The Cataclysmic Euromess in a Nutshell

“Greece, like other countries, has to experience that if one doesn’t stick to fundamental rules of stability one has to pay a high price, which Greece can’t be spared from.”

German Finance Minister Wolfgang Schaeuble

The recent crisis has revealed in very agonising fashion the endemic failings of EMU from a policy ‘one size fits all’ perspective. The usage of EMU by peripheral EU members to ‘leapfrog’ on the back of credible, creditworthy financially strong nations has led directly to the restructuring-default impasse of 2011. The consistent view of the financial markets is not default per se, but the risk of contagion from and between the so-called PIIGS and its effect on the larger more stable nations and, inevitability, on the European lender of last resort and anchor of the euro, Germany.  Aside from the rhetoric, fiscally speaking, just as a budget crisis in New Jersey or California cannot pull apart the US dollar, one in the PIIGS cannot, by itself, bring down the euro.

The real problem is that if the situation among the PIIGS is not uniformly the consequence of a sustained period of spending binges like some assert, than how can EU-European Commission-IMF (troika) force common austerity plans upon structurally and fundamentally different economies? For example, previous economic mismanagement and governmental profligacy is far more prevalent in the Greek case than the Irish case, which is predominately a fiscal crisis caused by a severe banking crisis. Does that mean preferential treatment is likely for Ireland? If not, why not?

The problem now is how, without the correction mechanism of devaluation to reinstate a competitive edge for exports do Portugal, Ireland and Greece return to economic health especially in the midst of painful deflationary austerity plans and, in the Greek case, future massive privatisation schemes and public sector wage slashing. As Krugman asserts, we are in a quite bizarre situation, akin to the Hoover Administration in 1930s Great Depression America, where authorities sought to deflate a balloon economy which had already unceremoniously burst. This so-called ‘inverse Keynesian compact’ took the opposing view of Keynesian stimulus spending (to jump start economic engines by pumping in cash, like ‘oil’, to get the economic ‘engines’ working again) by aiming to tackle crises by doing all you can fiscally to restore confidence.  In a panic, all you can really do with any assurance is combat collapsing recessionary tax revenues with deep cuts to public spending to meet avoid drowning in red ink. Of course, the question then arises – if the Hoover method prolonged the Great Depression, why are the troika insisting on this in the Irish, Greek and Portuguese cases?

The most obvious answer to this is simply, the lack of an alternative. Adopting the Keynesian approach of fiscal stimuli, or some variant of a 21st Century Marshall Plan (as tentatively accepted in the July EU Council Summit), requires a total recalibration and reappraisal of monetary policy within EMU to possible incorporate the creation of Eurobonds, the creation of a European Treasury Ministry through the beefing up of the ECB or a pan European bank rescue plan. Politically, this is difficult because, ironically, the ECB is a-political and therefore semi-detached from the meddling influence of the EZ-17 and EU-27. It is perhaps also true that it is the response of the Franco-German alliance to the Greek situation that has the markets gittery. The game of German-PIG brinkmanship over aid packages, sharp political disagreements in Ireland and Greece over their EU-IMF deals and recent Franco-German disputes over the role of the IMF has contributed to a deepening global realisation of a farcical situation – there remains a continuous absence of economic governance in Europe. Essentially, no one wants to make the tough decisions and we arrive at the clichéd term of ‘kicking the can down the road.’

The ‘inevitability’ of eurozone bail-outs and yet the weakness of detail over the European Stability Mechanism (ESM), the post-2013 successor to the €440bn EFSF eurozone fund, has shaken financial markets by injecting uncertainty into an already festering wound. Were a common, comprehensive and most importantly financially enormous solution to be found, weaker nations would be able to lower their astronomical borrowing costs, tap emergency funds and return to normal borrowing from the bond markets in short order which would reduce pressure at EU level considerably, at least staving off disaster temporarily.

If investors cannot forecast, in the worst case scenario, whether peripheral nations will be aided sufficiently (whether with one, two or twenty bailouts) then evaluating perceived risk becomes impossible and unattractively costly.  Addressing this risk can be futile. In February 2010, Luxembourg Prime Minister Jean-Claude Juncker, the head of the Eurogroup of EZ finance ministers, stressed that Spain and Portugal pose no risk to eurozone stability, implying indirectly at that time that the situation with Greece is the exception rather than the rule.  When Ireland requested a bailout in November, this argument had already lost resonance with expectant investors, further losing resonance when Portugal followed suit in March 2011.

The stringent position of ECB head Jean Claude Trichet while reflecting the importance of avoiding moral hazard (where those responsible are let off the hook, bailed out and expect this in the future so continue to behave recklessly), is deliberately understating the problem. Arguably, it was an equally stringent approach by the US Bush Administration which permitted the collapse of Lehman Brothers and ushered in speculative panic on global financial markets. This is something the ECB clearly fears.  The after effects of Lehman in hindsight were disastrous and the decision an historically bad mistake. Ultimately, adopting the Lehman’s approach will likely result in Lehman 2.0 in Europe, with nations on the chopping block rather than Wall Street investment banks.

The ECB’s current approach can be accused of merely allowing speculation to continue unabated and relegating responsibility for Greek and Irish bonds to the credit rating agencies, agencies implicit in the sub-prime mortgage bond debacle. How much is deliberate stalling for time and how much is a reflection of incoherent structures in place is not certain.  One thing is certain – the issue of the euro has been relegated to minor importance amidst the threat of national defaults. Its failure is predominately emblematic of the indecisiveness of political leaders in relation to economic governance but it not symptomatic of the current crisis.

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