The Greek and eurozone debt crisis has ceased being about political economy – it has evolved into an existential crisis for the EU itself. The euro has resulted in benefits for Germany and other countries but the euro was also born with some inherent defects, resting on two flawed assumptions: firstly, that political ambition can stamp out financial realities – the idea that Germany and Greece, despite their economic divergence, could successfully share the same currency. Secondly, that citizens in weaker and stronger eurozone countries alike would automatically accept further EU integration once the Single Currency crashed into economic reality requiring new tools – such as bailouts – to keep it together.
The effects of these assumptions are now evident across Europe – on the streets of Athens, in political meeting rooms in Helsinki and in the rise of populist parties from Vienna to Paris. In this toxic environment, what can Europe possibly do to get back on track? The European Central Bank, for one, has told us that a Greek default would result in a “Lehman moment” for Europe, meaning that yet more bail-outs are the only option.
But here’s the catch: the bail-outs aren’t working, and a second Greek bail-out could even make things worse in the longer term for both Europe and Germany, without solving any of the root causes. Eeven with the help of a second bail-out Greece will most likely again run out of money in 2014 given its poor growth rate and lack of competitiveness.
One argument for postponing the inevitable is to allow banks to buffer up against potential losses resulting from a Greek default. But the truth is that banks have had more than enough time to reduce their exposure to Greece. As late as February, Greek bonds were trading at 80% of nominal value – A good recovery rate given the mess that Greece is in. Why did the banks not take this deal? A big reason is that they are continuing to expect that politicians and the ECB will continue to bail out Greece. This is fuelling, not ending, Europe’s debt bubble (while taking moral hazard to a whole new level).
The most important political point: Open Europe estimates that the EU, IMF and ECB accounted for 26 percent of Greek debt at the start of this year but, by 2014 this will have risen to 64 percent. In other words, every household in the eurozone today underwrites 535 Euro in Greek debt (through loan guarantees – so these are not yet costs for these households). However, by 2014 this will have increased to a staggering 1,450 Euro. Meanwhile, private investors are largely being let off the hook. This simply isn’t right.
If you think that the mood in Europe is toxic today, imagine the potential political fall-out when Greece defaults and taxpayer-backed loan guarantees are turned into outright losses. The vacuum created by such a crisis could well be filled by anti-European populist parties. Then don’t be surprised if citizens across the EU opt to throw out the baby with the bathwater. Now, that would be a political “Lehman moment”.
Instead, Germany should be pushing EU leaders to plan for an orderly restructuring of Greece’s debt (combined with a limited cash injection) a soon as possible which will actually deal with Greece’s debt burden. This would serve Germany’s interests far better than any of the proposals currently on the table.