The European Union is facing one of the worst economic crises of its life. The immediate trigger is Greece, which has been living well beyond its means. As the prospect of a default looms, the Athens government has pledged to embrace austerity measures, but public resistance is high. The Greek government has pinned its hopes on aid — read: bailout — from other EU governments, which worry about the precedent such a move could set as well as resistance from their own publics. An EU summit has cobbled together a response, but it is likely to only postpone the reckoning. Europe is in trouble.

Greece has been a poster child for profligacy. As The Economist, citing research, recently noted, “it has spent half of the last two centuries in default.” Nevertheless, as a sign of its commitment to a united Europe — and Europe’s commitment to Greece — the country adopted the euro nine years ago. That move was designed to force discipline on the country’s economic decision makers. Adopting the euro meant that the Greek government was ceding control over economic matters to the European Central Bank: Being part of a continent-wide economic zone meant it could no longer print money to pay bills or devalue its currency to regain competitiveness. It was an ambitious undertaking: When Greece joined the euro, its public debt already exceeded 100 percent of its GDP.

At first, the strategy worked. Membership cloaked Greek decision-making with confidence. The government refinanced debt on easier terms. That also allowed the government to borrow more money. Government spending prodded the economy to higher levels, growing an average of 4 percent a year until 2008.

Reality caught up last year. In 2009, the budget deficit reached 12.7 percent of GDP, more than twice original estimates — blame slowing tax revenues resulting from the global downturn and increased spending in the run up to a national election in October. That sparked a jump in the yield of government bonds: In January, 10-year Greek bonds paid 7.1 percent, the highest rate since the country joined the euro and 4 percentage points more than their German equivalents. Credit agencies cut Greek bond ratings from A- to BBB+. After the financial earthquakes of the last 18 months, that level of risk scared off bankers and the prospect of refinancing 20 billion euro ($28 billion) in April and May looked distant. Sovereign default was on the table.

Officially, the EU treaty has a “no bailout” clause: member states are forbidden from assuming the debts of others. In fact, however, the prospect of leaving Greece to its own fate could spook investors and force them to look hard at other European governments facing similar difficulties: Spain, Portugal and Ireland top the list of problem economies.

Conscious of the dangers, European leaders pledged to take “determined and coordinated action” to defend the euro if necessary. Welcome though it was, that statement was merely a demonstration of political will: No details were provided as to what actions specifically would be taken. Instead, the European Commission will monitor the situation as Greece tries to implement an austerity plan designed to cut the budget deficit to 3 percent of GDP by 2012. In addition, the Commission said it will draw on the expertise of the International Monetary Fund as it studies ways to handle this situation.

As a first step, the Athens government hopes to pare the deficit to 8.7 percent of GDP this year. Part of that plan includes higher fuel taxes and a freeze on wages paid to some civil servants, which was enough to trigger a wave of strikes in Greece. More are likely to follow. Bold steps are required, and the scaling back of the Greek social safety net — which is one of the most generous in Europe — is going to be painful. Greece is the proverbial canary in the coal mine when it comes to restructuring social security benefits. The country has lived beyond its means and the return to reality will be painful for citizens and politicians alike.

There is no mistaking Greece’s readiness to run a budget deficit well in excess of the 3 percent of GDP set by the treaty that established the euro. It is not clear if Athens engaged in accounting tricks to deliberately hide the size of its deficit; the European Commission has promised an investigation. The extent of that deceit will have a profound impact on the readiness of other EU publics to bail out the country. One recent poll shows that 70 percent of Germans oppose financial support for Greece.

Some form of EU action is inevitable. A default by any one of its member governments could threaten the viability of the euro and could even damage the prospects of the entire European project. Moreover, a sovereign default in Europe could ripple across the world and trigger similar defaults elsewhere, outside the euro zone. This raises the prospect of a second dip in the global economy. There is much at stake as Greece struggles with solvency.

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