After weeks of uncertainty, Greece accepted a deal with $146 billion dollars, a massive number for such a small country, to avoid default, in exchange for painful austerity budgeting that could cause social unrest and an increase in poverty. Sadly, not everyone believes this will even stop the contagion of sovereign debt crises within the eurozone:

But analysts warned that Greece had not yet solved its fundamental problems and that other sovereign debt crises could arise as lenders and market speculators turned their attention to a handful of similarly vulnerable nations across southern Europe.

“The immediate impact may be soothing, but the inflammation will soon show up again,” said Edward Hugh, an economist in Barcelona who writes for the influential Fistful of Euros blog. “My feeling is the rot has now gone too far.” […]

While the bailout provides a lifeline to the Greek government, similar challenges await other deficit-racked countries like Portugal, Spain and perhaps even Italy. Moreover, nations like Latvia, Hungary and Romania — which are outside the 16-member group that uses the euro as its common currency — are all struggling in their own efforts to meet economic and fiscal goals set in conjunction with the I.M.F.

In exchange for the $146 billion in loans, Greece will increase its value added tax from 21 to 23 percent, increase sin taxes on tobacco and alcohol as well as gas taxes by 10%, freeze public employee wages (earlier cuts to base salaries were expected), crack down on early retirement, and eliminate public employee bonuses that used to be worth two months’ pay. Basically, they will put a lot of pain on the working class to avoid a default. The bailout money passes through the Greek government can goes right into the hands of European bankers.

This has the Greek people fairly outraged. It also may not even fix the problem in Greece, because it could lead to a deflationary spiral:

Some influential economists, however, fear that such harsh measures risk killing the patient, even as they see the intensity of Greek pain as a serious warning to other countries that use the euro to get their own economies in order before the currency union itself is undermined by rampaging market speculation.

This new wave of austerity also risks pushing the entire European Union into a period of artificially low growth just as economies are trying to recover from the recession of last year, caused by the huge housing and banking crisis that started in the United States. Negative or low growth will increase already sizable unemployment and put new pressure on government spending, as well as on the banks themselves, and make it harder for everybody to reduce their debts.

“How can Greece grow out of its debt if there is deflation?” asked Jean-Paul Fitoussi, a professor of economics at the Institut d’Études Politiques in Paris. “Deflation increases the debt burden, so we are following this virtuous circle that is bringing us toward hell. Economics has nothing to do with virtue, which can kill an economy.”

Such attacks on public-sector pay and increased consumption taxes in the middle of a recession only makes sense to those who want everyone but creditors to “sacrifice.” And the market may just up and move on Portugal or Spain or Italy, extending the crisis across national boundaries.

The worst-case scenario would be all this suffering for loans that didn’t meet the scale of the problem. The deal at least looks serious. But the outcome could be severe.

David Dayen

David Dayen