MS. DIANE REHMThanks for joining us. I'm Diane Rehm. Greek socialist leader Evangelos Venizelos says his country is heading for new elections after coalition talks failed. German Chancellor Angela Merkel said yesterday it would be best for Greece to remain in the eurozone and that European leaders must do everything possible to help that country back to economic growth.

MS. DIANE REHMJoining me in the studio to talk about the fate of the eurozone, Zanny Minton Beddoes of The Economist and Jacob Kirkegaard of the Peterson Institute. I hope you'll join our discussion. Call us on 800-433-8850. Send us your email to drshow@wamu.org. Feel free to join us on Facebook or send us a tweet. Good morning to you.

MS. ZANNY MINTON BEDDOESGood morning, Diane.

MR. JACOB KIRKEGAARDMorning.

REHMGood to see you both. Joining us now from Athens, Greece, is Alkman Granitsas. He is Dow Jones Newswires bureau chief for Greece and Cyprus. Thanks for joining us. Alkman, are you there? I'm afraid we do not have him. We'll hope to get him a little later. Zanny Minton Beddoes, the Greek government this morning announced there's going to be a new election. What does that mean?

BEDDOESWell, it means an enormous amount of uncertainty over the next few weeks. As you know, in the aftermath of the last election, the parties were unable to form coalitions, were unable to form a new government, and there were three different attempts. And this morning, they failed on the third attempt. We're now moving towards new elections. I think the question will be: What happens over the next few weeks? As you know, the party that got the single biggest number of votes and is very against the austerity package.

BEDDOESLarge majorities of Greeks want to stay in the euro, but they also want to renegotiate the austerity package. So I think we're going to see a lot of uncertainty in Greece, and the worry is that we're going to see a lot of flight of deposits from Greece as people worry that a -- an election outcome of rejecting the austerity package -- the rescue package with the Europeans -- will eventually mean Greece's exit from the eurozone.

REHMHow much leeway is there here, Jacob?

KIRKEGAARDOh, I don't think there's going to be much leeway. I mean, we heard yesterday from the Eurogroup that there is a little bit of conflict. Some say absolutely no changes at all. That's -- for instance, the Dutch finance minister was out saying that. Jean-Claude Juncker, the head of the Eurogroup, said, well, maybe we can negotiate a little on the margins on the IMF program. But he then also made it very explicit that we need a functioning Greek government in order for that to happen. So I think, in reality, there isn't much leeway with respect to renegotiating the IMF program.

REHMZanny.

BEDDOESYou know, I think, as with all things in the eurozone, the Europeans are deeply divided. And they -- on the one hand, they're very worried -- the rescuing countries if you will. The countries that are helping Greece are worried that if they say, oh it's fine, Greece, you can do whatever you like and tear up the program, that this creates some terrible moral hazard. So they can't do that.

BEDDOESOn the other hand, they know that the consequences of a sudden Greek exit from the euro are complete -- potentially cataclysmic for the rest of the eurozone. So if you push Greece too hard, such that it looks like it's going to be forced out very soon, you could have big knock on consequences in Portugal and Spain and Italy.

REHMWhat would it actually mean for Greece itself if it were to pull out of the zone?

KIRKEGAARDWell, in my opinion, it will be an absolutely -- catastrophe for Greece because Greece is a country that still has a sizable primary deficit, which means that if they were to pull out and if they were to lose the IMF bailout, they would actually end up doing more austerity immediately because they would simply run out of money than is now penned in in the IMF program.

KIRKEGAARDBut, more importantly, Greece also has an ongoing current account deficit of which only a part of goes to finance foreign debt, which means that, essentially, you would need -- and they would now have to pay -- they would finance that current account deficit in drachmas rather than euros, which I think will be very difficult, which think -- I think there is a risk when you look at the type of things that Greece imports, including things like medicine, food, fuel.

KIRKEGAARDYou could have real -- these types of shortages in Greek society very rapidly if they were to exit very quickly. I don't think that that is likely, but it would certainly be a disaster for Greece in my opinion.

REHMNow, what about this meeting this evening between Angela Merkel and Francois Hollande? What does that mean not only for France but for Greece and the entire eurozone, Zanny?

BEDDOESWell, it's symbolically an incredibly important meeting. You know, Francois Hollande, sworn in this morning, he's literally just become officially president of France. Where is the first place he goes? Berlin. And he goes there because, as you remember, you know, Chancellor Merkel was pretty keen actively to campaign for the President Sarkozy, his predecessor. And so she's very much on the other side.

