Greek Rescue Will Fail; Euro Zone Will Survive: El-Erian

The Greece rescue package is likely to fail, but that may not be an entirely bad thing so long as the nation's debt problems can be walled off from the rest of Europe, Pimco's Mohamed El-Erian said.

Photo: Norbert Schiller for WEF

As European leaders fight to keep the euro zone together and Greeks take to the street to protest austerity measures connected to a debt bailoutpackage, the larger battle has shifted toward preventing a collapse of the currency that could result if the sovereign debt contagion spreads.

Leaders are working to build a so-called firewall that will aim to keep the banking system capitalized in the event of defaults from Greece and probably Portugal.

"Greece has been sacrificed in order to build that firewall," El-Erian, the co-CEO at the world's largest bond fund firm. "In Greece, we are sustaining the unsustainable, and it comes at a cost and the cost is a society that has to put up with tremendous austerity without seeing a light at the end of the tunnel.

"That's why this package will fail just like the previous package failed."

With Greece's agreement likely to fail, attention then will shift to Portugal, which faces its own onerous debt burden.

French President Nicolas Sarkozy has said that his priority is to make sure the core of the euro zone survives.

"I think you can draw the line above Greece and Portugal and I think Europeans will draw the line when they're confident the firewall is there," El-Erian said.

Going forward, El-Erian said the European Union will be left to debate whether its future can entail the large social welfare programs that the public sector funds.

Runaway spending is what got the so-called PIIGS nations— Portugal, Italy, Ireland, Greece and Spain — in such trouble. Yet nations such as Sweden and Germany are able to thrive despite their cradle-to-grave promises from their respective governments.

Sweden "is a lesson for others (that) you can combine fiscal and financial soundness with growth and with a social system that has good safety nets. It can be done," El-Erian said. "Europe has to balance austerity for deficit reasons with growth. And if it doesn't we're going to be talking about it for years and years."