galbraith says. "There's a tendency to weaken the [euro zone] economy by imposing deflationary policies."

In sum, the Greek bailout may alleviate the immediate crisis but is far from a "permanent solution," the economist says. European officials will be "fighting fires continuously until they address the constitutional problem" of the EU.