THE EURO´S GREEK MOMENT OF TRUTH / THE WALL STREET JOURNAL REVIEW & OUTLOOK ( VERY HIGHLY RECOMMENDED READING )

REVIEW & OUTLOOK

FEBRUARY 16, 2010, 12:07 A.M. ET.

The Euro's Greek Moment of Truth

An Athens bailout is a bigger threat to Europe than is default.

Last Thursday's show of European solidarity for Greece failed to calm the markets or reassure investors in Greek sovereign debt. So today the euro-zone's finance ministers will be back in Brussels to try again.

It's hard to imagine a country less deserving of solidarity than Greece. Its debt-to-GDP ratio is nearly double that of would-be savior Germany, and the previous government in Athens was actively concealing a 13% budget deficit. Some European leaders are also beginning to understand that there is an even bigger threat to the euro than Greece's public finances. The single currency itself could be dragged down by the consequences of a bailout for one small profligate country.

A default or debt standstill would be disruptive and painful, especially for Greece. But it would also be clarifying about the purposes the euro does—and does not—serve. Above all, the crisis should underscore that the euro is not a debt union. The treaty instruments that established the single currency left no ambiguity on that point, but the mooted bailout of Greece is undermining that resolve. And a debt union, far from bolstering the euro, would destabilize it, perhaps permanently.

It is true that until a couple of years ago most euro-zone sovereign debt traded as if it didn't matter much whether you bought German, Italian or Portuguese bonds. With Greek bonds now trading two to three percentage points above German bonds, which are Europe's benchmark, and Portugal's bond yielding more than one percentage point more than Germany's, the markets are pricing in differential risks of default.

Greek Prime Minister George Papandreou and his Spanish counterpart José Luis Rodríguez Zapatero have chosen to characterize this divergence as the result of an "attack" on their countries or on the single currency. In fact, the widening spreads are nothing more than a belated acknowledgment of reality. Joining the euro did not turn spendthrift governments into sober ones. Greece had enjoyed what appeared to be a free lunch as German interest rates pulled down everyone else's in the currency bloc for a decade.

More broadly, governments around the world took advantage of a suspension of the normal rules of fiscal probity during the financial panic of the past two years. In that environment, governments borrowed very freely to support their economies and banks. The strong investor aversion to risk at the height of the panic meant that there was a huge appetite for that debt at almost any price.

Now that recovery is under way in many places, that flight to safety is being unwound and investors are starting to sort out which countries have done the most long-term damage to their public finances. It turns out that countries sporting budget deficits north of 10% of GDP and overall debt burdens larger than their national output are good candidates for an early heart attack. Far from being irrational marauding by speculators, this is sensible investor behavior.

Greece's European partners may now be coming to see that there are limits on their own capacity to tap the credit markets as well. A normality of a sort is, in other words, reasserting itself when it comes to investor tolerance for governments that live beyond their means and make promises they can't keep. If Paris and Berlin are smart, they'll grasp the point before they yoke themselves to Greece's debt. Otherwise, the whole euro zone could find itself dragged down by the profligacy of a few.

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