BEDDOESHollande comes along, has a campaign that says we need to move away from austerity, we need to focus more on growth, I want to renegotiate the fiscal compact, which is the agreement that the Germans pushed through onto everybody else in Europe. And so Angela Merkel is, on the one hand, very keen to show that she's willing to work with Hollande, on the other hand, very determined to stick with her austerity package.

BEDDOESSo I think the question -- people will be looking at the body language. They'll be looking at how do these guys get along. Are they going to loathe each other? Will they work together? And will Hollande be able to convince Angela Merkel to move away from her very strict focus on austerity?

REHMBut this question of the German negotiators themselves, having indicated that there could be some maneuvering room, does that contradict directly what Angela Merkel is saying?

KIRKEGAARDNo, I don't think so. I mean, what the German's government has signaled, as you say, is that we want, as Zanny said, what has been agreed has been agreed, and that stays. There'll be no renegotiation of what -- with respect to a member states' fiscal targets, the fiscal compact as such. What we can talk about are various forms of things you can add on to that, and that's essentially where they're thinking, you know, they want to expand the balance sheet of the European investment bank and other types of infrastructure-type expenditure, which is pro-growth.

REHMBut wouldn't that still mean that the austerity measures imposed on Greece stay right where they are and that the Greeks keep protesting and threatening?

BEDDOESI think it's not just Greece. I think the whole question of austerity is a broader question in Europe.

REHMOf course.

BEDDOESAnd just to kind of simplify a bit -- and I think that this is a bit of a caricature, but the caricature is the Germans, who are the sort of the money bags of Europe, have imposed a counterproductive excessive obsession with austerity. And now, the populace of European countries is kind of rising up and angry about that and are demanding a change in it. Now, I think it's a bit of a caricature because I actually think many countries -- the question is not austerity or no austerity. It's how much austerity, how fast.

REHMSure. Sure.

BEDDOESI think there will be some changes. I think Jacob is right. We're not going to see a wholesale shift from austerity to stimulus in Europe, but we are going to see some changes. We're going to see some focus of using Central European funds for helping peripheral economies. That's good. We're probably going to see countries like Spain, I hope, be allowed to cut their deficit somewhat more slowly.

BEDDOESWe're going to see a bit more pragmatism. And if Francois Hollande, who has -- there's a lot of things wrong with Francois Hollande's policies, but if he manages to achieve a sort of more flexible focus on the pace of austerity in Europe and can convince Angela Merkel to do it without her having to feel that she's losing face, then I think that's a step forward.

KIRKEGAARDWell, I think -- I mean, I think it's actually somewhat ironic, and I completely agree with what Zanny just said. We're going to see more stimulus at the Central European level through the European commission, through the European investment bank while you're going to maintain austerity measures at the member state level.

KIRKEGAARDWell, guess what? That's actually quite a lot like what we have here in the United States, where the federal government is running huge deficits while the states are cutting back to balance their budgets. Europe is actually, in some ways, ironically replicating that very model.

REHMBut what about the general public? For example, in Greece -- just stay with Greece for a moment. How is the public going to react to what you're describing as more technical adjustments that may somehow satisfy the bankers, the negotiators, but maybe not the public at large?

BEDDOESYou know, the Greek public is understandably furious, and there's a huge -- this election has thrown a huge amount of anger.

REHMRight.

BEDDOESIt was a massive anti-establishment vote. But trying to sort of pass what the Greeks really want is quite tricky because, on the one hand, they hate the rescue plan. They hate the austerity. They think it's wrecking the economy with some reason. On the other hand, they want to stay in the euro. There are big majorities for both of those things, for ripping up the rescue package and for staying in the euro.

BEDDOESAnd the -- what the European rescuers are pointing out is that you can't have it both ways. You can't want to stay in the club and, you know, ignore the rules of the game that we've set out for you. What I suspect will happen is that either the sort of extremist anger view will win out and Greece will be eased out over the next few months, or there will be some kind of face -- change of face both within Athens and within Brussels. And they will come, yet again, to some kind of wishy-washy compromise.

REHMIt's interesting because, more and more, we hear Greece may be eased out. What's your thinking?

KIRKEGAARDI think eased out is the right word. I mean, they won't be kicked out. I mean, they won't be given an ultimatum, in my opinion. I mean, they will -- they may be basically presented with terms that means that they cannot form a functioning government. That's a very real possibility after the coming elections if the radical left, the Syriza party, and others do very well.

KIRKEGAARDBut they won't -- I mean, there's no legal foundation for sort of basically throwing them out. But they will have to basically initiate the process themselves. And if they were to do that, then, I think, there is a real risk for that. But there's also a middle ground. I mean, they can stay in the euro but lose access to the ECB, basically meaning they become eurorized, a little bit like Macedonia, for instance.

