The Greek Rescue Plan Isn't Likely to Save the EU From More Turmoil

The 16-member European Union (EU) is like an insurance company. The healthy subsidize the weak. But sometimes the subsidy's cost becomes so high that it threatens the survival of the union. This comes to mind in considering the fate of Greece and other EU weakest links.

Take the problems Greece is grappling with. The country is facing deadlines on $72 billion (54 billion euros) worth of debt in 2010 and is struggling with the high interest rates. Moreover, its budget deficit makes the country a far riskier prospect than what the EU requires. Specifically, in late 2009, Greece revealed that its budget deficit was 12.7% of GDP, 7.7 percentage points above the EU limit. But Greece wants to cut that deficit to 8.7% in 2010 and reach the EU's 3% target by 2012.

Delay on Stricter Lending Rules

To remedy Greece's problems, EU members had quite an internal battle. Germany, the richest of the EU members, was holding out for tougher fiscal discipline. It wanted to rewrite the EU treaty to expel members like Greece that can't meet the group's economic requirements. But ultimately, the deal didn't offer Germany's hoped-for discipline.

The agreement does have numerous backstops before it starts costing the EU money. If Greece can't borrow in commercial markets, the EU will lend money to the country at market rates -- but only if all EU nations agree to the deal. That loan from the European Central Bank (ECB) could amount to $29 billion (22 billion euros).

Lending rules for EU members would also tighten -- but not until 2011, instead of the end of this year, as previously announced. If the rules were stiffened now, it may hurt Greek banks since they hold a lot of Greek government bonds, which ratings agencies have downgraded in recent months. Further downgrades mean Greek bonds may not qualify as collateral for the country's banks trying to get low-cost ECB loans.

Fortunately for Greece -- and not so much for Germany -- the ECB seems to be giving Greece special treatment. At the moment, it would take a massive downgrade of Greek government bonds for them to be excluded from ECB operations. How massive? Greece's debt would need to be downgraded five times by Moody's and three times by Fitch and S&P, according to analysts quoted by The New York Times.

Other Trouble Spots?

Meanwhile, Greece is not the only problem that threatens to unravel the EU. Fitch downgraded Portugal's sovereign debt rating one notch Wednesday to AA-. The ratings agency says Portugal must implement "sizable" budget measures to meet its target of getting its deficit to the 3% of GDP target by 2013.

The debt contagion is not limited to Greece and Portugal -- it could also hammer other EU members like Spain. According to a Portugal-based economic analyst, "Spain is a more complex problem than Greece or Portugal because of its economic dimension, but anyway its total external debt (government + private) ratio to GDP (only 168%) is not so huge."

The analyst is more concerned about the total external debt-to-GDP ratio of some other countries: "[The biggest problems in the EU are with the] Irish (1,050% external debt to GDP), the British (413%) or the Belgians (293%). I see real trouble if something goes wrong in Ireland or Belgium. I hope not. The British are out of the eurozone, but it seems to me, that in the long run, it's the most critical problem in the EU."

Can the EU survive all this? It's hard to tell. But one thing is clear: All this euro instability is going to send investors looking for a safe haven -- the U.S. dollar. And guess who will be hurt by the stronger dollar? The U.S. economy, struggling to recover from recession, may be burdened with a further strain.