A lot of attention has been paid to the economical crisis in Greece. This is understandable, for Greece has broken important promises and apparently committed fraud towards the other eurozone members. However, the narrow focus on Greece clouds what really matters: This is no mere Greek crisis, this is a crisis for the euro as such.
Currently, there seems to be some sort of rescue plan for Greece in the wings. This is good for Greece, since it would then not have to confront its mistakes, and it is good for the European Union, as it would show how powerful the Union is and how irrelevant free markets are in todays financial situation. Further, avoiding giving Greece a hard ultimatum would demonstrate that no matter how reckless a country is run, no matter how far it is from complying with the requirements for eurozone participation, and no matter how much fraud has been committed to keep up appearances, no country will be left alone.
A compromise can ultimately be found that paves over any risk of confrontation with more money. Though at the expense of Greek sovereignty.
The exact extent of fraud committed by Greece to appear euro-ready is still uncertain, as new details are still emerging, the latest being complicity by the controversial US investement bank Goldman Sachs. From EUobserver:
Investment firms including Goldman Sachs arranged currency swaps for Greece over the last decade that allowed Athens to raise funds to reduce its budget deficit while pushing payments well into the future. Those transactions were not classified as loans, reports the the New York Times, and not made known to Brussels officials.
No material consequences are expected to follow from the disclosure, though.
Greece really needs a devaluation
One of the core ideas of the euro is that the member nations will no longer be able to devalue their currencies. Devaluation is a trick that constitutes a semi-default by a country. Officially, no default is set into place, all loans are paid out in full - but in money worth significantly less than when the loans were originally made.
This sleight of hand has historically proven itself eminently workable, as investors seem to have short memories and not quite comprehend the risks and the losses they incurred when lending to countries debasing their currencies. Devaluations were common in the Bretton Woods system from 1945 through 1971, have been less frequent in the European Exchange Rate Mechanism (ERM), and is not an option in the euro.
Devaluations not only makes the national debt lose value, it also renders imports more expensive and exports cheaper, creating at once austerity measures and improved conditions for exports, both good for reversing problematic deficits. This is exactly what Greece could use these days.
Now, since Greece no longer has a national currency, devaluation is not an option. Cutting back public spending is pretty much the only thing to do, and the advantages for the export industries cannot be created. All improvements have to come from strict austerity measures imposed by the state. This is not likely to go down well in Greece, which is already politically unstable.
The government will tell the Greeks that the European Union requires this, and probably be under significant pressure to get away with as little austerity as the EU will tolerate. Thus, it can be expected that Greece gets stuck in its economical crisis instead of implementing the required reforms.
A core promise: No bailouts!
(Except in extraordinary situations)
When the euro was created, the question was raised if the common currency would imply a common responsibility for rescuing faltering economies. That task would, for obvious reasons, land on the stronger economies like Germany, effectively punishing the thrifty and rewarding the reckless. It was made crystal clear that the euro would not have such implicit responsibility.
Except in extraordinary situations, like major natural disasters. The Greek crisis has been declared 'extraordinary', and a bailout package is probably being prepared in secrecy. A worst-case cost of € 100 billion is reported by Reuters. Such a bailout would create a blueprint for future bailouts of countries like Portugal, Italy, Ireland & Spain, who also suffer major deficit problems.
In an interesting display of who really holds the power in the Euroean Union, EU president Herman Van Rompuy was assisted by EU Commission chairman Barroso when delivering his official statement on the Greek Crisis on February 11th 2010.
What about inflation?
Inflation is a key to the mighty power of the central banks. By supplying freshly 'printed' money to the financial sector, the central bank has the power to bail out any failing institution if it wants to, if it is considered financially or politically desirable. As for central banks being the protector of the citizen against the spectre of inflation, forget it, it's the other way round. As Fed chairman Ben Bernanke said back in 2002:
The US government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many US dollars as it wishes at essentially no cost. By increasing the number of US dollars in circulation, or even by credibly threatening to do so, the US government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services.
Increases in the consumer price index is the least interesting and least damaging aspect of inflation. Much more significant is the fact that some parts of the economy gets the inflationary money before others - and in the fractional reserve system, banks and other financial institutions are the beneficiaries. This may be good for Wall Street, but is bad for agriculture, industry & shipping, who will need to work harder in order to earn the freshly created money.
A couple of problems exist when trying to measure inflation. Inflation is commonly expressed as increase in the Consumer Price Index (CPI), but changes to the CPI calculations have made that yardstick irrelevant. Increases in the money supply are a better measure. The numbers can be found a the ECB Data Warehouse. While the sheer amount of data tends to make research difficult, this pdf file holds a 2-page overview of the eurozone money supply. The data for 2009 show a rapid growth in core money (M1, ECB supplied funds used to support banks and stimulate the economy), and a stagnating growth in derived money (M3), reflecting the fact that individuals and corporations are reducing outstanding loans. The increase in M1 sets the stage for a later rapid increase in M2 & M3, resulting in significant inflation.