REHMJacob Kirkegaard, he is research fellow at the Peterson Institute. Short break here, and when we come back, more talk about the eurozone more broadly. Stay with us.

REHMWelcome back. As we talk about the unfolding crisis in the eurozone, joining us now from her office in Washington, D.C. is Christina Bergmann. She is a senior correspondent with Deutsche Welle. Thanks for being with us, Christina.

MS. CHRISTINA BERGMANNGood morning. Thank you for having me.

REHMTell us how Germany internal politics are affecting these negotiations in the larger eurozone.

BERGMANNWell, Germany is not very happy about having to pay a lot of money, obviously. And especially, for example, if you look at the polls, the German public is not very happy, and I think the latest -- the result of the latest election in North Rhine-Westphalia show that very well.

REHMWell, what does that mean? Does Angela Merkel retain her support? She's just had an election, which casts a little doubt there.

BERGMANNYes. She just had an election in North Rhine-Westphalia, and her party lost very big. It was the worst result in history in North Rhine-Westphalia for her. But, on the other hand, I don't think that it will have any immediate consequences on her ability to negotiate on the European level or on the international level. I think she will stay her course.

BERGMANNShe will make sure that the policy of austerity is the way to go, maybe give, for example, Francois Hollande, the new president of France, whom she will meet tonight, a little bit of, yeah, a little bit of a gift -- of a present that his side -- his socialist side views will be recognized as well. But there is, in my opinion, no way that she will -- yeah, she will not stay the course.

REHMWhat kind of a gift do you mean?

BERGMANNWell, I think they may -- there's no way, I think, they will be -- negotiate this fiscal agreement. It will not be reversed or renegotiated. But, for example, that they will have some kind of growth program, some kind of addition to this agreement finalized. And there will be several meetings on the EU level in the coming weeks and months that he can save his face in a way, but not -- but again, not kind of opening again this fiscal agreement from December of last year.

REHMI gather that opinion polls in Germany show that a majority of Germans back her focus on debt reduction, and they don't want her to soften her stance toward her struggling partners. But, on the other hand, from the view of those negotiating partners, how well do you think holding to her line will go over?

BERGMANNWell, that remains to be seen, but you're absolutely right that the Germans back her. And they're very skeptic about the help to Greece as well. For example, if you look at the latest polls from March, 64 percent of Germans say that financial help for Greece makes no sense, and it will not save Greece. And 60 percent say that Greece should get out of the euro and then go back to the drachma, to their former currency. So Germans are very skeptical, and they and Chancellor Merkel is in very high regard with the Germans despite the setback her party just had at the North Rhine-Westphalia.

REHMI think Zanny Minton Beddoes would like to say something.

BEDDOESI just want to test out, perhaps, or offer a slightly more optimistic take on all of this 'cause it's pretty depressing and pretty grim to hear that, you know, there's elections around Europe, people rising up against austerity, people angry about it, where Greece possibly exiting -- where's all this going? And if you just stand back a bit and say -- it seems to that, in the medium term, there are three things needed.

BEDDOESOne is the sort of tinkering with a recalibration of the austerity, so you don't have so much austerity so fast. Two, there are two other fundamental changes that, I think, most people are beginning to agree the eurozone needs. One is some kind of Eurobond, some kind of fiscal-risk sharing, some way in which the countries show that they are coming ever closer together and, secondly, some kind of euro-wide bank rescue scheme, euro-wide banking rules.

BEDDOESAnd the question is: how do you get there? And let me just suggest that, possibly, the combination of Hollande's victory in France -- and now it wasn't just that Angela Merkel's party did badly in North Rhine-Westphalia. The Social Democratic Party, the SPD in Germany did relatively well. And I think there's rising speculation in Germany about the possibility of a grand coalition next year where the Chancellor Merkel's party has to join with the SPD, and the SPD is more keen on this euro-limited Eurobond idea.

BEDDOESAnd perhaps, over the next year -- and particularly if Greece actually exits the euro, you have a sense that the real sinner has gone. The rest of the zone makes a sort of quantum leap forward towards closer fiscal integration, towards a bigger banking -- a euroization of the banking system. Now, I'm not suggesting it'll be without hiccups. But I think as now and as sort of an agreement on where the single currency has to go with, it wants to stay together.

REHMChristina.

BERGMANNYeah, and I think the -- if Greece leaves the euro, this does not mean the end of the euro or the eurozone. I mean, the finance minister, Wolfgang Schauble, has said that the euro is quite strong right now. So I do believe that the exit of Greece may be a possibility but that this does not mean the end of the euro.

REHMBut here's the question for you, Jacob, if, as Zanny suggests, you have the creation of a Eurobond with or without Greece, don't you have to have or establish some kind of political connection that joins these people together not just economically but politically?

