|The EFSF sets up the perfect structure, for a spectacular domino effect.|
The EFSF basically is a common fund in which all member-states provide part of their taxpayer's money, to bail out countries in need. In the architecture of the EFSF the best economy guarantees the second best, which guarantees the third and so on (see The seven classes of the eurozone). This means that all states are practically tied together and to the countries that have received the bailouts.
In times of a boom this would have worked fine, but in times such as today's, this is a highly unstable web. It sets up a domino structure whereby an imbalance in the weakest country will directly affect the next weakest and the effect will progressively reach the economically healthiest one (the European core). Thus not only contagion fails to be contained, but it compounds instead.
The reason is simple. Hardly-pressed governments, whose economies are going through a serious recession and who have imposed austerity measures to reduce their spending are called to contribute to a common fund to bail out other countries. One country would be affordable but as time passes more and more countries join the club of the "fallen", coming to the need of a bailout, thus making the burden even heavier for the rest. We currently see this in the plan that was decided on the July 21 EU summit, where countries that face serious problems in their economy, such as Cyprus, Spain and Italy are asked to pay a second bailout to Greece.
So these hardly-pressed countries come to the point where they adopt strict austerity measures to put their finances under control at the expense of shrinking their economy and at the same time are called to increase their spending for the sake of saving another country. Hence austerity diminishes their economy and the EFSF further worsens their fiscal position. This means that interest rate spreads over government bonds increase, since everyone in the market realizes the inviability of the system.
In such an unstable structure the contamination of the healthier parts is inevitable. That is why the "Greek" crisis, became "Irish" and then "Portuguese" and now it has seriously affected Italy, Spain and Cyprus, while France and Belgium are close behind.
The truth is that the crisis was from the beginning a systemic crisis of the euro, deeply rooted in the current architecture of the single currency. The EFSF and in the near future the ESM, which are thought to be the solution to the problem are in fact making things worse and the systemic crisis turns out to be an existential crisis of the euro.
The latest deal that was agreed upon on the July 21 EU did not solve the root of the problem. It built upon the same failing practices that have allowed for contagion.
The calls that are now being made by many, including European Commission President Jose Manuel Barroso, to expand the EFSF by significantly increasing its size, fail to understand (or to accept) the above-mentioned toxicity of its structure. If the EFSF is not fundamentally redesigned, then no matter how big it is, it will remain the source of contagion. A bigger size only means bigger burdens for the contributors.
The current practice, where quasi-bankrupt states bail out and guarantee their bankrupt partners is the most toxic of structures. It puts everything in place for a spectacular domino effect. If the EFSF, remains as it is the chain effect will not be prevented and thus the situation in many countries will only get worse.
Article source: http://www.protesilaos.com/2011/08/toxicity-of-efsf-is-source-of-contagion.html
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