Greek Crisis and the Future of the European Union – Part I

LONDON: So Greece won’t become the euro zone’s Lehman Brothers. Even with its catastrophic state finances, bonds downgraded to junk status and a record of fixing its balance sheet, the nation is too big to be allowed to fail.

Still, it must be made to pay the price for profligacy of a kind often associated with US consumers and sub-prime house buyers. The remedy decreed by European partners and the International Monetary Fund in return for their €120-billion, or $147-billion, rescue package may condemn it to deflation and internal political tensions that will keep the nation on its knees for years to come, As European leaders put the best face on events and insist that the crisis is about to end, the true ramifications of the crisis cannot be swept under the carpet in a world where global market operators take no prisoners.

Monetary union was meant to bring the chain of 16 resilient economies closer together, sturdily linked for a globalized world. It was supposed to offer greater stability than could be achieved from disparate currency regimes built on national financial discipline and also offer the world a strong alternative to the dollar. Unity was seen as strength. The financial probity preached by Germany, the strongest member of the zone, would be adopted by other member states as virtue prevailed and laxity was banished. The euro would emerge as a second great world currency alongside the dollar.

What the Greek crisis has shown is that union is not everything and that membership of the zone does not protect weak states from the pressures of international finance. Countries still issue their own bonds, even if they are denominated in euros, so they remain vulnerable to attacks by investors betting that these instruments will decline in value. In putting a premium on loans to Greece, governments in the euro region acknowledged that some member states are less creditworthy than others.

At the national level, budget black holes gape as widely as they did when each nation ran its own currency – when Greece finally came clean late last year, it revealed that its deficit would reach 12.7 percent of gross domestic product in 2010, double the original forecast and four times the limit laid down by the common currency’s guidelines. The European Central Bank in Frankfurt can preach German-style rigor, but other governments may choose to follow a course of short-term comfort to win elections or avoid social unrest. The reaction of European governments to the question of how to deal with their erring partner has, to put it kindly, lacked coherence, varying from early suggestions of an aid package of structural funds from the European Union to a suggestion from Germany that repeat offenders against the euro’s rules should face expulsion.

As leaders dithered, markets noted the weakness not only of Greece but also of other southern members of the currency zone, underlined by last week’s downgrading of Spain by ratings agency Standard and Poor’s. S&P delivered a similar verdict on Portugal:  A 9 percent budget deficit, high state debt, large current-account deficit and negative growth make it the next potential target for attack from the market. Ireland, meanwhile, is tightening its belt to make up for years of overspending and reducing its budget deficit, the biggest in the EU.  

The size of the Greek rescue package was finally decided on May 2, the first of its kind in the zone, and the intention was to choke off further doubts. But the global economic climate has changed since the days when governments like the one in Athens could borrow more or less at will. Any national economy that attracts the attention of market operators will be subject to intense scrutiny. While Greece may, indeed, be a special case in many ways, other European governments, not to mention the US, have not confronted the true cost of the stimulus packages they implemented in the face of the economic downturn that gripped the globe in 2008. To that daunting financial challenge must be added the likely public reaction to the kind of cuts needed to put state finances right.

For banks concentrating on rebuilding their balance sheets, the crisis has aroused nasty questions about the sovereign debts of nations such as Greece that have sailed too close to the wind. If, as some forecast, the rescue package has a limited life of two to three years, the possibility of subsequent rescheduling of debts is an uncomfortable one for European banks holding Greek government paper, not to mention big exposures to debt from Spain and Portugal.

At the national level, the crisis has shown in stark relief the inherent difficulty of operating a currency zone without a common political structure. The different approaches of Germany and France delayed decisions and generated uncertainty on which market operators could play. The comment reported by “The Economist” from Didier Reynders, Belgian finance minister – that his government could “turn a profit” on loans to Greece by borrowing at lower rates than Athens would pay – undercut thundering from Paris about speculator activities out to profit from the crisis.  

A long-term benefit of the rescue package could be more rigorous discipline in the currency region. But in the more immediate future, the package could put the spotlight on countries that have got away with laxity so far. It should not be forgotten that, while Greece is an extreme offender, other euro-zone countries, including France and Germany, have set aside budget-deficit rules – limiting a rise above 3 percent of GDP. In the past Greece’s budget deficit climbed close to 14 percent of GDP.  Another of the EU founding nations, Italy, has built up public debt of 115 percent of GDP, and expenditures before interest is paid are bigger than state revenues.

Tightening enforcement will do little to address a central fault line running though mainland Europe – the imbalance between Germany as a big exporter with a relatively low rate of consumption and other countries which export less and consume more in relation to GDP. At the same time, the soggy economic outlook in Europe, concerns about unemployment and political uncertainties as the governments of some major countries face electoral reverses, hardly point to resolute action that could alienate voters. The flaws in the common currency – above all, the lack of a united political project to back it – have been evident for some time.

The Greek crisis has brought the pressure of global financial markets to bear, with the inevitable potential for contagion. The nature of the imperfect union means that the need to bail out the weakest link in the chain becomes the dominant concern while the absence of a speedy, convincing reaction only fans speculation.

Next time round, the stakes could be much higher, which is why European leaders are so anxious to discount the possibility of a repeat performance on the other side of the continent. Greece may have had its rescue moment this week, but will there be a Lehman down the road?