KIRKEGAARDOh, yeah. No, I don't there's any doubt that that will be required. You need to basically transfer democratic legitimacy to the European level in order to do this.

KIRKEGAARDI think, in my personal opinion, if you look at what has already been implemented in Europe, the fiscal compact, the so-called European semester, and these -- this whole set of agreements that basically control national member state's budgets, that, in my opinion, is actually already transfer of so much de facto power to the European Commission that, in the long run, this will not be sustainable without a direct democratic mandate for the people who administer and, in effect, oversee national government's fiscal spending.

REHMBut it's interesting. Zanny said, OK, so if the Greeks decide to move away, that's not going to affect the possibility of the rest of the union.

KIRKEGAARDNo. I mean, sort of slightly ironic and tragically for Greece, perhaps, I think we need to be realistic that the European Union has always emerged and integrated further in times of acute crisis. And as Zanny just said, I mean, if Greece were to leave, the European -- the remaining 16 in the euro area would need to actually constitute or create just such a quantum leap because, otherwise, you risk the run of -- you risk sort of uncontrolled bank runs in other euro area countries.

KIRKEGAARDI mean, I for -- I would strongly believe that the minute that the Greece's exit for the -- from the euro is announced, you would need to move immediately to upend European bank deposit insurance scheme to basically prevent bank runs from spreading from Greece to Spain and Portugal and elsewhere.

REHMZanny.

BEDDOESYeah, it's -- you know, I don't want to sort of underplay how, in some sense, how high the stakes are and how potentially things could go very wrong. And I think there's still -- I mean, I don't know what Jacob's odds would be, but I would put pretty significant odds on the whole thing potentially fracturing over the next few years. I think that's still a very real risk, but I...

REHMThe whole thing.

BEDDOESA big fracture that you...

REHMOK.

BEDDOESBecause I think that you -- to keep it together, you have to do the -- the sort of economic logic is pretty brutal, and you have to have, as I've argued, you know, the fiscal union of some sort. You have to have the banking union. You have to have a way for these huge competitiveness adjustments to be made between countries like Spain and countries like Germany. So the economic logic is clear.

BEDDOESI think what I see now is, for the first time, a way, a path through the politics that, I think, that it is possible. But I think there's big risk because the history of the European Union is that the elites make these decisions without very much democratic legitimacy. And then over time, you know, they hope that the people will come along. And this time, it's not clear that that's going to happen. So I think there is a risk of a sort of big political blow up that this doesn't work, but it could do.

KIRKEGAARDI mean, I guess, I just want to push back a little bit about this entirely being an elite-driven project. There's no doubt that it is European elites that have taken these decisions. But the reality is that European populations have repeatedly -- and across the euro area and the European Union, with the exception of possibly of the U.K. -- actually re-elected people in office that have agreed to this.

KIRKEGAARDAnd, therefore, I don't think that -- I mean, there is a degree of schizophrenia here in the European electorates as well. You know, they may object to something if they are put in front of them in a referendum. But then they're going to turn around the next day and actually elect the same people that agree, you know, that put that treaty or that decision in front of them. They're going to re-elect them as the national government.

REHMChristina, final question for you: How much do the Germans need France to partner in this arrangement?

BERGMANNWell, of course, France has been, over the last years, a very strong partner for Angela Merkel with President Sarkozy. But everybody in Germany is very optimistic, actually, that Francois Hollande will take over this position. Angela Merkel is very pragmatic. She clearly sided with Nicolas Sarkozy in the past. But, as I said, they are meeting today, and everybody expects her to kind of forget the past and move on and, yeah, partner together with Francois Hollande.

BERGMANNAnd the chances are that this is actually being a very good partnership because he's coming from the left and she's coming from the right end of the spectrum, and they may be a very good team, may make a very good team.

REHMA good team with lots of compromise, Zanny.

BERGMANNYes.

BEDDOESWell, I hope so. I mean, a good -- I think the question -- is a good team where Francois Hollande compromises and it's remade in Angela Merkel's image? I suspect that's what will happen. I think that, in the end, Angela Merkel will maintain the focus on austerity. There will be some -- the word was used, gift, but there will be some cosmetic changes and, I hope, some greater focus on stimulus at the sort of central European level.

BEDDOESBut this isn't going to be a sort of whole quantum change of direction immediately. But where -- what I hope is that Francois Hollande will sort of prod and push Angela Merkel in the direction of accelerating the, I think, necessary move to some fiscal risk-sharing, some greater fiscal integration.