When banks and others have been bailed out, there has been talk of 'unconventional' measures by the central banks. This actually has a specific meaning, that the central bank purchases commercial papers (debt) directly, paying out in freshly created money. This is a directly inflationary method.
Are loans from the ECB ruled out?
It has been mentioned that the latest downgrading of Greek debt precludes the use of this debt as collateral in the European Central Bank, ECB. It should have been so, but due to the 'extraordinary' financial situation, an exception exists. Wall Street Journal digs into the details on this:
Following the collapse of U.S. investment bank Lehman Brothers, the ECB in October 2008 lowered the credit quality threshold for collateral to BBB- from A-, with the exception of asset-backed securities, which require a higher rating. The arrangement is in place until the end of 2010.
"So unless the ECB fiddles with its rules before the end of next year, then from the beginning of 2011, Greek sovereign bonds will no longer be eligible for ECB collateral if Moody's or S&P downgrade them," Nielsen cautioned.
Now, it would seem rather unlikely that the European Union and the ECB would let Greece slip through the cracks and kick Greece from eligibility for ECB funds. All things considered, fiddling with the so-called 'rules' (which by now seem more like 'statements of intent') is the likely outcome. That will keep in place the option to use Greek securities as collateral for loans from the ECB, which effectively constitutes money-printing.
What will happen if ECB sticks to its rules?
The immediate consequence would be cutting Greece off from low-interest rate loans originating from the ECB. Greece would then be restricted from taking loans in the free markets, where investors are free to rate the risk themselves, rather than rely on rules based on rating agencies. Given the unstable political situation in Greece, that would send the value of Greek debt through the floor, and correspondingly send the interest rates through the roof. That would automatically limit the amount of loans available to the Greek government and force austerity measures directly, no EU 'pressure' required. Letting things develop by themselves is not the EU way, so this simply won't happen.
An intermediate option would be the use of IMF funds. From a European perspective, this would seem preferable, as the IMF Special Drawing Rights (SDR) are inflationary for every currency of the IMF member states - that is, everyone. By inflating all currencies, value would be taken from every kind of money on the earth, making also the Arabs, Australians and Russians pay for the Greek mess. But the European Union is intent on showing that it is able to deal with the crisis, and will not be interested in drawing on IMF, except for expertise. Thus, European citizens will end up footing the bill, Australians will be off the hook.
The worst-case scenario is a Greek bankruptcy. This means that Greece declares itself unable to pay the full value on its debt, and that its lenders will have to take severe losses, to the tune of € 100 billion or so. This would have severe impact on the financial stability and might kill off some of the most exposed investors. Permitting a Greek default would also mark a reversal of the trend towards more 'moral hazard' in international banking, as the creditors would have to bear the losses themselves, having nowhere left to shift the losses.
Further, the ECB would incur losses on the supposedly safe loans with national debt as collateral. That would cast doubt over a central function of the ECB, that of providing fresh money based on government debt, a key function of the institution, as described aptly by Anatole Kaletsky. This simply won't be permitted to happen.
This isn't just about Greece
While the fuzz is about Greece these days, an observer with some overview of the situation will understand that this is not merely about Greece. Eurozone average public sector deficits have been 6.4 % in 2009 and are expected to be at least 7 % in 2010 (Wall Street Journal), with public debt approaching 84 % of GDP in 2010 (Global Times). The debt limit for eurozone member states is 60 % of GDP, paradoxically rendering the eurozone on average not qualified for euro membership.
Combined with runaway unemployment, a credible reversal is hard to spot at this time, and other countries (Spain, Hungary, Netherlands, Ireland) than Greece could easily find themselves in serious debt crises during 2011 or 2012.
Any bailouts for Greece would serve as a model for other countries, and it is thus in their interests to create a bailout model with a dual purpose: Outwardly it should appear tough enough to instill confidence in prospective investors (insurance companies, pension funds etc.), while not being so hard that it would impair their chances for reelection.
Also, there is a risk of a guaranteed bailout being seen as automatic. From EUobserver:
EU institutions and national capitals have engaged in a tricky balancing act regarding Greece, say analysts. On the one hand they have sought to convince jittery investors that Athens will not be allowed to default on its debt obligations, while at the same time avoiding the signal that overspending governments will simply be bailed out.
Which gets us to another question: Who would really pay for a Greek bailout package? The details are not known at this time, as the European Union (the Summit Meeting, the Presidency and the Commission) are not exactly talkative about the details. They want to reassure investors that Greece will not be left in the cold, yet do not want to give a guarantee to Greece that would seem unconditional and cause the Greek government to slack off on economics once again.
In reality, the stronger economies would have to pay. Who else? If we didn't have strong economies with great corporations and hard working employees to pay for the bailout of countries with bloated public sectors and low productivity, who would? One may of course wonder why the productive are being punished and the inept rewarded. One has to take the EU Commission and experts on faith for this approach, for conventional wisdom would reward the productive and avoid unearned incentives for the inept. We have confidence in the unconventional measures taken by the Union. Should they fail, we will need to think up something else. Like rewarding the productive rather than bailing out the spendthrifts.
