First published in the Telegraph on 29 April 2010
It has all the ingredients for a perfect Hollywood sequel. The cliffhanger plot kicks off right where its predecessor ended; the cast is stellar, some characters from the original reprising their roles. But this time the stakes are even higher, the mood even tenser.
Greece is on the brink of bankruptcy. Based on almost any yardstick, markets are now betting that the government will default on its debt. At a staggering 18 per cent, the going rate to borrow for a mere two years is similar to the penal rates credit card companies charge their dodgiest customers. The government, International Monetary Fund and European Union have promised, vaguely, to hand over the necessary cash to help tide the country over, but to no avail.
It would be all the more shocking had it not happened before. But Greece’s problems today are merely Lehman Brothers redux. This is Global Meltdown 2. Granted, this time it is a country, rather than a mere bank, that faces collapse; this time, the victim may really be too big to fail. But the pattern is eerily familiar: the money starts to run out; investors realise with horror that there is a real chance of failure; the politicians promise that they will stand behind the institution; in a last-gasp attempt to halt the disaster, they ban short-selling; eventually the law of gravity proves irresistible, investors stage an effective run on the banks and the end is nigh.
Faced with such a scenario, there are two options: confront the crisis, knowing you simply may not have the firepower to deal with it, or go running, screaming, for the hills. The head of the Organisation for Economic Co-operation and Development, Angel Gurria, has chosen the latter path, declaring that the contagion is spreading “like Ebola… when you realise you have it you have to cut your leg off in order to survive”.
Before we lapse into amateur dramatics, however, let’s establish the facts: the market for Greek government debt has effectively frozen, much as the money markets did worldwide in 2007 – the initial trigger point for the crisis. Its banking system, stacked high with those same government bonds, is effectively insolvent. The country had been due to return to investors on May 19 to raise money; if a bail-out cannot be agreed by then, Greece will have no option but to default. But even that deadline is increasingly academic: the country has fallen victim to a run, and as anyone who watched Northern Rock’s demise knows, what follows is not usually pretty.
How did it come to this? This is where the screen dissolves for a flashback. Let’s float back to 1998, when the German parliament voted through the adoption of the euro and the dismantling of the Deutschmark with a landslide majority. True, there were voices of concern from a few fringe politicians and economists; four German professors tried and failed to have the decision overruled by the constitutional court, but they were derided as reactionaries.
The main argument against joining was simple: history shows it is impossible to have a fully fledged currency union without having fiscal union. Unless there is a central Treasury with the power to tax and spend, at some point one or other member state will borrow too much, throwing the region into economic disarray. Recognising the validity of this point, if not its logical conclusion, the euro architects jammed two cardinal rules into the currency’s framework: first, fine any country that runs excessive deficits (“The Stability and Growth Rule”); second, a no bail-out clause. Unfortunately, inevitably, both were broken: the first gradually eroded away as France, Germany, Portugal and then Greece broke the limits without being fined; now, euro members are edging closer to a bail-out.
Were Greece a character in this blockbuster, its first screen appearance would coincide with an ominous orchestral soundtrack. Ever since its lastminute inclusion in the single currency in 2001, Greece has been considered by many in Brussels to be an accident waiting to happen. The country has been in default on average one in every two years since the dawn of modern finance two centuries ago, according to Carmen Reinhart and Ken Rogoff, the chroniclers of debt crises. It had to negotiate special dispensation when joining for its national debt, then 100 per cent of gross domestic product: more than twice the EU-acceptable level of 40 per cent. The government struggles to raise tax from a middle and upper class that ducks through the many loopholes. It is hamstrung by union power, so even in the good times tough decisions are greeted with widespread strikes. To make matters worse, it has a demographic profile that makes the rest of Europe look sprightly.
It is no wonder Chancellor Angela Merkel rather callously indicated yesterday that the country should never have been allowed to join the single currency. Much to her annoyance, Merkel is rapidly taking on protagonist status. The Germans have refused to sign off the emergency loan, which is probably reasonable, given that Greece only officially asked for it on Friday. But this delay – precipitated by the fact that there are regional elections early next month, and that the German public are almost unanimously against a bail-out – is what has sparked this week’s chaos.
The country needs perhaps 100 billion euros to stay afloat for a few years. The International Monetary Fund can provide a maximum of 20 billion euros- and even then, that is far bigger proportionally than any of the bail-outs during its existence. If Germany is reluctant to bail out Greece, where does that leave Portugal, which is also cursed with many of the same problems (gaping budget and current account deficits), or for that matter Spain, Italy or Ireland? For although the politicians are desperate to portray Greece as sui generis, it is merely the canary in the fiscal coalmine. The financial crisis occurred when investors realised banks were excessively overburdened with debt; in the sequel, they realise that the same can now be said of a swathe of countries. Britain shares many of Greece’s problems, but not the most problematic – membership of the euro.
Without recourse to depreciation, Greece and its Mediterranean members have only two options: default, or slash public spending and raise taxes, and risk sending the economy into an inescapable recession. Some in Athens half-jokingly suggest a third path – selling off one or two islands to foreign investors. Yesterday in Berlin, Merkel insisted, again, that it take the deflationary, deficit-cutting path. But markets suspect default is far more likely – and perhaps not just a Greek one. Having downgraded Greece’s debt to “junk” status and Portugal’s to just above this level on Tuesday, they downgraded Spanish debt yesterday.
The consequences of a Greek collapse would be horrific for the euro area: it would leave an instant dent in the balance sheets of member banks; then, when the bond vigilantes turned their attention to the other indebted nations, the risk is that other countries, and banking systems, would fall victim. Even if the UK is not a target, the impact of a potential second recession in the euro area – Britain’s major trading partner, the world’s biggest economic bloc – would be disastrous. And don’t forget the implications for all sorts of companies: National Express has been forced to postpone a 300 million euro bond auction because of the chaos.
In the long run, the crisis must invite a reevaluation of the euro project, but that task will be left on the back-burner until the immediate drama has played out. Europe begins this crisis with barely a cent left to spend on future bail-outs. A full-blown double dip recession this year could derail the global economic recovery. And that’s before one considers the consequences for internal European diplomatic relations. Hollywood loves films that snatch victory from the jaws of defeat – but what hope now for a happy ending?”Greece’s problems are not unique in the eurozone. It is merely the canary in the fiscal coalmine “