KIRKEGAARDBut I think just one aspect of that is also that Angela Merkel actually domestically, in Germany, needs the support of the opposition, Social Democrats, in order to pass -- ratify the fiscal compact, as well as the ESM treaty in the German parliament. And the German Social Democrats are much closer obviously to the position of Francois Hollande.

KIRKEGAARDSo you can have sort of a tag team, you know, where you have Francois Hollande externally and the SPD internally where, I think, the kind of compromises that we've talked about are actually not only likely but absolutely necessary for Angela Merkel as well.

REHMChristina, I want to thank you so much for joining us. Christina Bergmann is senior correspondent for Deutsche Welle. Thanks for being with us.

BERGMANNThank you for having me.

REHMAnd you're listening to "The Diane Rehm Show." We're going to open the phones now, 800-433-8850. Send us your email to drshow@wamu.org. First to San Antonio, Texas. Good morning, Robert. You're on the air.

ROBERTYes. You know, Greece has lied on its balance sheet. People there have not paid taxes. They've been living on borrowed money for years as a consequence. And now they're negotiating a free ride by threatening to leave the euro and the idea of being -- sort of "destroying" the European Union. It's an "Alice in Wonderland" scenario, and the obvious answer -- it's like dealing with a spoiled brat. If you're going to be that bad, kick him out of the classroom.

REHMWhat do you think, Zanny, kick him out of the classroom?

BEDDOESSpoiled brat of Greece. Well, I think the caller has a point, to a point. I'm not sure I would characterize that what the Greeks are going through now as a free ride. The Greek economy is imploding. You know, Greeks are being hit very, very, very, very hard. Yeah.

REHMShops are closed. Unemployment is high.

BEDDOESI think anybody who's been to Athens recently would not think that it's a fun time there. But what is true is clearly there are elements of the Greek political class who are figuring out quite how much of a brinkmanship game they can play with the Europeans. And I think it does get back to this sort of basic thing that, you know, if -- what is it? If you owe the bank $100, it's your problem. If you owe them $1 million, it's the bank's problem.

BEDDOESAnd I think it's -- that's the case in Europe now because the problem is that a sort of -- a sudden and chaotic Greek exit from the eurozone, which it sort of almost by definition will be because it's -- you know, you're not supposed to be able to exit from a single currency area -- will have potentially cataclysmic consequences for others unless it's very well handled. And I think that's what the Europeans are having to figure with. How much do we need to worry about what goes on in Greece?

KIRKEGAARDWell, I think the listener really puts a finger on an important thing, is that, you know, one thing really is the sort of hardship that the populations of Greece is going through right now. But we should keep in mind that, from the perspective of taxpayers in the rest of the euro area, they look at this, and they say basically, oh, this looks like the Greek population is voting to have more of my tax euros.

KIRKEGAARDAnd it just really illustrates the kind of constraints that people like Angela Merkel -- but not just in Germany, but across the euro area, these leaders are under tremendous pressure domestically as well because they cannot give Greece a free ride.

REHM(word?)

KIRKEGAARDI mean, they have already given Greece more than 12,000 -- or given them financing for more than 12,000 euro per Greek person, you know. And this is not sustainable in the long run. And if you keep doing this, you really run the risk of having the sort of Tea Party-type insurrection against bailouts across the euro area.

REHMAll right. To Louisville, Ky. Good morning, Preston.

PRESTONGood morning. My question is a pretty simple one, and I realize the people there would not -- would hesitate to give an answer simply 'cause no one has a crystal ball. But my son and I were left a piece of property, which we sold a couple of years ago on the island of Lesbos, and we've taken the money and left it in the bank there, in two banks there, because we were told that any amount that's under 100,000 euros is insured.

PRESTONAnd now I'm becoming increasingly concerned about leaving the money there, the intent being that we were going to go back and buy another piece of property. But, in the meantime, I'm becoming more and more afraid that, you know, somehow we're either going to lose it or we'll end up with drachmas. And the inflation being what it will be if they go back to the drachma, it won't be worth anything.

REHMAll right. Jacob, very briefly.

KIRKEGAARDWell, that is a very good question. Let me put it this way. I would certainly put it in a foreign subsidiary of a Greek bank or a Greek -- a foreign subsidiary bank in Greece, meaning Emporiki or a couple of other banks at this stage. I would personally think the risk would be too high to leave them in a domestic bank.

REHMAll right. And as we've said, there are no financial advisers on this panel, but there's your word. We'll take a short break here and come back briefly.

REHMAnd now to what's happening in Spain. Joining us is Xavier Vila. He is a correspondent with Catalunya Radio. Thanks for joining us. And are you there, Xavier? We are certainly having problems with our phones this morning. Zanny Minton Beddoes, can you talk about the difference between what's happening in Spain and what's been happening in Greece?

