Street battles, looting and arson turned central Athens into a war zone in December, 2008. While the violence was set off by the police shooting of a teenage student, it was stoked by anger and frustration about the rapidly deteriorating economy and rising unemployment.

Thirteen months and one government later, Greece is again braced for social upheaval as the country comes under extreme pressure from the European Union, the European Central Bank (ECB) and the credit rating agencies.

They are demanding that it whip its finances into shape or risk going bust, a scenario that some economists think could trigger a debt crisis that might rip the EU’s monetary union apart.

Greece’s main trade and civil servants’ unions have threatened strikes in February to protest austerity measures that they say will hurt the poor more than the rich.

Still, Greece appears to have little choice but to push on with the measures as fears grow this week that the country will default on its debt.

That could potentially trigger defaults in other debt-swamped EU countries.

The result is a EU divide between the countries, that, because of their rotting financial health, are known to bond investors as the PIIGS – Portugal, Ireland, Italy, Greece and Spain – and the more stable nations such as Germany and France.

The presents a conundrum for the European Central Bank.

Since the introduction of the euro, the ECB has had to come up with a monetary policy suitable for the 16 countries that use the currency. There are those who believe it cannot be done.

Nouriel Roubini, the New York University professor who predicted the 2008 financial crisis, is one economist who thinks the euro faces potential disaster as the weak countries struggle to pay their debts.

“Down the line, not this year or two years from now, we could have a breakup of the monetary union,” he said this week in a Bloomberg Radio interview from the World Economic Forum in Davos, Switzerland.

“The euro zone could drift essentially with a bifurcation, with a strong centre and a weaker periphery and eventually some countries might exit the monetary union.”

Other economists and policy advisers are more optimistic about the PIIGS getting their financial acts together and keeping the euro intact. But they note that the current crisis has exposed the design flaws of the euro.

“Greece, Spain and other countries are losing competitiveness rapidly and there’s no easy way out because they can’t devalue,” said Paul De Grauwe, professor of international economics at the University of Leuven in Belgium, and a member of the economic policy group advising European Commission President Manuel Barroso.

For the euro zone to survive in the long term, he says, the EU will require a drastic overhaul aimed at levelling the competitive playing field.

While Greece’s debt problems began well before the financial crisis, they were largely ignored during the boom years of the past decade, when the country’s growth and capital inflows were strong. The financial crisis wrecked the party and came as a shock to a traditionally poor country enjoying a few big, fat years.

Greece’s gross domestic product fell 2.9 per cent in 2008 and 1.1 per cent in 2009. No recovery is expected before next year. Worse, its debt and budget deficits soared.

Even using the government’s most optimistic projections, Greece’s debt-to-GDP will reach 120 per cent this year (about double Canada’s). The 2009 budget deficit was about 12.7 per cent, more than two times greater than the previously announced figure and more than four times higher than the EU’s economic stability pact rules allow.

Greece’s debt problems are not entirely its own. Part of the blame can go to the ECB, which announced in December the winding down of the “credit easing” scheme that provided unlimited liquidity to the banks, which in turn used it to buy higher-yielding European sovereign debt. As the ultra-cheap liquidity is withdrawn, bond prices have gone down, taking yields in the opposite direction.

Greece’s debt crisis intensified this week. On Monday it issued €8-billion ($12-billion) of bonds on the international market. While the issue was oversubscribed, the bond prices fell off a cliff on Tuesday and Wednesday amid reports that it had approached China to buy €25-billion of future bond issues. On Wednesday, Greek 10-year bond yields reached a record spread of 3.56 percentage points over the benchmark German bonds and a similar spread over U.S. Treasuries. The yawning spread made Greece a riskier credit than emerging-market bonds.

Even though the Greek government denied the China reports, the damage was done. In London, UniCredit chief economist Marco Annunziata said “such a development would represent a major blow to the euro zone and the EU, as it might be seen as a ‘rescue operation’ by China, far worse in terms of image than an International Monetary Fund intervention.”

The Greek debt crisis heightened fears about default risks in Spain, Portugal, Ireland and Italy, where deficits and debt-to-GDP ratios are shooting up and where the recession is proving enduring; Spain’s unemployment rate is 20 per cent, about double Greece’s. In Portugal, where debt is expected to swell to 91 per cent of GDP next year, 50 per cent higher than 2007′s level, bond spreads rose to their highest level since July.

The EU has given no clear indication that Greece or any other country about to hit the debt wall will be bailed out. The strategy is probably designed to ensure that Greece and other ailing countries do everything in their power to repair their finances. Greece’s Finance Minister George Papaconstantinou said the country is not seeking a bailout and plans to get its own house in order. “There is no Plan B.”

Still, every country in the EU fears a Greek default. Economists say a default would clobber the weaklings by driving their bond yields through the roof as investors flee, putting even more pressure on their public finances. In the worst-case scenario, one or two countries might be forced to shed the euro and relaunch their old currencies, which could be devalued.

Many economists do not think it will get to that point, because the cost of bailing out Greece would be less than the cost of repairing the euro zone damage unleashed by an avalanche of sovereign debt meltdowns. Indeed, Mr. Barroso, the European Commission President, hinted that the euro zone countries might come to the rescue of Greece. “It’s quite clear that economic policies are not just a matter of national concern but European concern,” he told reporters in Brussels.

Still, economists say the debt crisis among the weaker countries shows that the euro is far from perfect and can create more problems than it solves during recessions

Prof. De Grauwe, of the University of Leuven, says the EU will have to take more control over national budgets if the euro is to survive in the long term. To keep countries competitive, the EU might, for example, try to co-ordinate wage settlements among the euro zone countries. “Eventually, some form of harmonization in the budgetary process will be needed,” he said. “But transferring some budget powers to the EU won’t be easy. You would need to create a democratic process, otherwise you would have EU bureaucrats making the decisions.”

In the meantime, the bond market and the EU will put massive pressure on Greece to rein in its spending through public sector wage and employment reductions, defence cuts and the like. For Greece, 2010 could be marred with strikes, protests, maybe even riots, as the knife cuts deep.