The 'fear' that the problems in Greece may spill over to other eurozone member states is a ruse. The reality is that other member states have also deep economical problems, and any market reactions, such as increasing interest rates, will be based primarily on the fundamentals of those countries, not on fear of the Greek situation. To prevent 'spillover', the other countries need to fix their fundamentals, not worry about psychology or public relations damage control.
What should be done
It is interesting to watch how responsibility for the Greek situation is being shifted away from Greece to Brussels. Bailout packages do not come for free: Greece would be partially ruled from Brussels should such a package be implemented. While it might seem dubious that Brussels is competent at running a country directly, it does make sense that fresh money supply comes with conditions and control. It is quite likely that Greece will accept to hand over part of her sovereignty in return for fresh supplies of much-needed euros.
In reality, this constitutes a further centralization of power in the European Union, based on the money-printing abilities of the European Central Bank. For any nation desiring to remain sovereign, this is not desirable. A direct default, with all its immediate hardship, would be a sincere alternative.
The fact that Greece used fraud to pretend to qualify for the euro does make the situation somewhat different. Rather than guaranteeing a bailout ('if needed'), the other euro countries should not put up with such an insolent and spendthrift nation. Rather than promising 'unconditional support', an ultimatum would be in order:
That would be dramatic, and would force Greece to be directly responsible for getting things in order. Should Greece fail, no rotten compromise should be searched for, but rather a direct execution of the threat: Kicking Greece out of the euro, forcing it to readopt the drachma. That would demonstrate to the world that the stability of the euro will be defended at any cost, and would be a powerful lesson for the other troubled economies of the eurozone: Shape up or get kicked out.
Either Greece gets the financial situation in order, or gets the boot from the euro.
Update: Botching the blame game
In a surprise development, Greece is now blaming Germany for having stolen its gold during WWII:
"They took away the Greek gold that was at the Bank of Greece, they took away the Greek money and they never gave it back. This is an issue that has to be faced sometime in the future," Mr Pangalos told the BBC World Service.
"I don't say they have to give back the money necessarily but they have at least to say 'thanks'," he added.
Now, for all intents and purposes, World War II is over, and a final settlement was achieved in 1990. as part of the German reunion process. Even if Greece is right, it is too late to make any demands in this respect. Also, war reparations have been paid to Greece earlier, $ 150 million in 1938 prices.
Any monetary compensation is a ridiculous idea. It isn't what Greece is asking for (formally), they would be happy with a 'Thank you' from Germany. But this is a poisonous apology. It was the Nazis who took the Greek gold, (and the Greek who didn't defend their property properly during WWII). Any apology would be an implicit acknowledgement that the current Democratic Germany is a successor state to the Nazi regime. This is sneaky on the side of Greek, and Germany need not take this bait.
One possible German reaction would be: "It is indeed unfortunate that the Nazis took your gold, and that you did not make claims to it in time. That, however, is not our problem."
Another would go: "World War II is over and all issues related to that have received final settlement. We see no reason to dig up ghosts of the past, in particular since you are the party in need of help."
Those responses would probably constitute breach of diplomatic etiquette. A third alternative would be:
"We are sorry that the Nazis took your gold. Since this seems to be a matter of great importance for you, we apologize for the past. As for the matter of less importance, providing you with economical help in the current situation, we believe you should be content with the apology. Good luck!"
That probably wouldn't go down well, either. Greece needs money, real money, and needs it now. So they try a different version of the blame game (also from the article in EUobserver):
Greece has come under pressure recently to explain allegations that it used complex financial products, provided by US investment banks, to conceal the true state of its debt pile over the last decade. Athens is also accused of manipulating its figures to gain entry into the eurozone in 2001.
Addressing the EU concerns, Mr Pangalos said Italy had done more to mask the true state of its finances before joining the single currency.
"You simply put some amounts of money in the next year ...it is what everybody did and Greece did it to a lesser extent than Italy for example," he said.
Greece does admit to extensive fraud in order to join it - but opens a different front, in stating that Italy is even more fraudelent. How is that for protecting confidence in the euro?
As things stand now, we need to put Greece on ice while examining what has taken place in Italy. If Greece is right, that the Italian fraud is more extensive than the Greek, Italy also deserves an eviction from the common currency, in order that its reputation and stability be protected.
As for Germany: There is every reason for the honest and hard working Germans to keep their money rather than spending (wasting) them on saving undeserving countries like Greece.
A prediction:
Since the other eurozone leaders are setting the rules, no credible threat of kicking Greece from the euro will be made, not to mention Italy. The expediency of lenience can be expected to dominate over strict consequences, the money supply of the euro will be permitted to expand, and the fundamental problems of competitiveness and mounting tension will remain, all while the eurozone economies will continue to falter.
There is a fundamental need for a return to market economy in the financial markets. Won't happen anytime soon. Further centralization of power in Brussels is a more likely outcome.