BEDDOESWell, there's an enormous difference. Greece is really a very acute political crisis. It's a country that's been in an economic crisis now for three years. It's a very sort of, I think, rather desperate political situation. Are they going to stay in the euro? Are they not going to stay in the euro? Spain has -- Spain is a -- is one of the four big economies. Spain has a very big economic problem. It had a huge housing bubble, a huge credit boom in the kind of boom years of the euro era. It's now got a very big banking crisis, a very tough economic situation. Its economy is in recession.

BEDDOESThe European Commission said last week it was the only eurozone economy that it projected to be in recession next year as well as this year. It's got, what, almost 25 percent unemployment, 50 percent youth unemployment. The economy is in a very, very tough situation. But it's a very different kind of economic problem than Greece, and just to call the -- the previous caller made the point that Greece had been kind of living profligacy, living on the hoof for many years. That's, in some sense, not at all the problem in Spain. The Spanish government doesn't actually have that much debt.

BEDDOESAnd it had certainly been running a very prudent fiscal policy before this crisis. What Spain's going through in many ways is not untypical to what happened here, which was a big housing bust and a big financial crisis. But in the U.S., there was a big stimulus, and the government responded by running a large deficit and building up its debt. The Spanish are really unable to do that in -- because they're in the eurozone. And so the problem in Spain is that the Spanish banks are in very bad shape.

BEDDOESInvestors worry about the Spanish banks. They worry about the need for more bailouts from the Spanish state, so then they worry that the Spanish state is going to have a much, much bigger debt load. And so there's this kind of vicious spiral between them. So I think Spain is a very tough economic question, but it's not yet -- it's nowhere near the sort of political uncertainty that you see in Greece.

REHMDoes the Spanish government have a plan to fix the system?

KIRKEGAARDWell, I think part of the problem, frankly, is that the market -- I mean, certainly, I have been somewhat disappointed with the new Spanish government that came into office in December last year because, so far, the new budget that they proposed was actually a very short-term budget. It had very little sort of long-term vision about how do we reorient, how do we get a medium and long-term fiscal, how do we get it back to balance, the Spanish government, the government accounts?

KIRKEGAARDAnd the second one is that they have not been -- and this is probably the critical point. They have not been very convincing in dealing with their banking problems. They have basically been trying to tiptoe around this problem and been fundamentally unwilling to commit the kind of public resources that we kind of know from all previous examples is necessary to deal...

REHMZanny, you're shaking your head.

KIRKEGAARD...to deal convincingly with this issue because, you know, this is a country that has banks that are way down by, you know, lots and lots of dud real estate loans. They need to take them off the balance sheet of these banks so that these banks can begin to basically become normal banks and channel credit.

KIRKEGAARDBut this -- such a bad bank needs to be financed, and the Spanish government have now, very reluctantly, moved towards creating bad bank structures as well as sending in independent auditors to look at these banks. But the reality is they haven't actually committed the public resources because they're afraid that if they do so, that, all of a sudden, markets are going to look at them, and they're going to think they're Ireland.

REHMHuh.

BEDDOESYou know, I was shaking my head no, but I actually agree with Jacob on the narrow point about the banks. But I think the broader point, the notion that Spain is in trouble because its government has been acting too timidly, I think, is very unfair to the Spanish government. Spain is in an almost impossible situation. It's got this huge housing burst. It's got a huge credit -- basically a massive credit crunch. It's then had -- lost the confidence of foreign investors. It's had, what, basically foreign capital fleeing or certainly having no more access to foreign money.

BEDDOESAnd if that was the set case in any normal country, that wasn't part of a single currency, it would depreciate. It would -- there would be bailout money from the IMF. You would have a sort of standard approach to dealing with these kind of crises. But because Spain is inside the eurozone, it's had a very different recipe thrust upon it, which has been almost exclusively huge fiscal tightening. And it strikes me that that is, at best, a very, you know, insufficient part of the answer. So I think it's a mistake to blame the Spanish government too much.

REHMAll right. Let's go now to Boston, Mass. Good morning, Ross.

ROSSGood morning, Diane. I've been a longtime listener and glad I could get on the air.

REHMI am too. Thank you. Go right ahead.

ROSSMy question is pretty simple. Can anyone give me an example of when austerity has ever worked and dragged a nation out of this sort of problem? The only example I can think of is the U.S. Great Depression. You know, we tried several different things, and there was the classic double-dip recession. The only thing that really pulled America out of the Great Depression was the massive government spending program known as World War II.

