SERIOUS MONEY:JEAN MONNET, the man considered to be the father of the European Union, wrote in his memoirs that "Europe will be forged in crisis and will be the sum of the solutions adopted for those crises".

The late economist’s dictum has been put to the test time and time again since the Frenchman passed away in 1979; his words have proved true and the long-term project, born of brave men like him, has achieved its primary objective, putting an end to the conflicts that were synonymous with European history since the continent emerged from the Dark Ages half a millennium ago.

Today the solidarity inferred by Monnet faces the sternest test of its credentials as Greece teeters on the brink.

A year after the Hellenic Republic called for help in May 2010, it has become clear that the original €110 billion EU-IMF facility will not keep it afloat and it is now asking for more subsidised money.

Until now the European leadership has steadfastly refused even to consider a restructuring of public or bank debt for fear of precipitating a Lehman-style chain reaction that could unhinge the financial system and, perhaps, even undermine the foundations of monetary union.

The moment of truth draws ever closer, however, as Greece rests uncomfortably on the brink.

Although a further aid package is likely to be granted, the surge in the yields available on two-year government debt instruments to close to 30 per cent in recent trading confirms that investors do not believe the country can be saved from the abyss.

The Greek economy has already declined 6½ per cent from its 2008 peak and remains mired in recession.

Yet further austerity measures are required if the country’s public finances are to be put on a sound trajectory.

The economic hardship and resulting surge in the unemployment rate to almost 16 per cent has contributed to social unrest.

It is questionable whether the political resolve to take the necessary action exists, although the unpopular government led by George Papandreou did survive a confidence vote earlier in the week.

In any case the public finances are in a dreadful state and it is unclear whether a further aid package would do anything other than postpone the day of reckoning.

Greece’s public debt burden is already the second highest in the developed world and is set to approach an amount equivalent to 170 per cent of GDP by 2013.

The primary budget deficit has been reduced by five percentage points to below 5 per cent of GDP, but remains some considerable distance away from the 5-6 per cent surplus required simply to stabilise the public debt.

Given that the maximum primary surplus registered in the decade preceding the current crisis was little more than 4 per cent, investors can reasonably conclude that the question of whether a restructuring of some form will take place is a matter of when and not if.

Concerted effort will undoubtedly be made to avoid a disorderly default similar to the Argentine shock in 2001, and rumours that a voluntary maturity extension or reprofiling of the public debt is imminent in the months ahead have gained traction in recent weeks.

The model in this regard is the Uruguayan restructuring of 2003 whereby, after discussion with creditors, the maturities of outstanding government debt were extended by five years without any haircuts to coupons or principal.

However, it is important to recognise that although Uruguay could not raise external finance in the wake of the Argentine debacle, unlike Greece the Latin American country was widely considered to be solvent. Thus it was in all parties’ interests to agree to the plan. In the case of Greece it is not clear whether a reprofiling would do anything other than delay the inevitable day of judgment.

The unsustainable level of public debt, combined with interest costs that are capturing an ever greater share of tax revenues, means a debt restructuring with appropriate haircuts to coupons and principal will ultimately prove necessary if the Greek economy is to have any chance of returning to prosperity in the years ahead.

Analysis of the nation’s debt dynamics suggests that haircuts to principal of at least 50 per cent would be required to put the public finances on a sound footing.

The goal for the European leadership in the months ahead must be to minimise the potential contagion that may arise from a Greek debt restructuring.

A restructuring in 2012 would enable the diversion of funds to recapitalise the Greek banking system while giving large European financial institutions in France and Germany the time needed to make appropriate provisioning.

Investors should be under no illusion – a restructuring of Greek debt is inevitable.

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