ROSSFrom an economic perspective, the government went into a massive deficit spending effort and basically hired every unemployed person it could find and put them to work. And that set America on, you know, a path to become the richest, most powerful nation, blah, blah, blah, all that stuff that you heard of. But in short term, the solution that got us out of the Great Depression was government spending.

REHMZanny.

BEDDOESYou know, you make a very, very good point, and I think that this debate about whether austerity can be, by itself, a recipe to success is going to go on. There are economists on both sides. I think the sort of -- the way I look at it is austerity, as part of a package that either allows -- results in a big reduction in interest rates, all comes with a big devaluation of the currency, has, in the past, worked. So, for example, Sweden in the early 1990s, after its big property and banking crisis, it had a big depreciation of its currency.

BEDDOESInterest rates came down. There was then some -- quite a lot of fiscal tightening. But I think -- and so if you have some other safety valve that allows the economy to grow, then you can have fiscal cuts, and the economy can still grow. What I think is a problem is when you have very -- it -- and let's take case of Spain. You know, is there going to be much room for Spain to export a lot more?

BEDDOESWell, it is beginning to, but it's got no room on interest rates because -- and it's got no room on domestic lending because that's all contracting. And if on top of that you put a large dollar for fiscal austerity, the short term consequence is going to be recession or very slow growth.

REHMYou've just described the United States, with interest rates at zero, with banks not lending, with austerity measures left and right coming from Capitol Hill.

BEDDOESYes. But by comparison -- and I completely agree with you, Diane, which is why I've long argued that too much belt tightening in the U.S. too fast would be a mistake. But, by European standards, there's actually been relatively little here. The danger in this country is what's likely to happen at the end of the year when you have, you know, taxmageddon or whatever you want to call it, the expiration of the Bush tax cuts and the sequester spending cuts kicking in.

BEDDOESAnd I think that will have a very damaging short-term effect on the economy. What all these rich countries need is we need to find a way to credibly lay out deficit reduction over the medium term without slashing so much so fast or raising taxes so much so fast that you push the economy back into recession.

REHMExactly. Jacob.

KIRKEGAARDWell, I mean, I think that this whole idea that it's a really sort of a dichotomy between austerity and, you know, sort of Keynesian stimulus, at least in the European context, I believe, is a completely false dichotomy because...

REHMBut doesn't -- didn't his example of what happened here in the United States have some validity?

KIRKEGAARDOh, yeah. No. I mean, there's no doubt that ultimately, it was World War II that pulled the United States out of the...

REHMAnd putting everybody to work?

KIRKEGAARDNo, absolutely. But I think in the case -- I mean, if you take Spain, for instance, there's no doubt that excessive belt tightening or excessive austerity at this point will clearly lead to an unnecessarily deep recession. But there is a -- so, you know, Spain, no matter what it does, is going to have a tough time for -- in the short run. I don't think there's any doubt about that. But the idea you need to have -- there is a -- and this is true not just in Spain but in all European countries.

KIRKEGAARDThere's a very important structural element here, which is that, you know, we hear a lot about Spain having 50 percent youth unemployment now, which is an absolute disaster. But what we don't think about is that, actually, before -- you know, in early 2008, before Lehman Brothers collapsed, before the global financial crisis, Spain had 33 percent unemployment -- youth unemployment, which is also a disaster. So you need to change a whole set of structural economic reforms in a place like Spain in order to make this work. So it's not austerity or. It's austerity and.

REHMAll right. To Susan calling us from Berlin. Good morning to you.

SUSANGood afternoon, Diane.

REHMHello.

SUSANNice to talk with you. Hello. Diane, I lived in Greece in beginning of the '70s. Knowing what I knew from then, I didn't understand how Greece could ever get into the euro in the first place. And I think it's come out since then that the books were fixed to get them in. But having said that, I've been in Berlin for over 30 years, and I must say, I think they're really between a rock and hard place because if they try to assert themselves, they're called Nazis. I think we've all seen that in Greece and other places.

SUSANAnd, you know, it's not that rosy here either. A lot of people are really hurting. I know that statistically, it looks very, very good. But if you're living here, it's really hurting all over the place. We don't have flowers anymore. There isn't water in the -- I know these are small things. But there's been a lot of changes here as well. But my question is -- they created the euro, and my question is, why don't they create a second currency?

SUSANLet's say the euro (word?) and put the weaker countries, the so-called PIIGS, I believe they're called -- Portugal, Italy, Ireland, Greece and Spain -- into the second category and to collectively support them. And then give them the chance to come back into the euro, one, if at all possible if they can make it. Just that's an idea. I've never heard anybody talk about it...

REHMZanny, what do you think?

BEDDOESWell, it's a very interesting idea. I've actually heard various versions of that idea, of a sort of hard euro and a soft euro. The problem is that it's not clear to me that it really solves that much. In a sense that the pain and the costs of a euro break-up would be the same if you put the group of weaker countries into a soft euro. You'd still have that depreciate, that soft euro, very dramatically relative to the hard euro, and that would cause all kinds of balance sheet effects.

BEDDOESThere'd be losses throughout Europe, so that would be one problem. And the second is it's not clear. If you're going to leave the hard euro, if you're Portugal or Spain, why would you want to stay in another second currency? You might then actually want to have your independent -- monetary independence back and have your own currency back. So interesting idea. I'm not sure it's really the way that people are going to go.

REHMAll right. To Chesapeake, Va. Good morning, David.

DAVIDGood morning, Diane. Thanks for taking my call.

REHMSurely.

DAVIDLet me throw a different bigger picture out there. You know, Golden -- Goldman Sachs and JPMorgan have had a direct involvement with then the European Union, several countries that are now having problems. There's clear evidence that JPMorgan and Goldman Sachs are both using diversification that pretty much set them off to fail with their economic situations.

DAVIDThat being said, the overall big picture is to federalize or force the European Union to federalize their monetary system and market just like what we have here in the United States. What that does is by -- since China has, you know, pretty much balancing their currency up and down and causing everybody problems, if the European Union federalizes, it's all the countries under one big system, then they can spread the debt.

DAVIDThey can use the diversification and hedging, like we do here, to kind of, you know, make it less of an impact. And then when something happens, they're all in it, not just -- you know, right now, each country is doing basically what they feel is best for themselves, whereas, you know, that creates less strength, so to speak. And by federalizing their market, that allows us to have more power over forcing China to quit playing with their currency.

REHMAll right, sir. Thanks for your call. Just let me remind you, you're listening to "The Diane Rehm Show." You want to make a comment, Jacob?

KIRKEGAARDWell, I guess, a couple of comments. I mean, first of all, this is certainly the case that Goldman Sachs and other big investment banks had a role in helping the Greek government, you know, cook its books if you like. But I think it was a relatively minor role to be honest. I think this was first and foremost a -- an act that was perpetrated by Greek politicians first. So we shouldn't overplay the role of global financing. This was essentially -- they serviced a willing client in the case of all the...

REHMBut didn't they urge that client on rather than simply servicing a willing client?

KIRKEGAARDWell, yeah, but at the end of the day, you know, this is a sovereign government. And if a sovereign government is engaging in this kind of -- you know, the responsibility, in my opinion, resides first and foremost with the government. And then also on the issue of strengthening the euro -- I mean, I think that there will be a lot advantages in going before the euro in going -- for Europe in going to a Eurobond because it would create, you know, a much deeper liquid financial market for debt, et cetera, which has a lot of advantages.

KIRKEGAARDI don't -- and I think it -- but first and foremost, it wouldn't play out vis-à-vis China or vis-à-vis anybody else, but it would first and foremost provide stability for the countries in the euro.

REHMWhere do you see this whole next few weeks going, Zanny?

BEDDOESNext few weeks? I thought you might say next few years.

REHMNow.

BEDDOESI think the next few weeks are going to be very volatile. I think we're going to be looking very carefully at Greece. We're going to be looking carefully at what happens in the election campaign. We're going to be looking at what happens to the deposits in Greek banks. If the pace at which the Greek banks lose deposits accelerate...

REHMSuch as from our caller.

BEDDOESFrom our caller. If people like our caller perfectly, reasonably get worried, and more and more of them move their money out of Greece -- and that happens on an accelerating basis -- we could very quickly see a very serious run on Greek banks that would force the rest of Europe, even before the election, to act. So I would be looking for that. I'd also be looking for what happens in Spain, what happens in Italy, what happens in Portugal, what happens to their government interest rates. Do they spike?

BEDDOESWhat happens to their stock markets doesn't mean that we get into another crisis situation where the European Central Bank, which is the only institution that can act very fast, is forced to step in again. So I think it's going to be a pretty rocky few weeks.

REHMAnd if shareholders start withdrawing funds from European, especially Greek banks, what's that going to mean to the U.S.?

KIRKEGAARDWell, I think, first of all, I mean, immediately, you know, what happens in Greece is relatively limited importance to the U.S. It only really begins to matter for the U.S. if it means contagion inside the euro area. So it's really what a deposit run in Greece would do to Spain and Italy that matters for the U.S.

REHMJacob Kirkegaard, he's at the Peterson Institute. Zanny Minton Beddoes of The Economist. Thank you both so much.

BEDDOESThank you.

KIRKEGAARDThank you.

REHMAnd thanks for listening, all. I'm Diane Rehm.

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