Wednesday, July 27, 2011

Greece, Germany, and the Euro

One hesitates to comment on the economic situation in Europe when stories come out daily from multiple sources indicating new activity. But new activity does not necessarily indicate progress. An article by John Lanchester in the London Review of Books, Once Greece Goes..., indicates that the troubles are far from over, and while solutions might be obvious, they may not be attainable. Lanchester provides valuable insight and a prospective that will help interpret events as they take place.

Lanchester provides this short course in Greek economic history.

“Greece joined the EEC in 1981....and subsequently the Greek government created a client state in which direct subsidies and transfers from the EEC were supplemented by easy loans from Western European banks. Money poured into Greece, and was used to fund a huge boom in public-sector jobs, most of them linked to political patronage. Various forms of corruption permeated the system, where cash gifts in fakelaki or ‘little envelopes’ were a fact of life, and where, crucially, the rich regarded paying tax as something that only the poor and stupid would ever choose to do. This latter fact meant that Greece was in certain vital respects a country without a functioning version of the social contract.”

When it became clear that Greece had accumulated more debt than it could possibly repay, a loan was provided to the country on the promise that expenditures would be drastically cut and revenues would be increased. It was hoped that these austerity measures would hold down the cost of borrowing money and diminish the national deficit. Unfortunately, no one bought this gimmick. The cost of debt continued to rise, and the austerity measures caused the economy to continue to crash.

It is well known that the Greek people are not happy with the situation. Demonstrations and strikes are frequent occurrences. Lanchester is worried that this confrontation between the Greek government and its citizens is entering a more serious phase. Demonstrations began with leftist protestors, but are now beginning to spread to the middle class, who Lanchester refers to as the Indignati.

“The Indignati are not stupid....the ‘bailouts’, as they are always called, are no such thing. Taxpayer-funded capital injections into otherwise bankrupt banks were bailouts. The Greek ‘bailouts’ are loans, pure and simple. The money will have to be repaid, and repaid at ungenerous rates of interest: 5.2 per cent for Greece, 5.8 per cent for Ireland. These short-sighted and grasping interest rates, motivated by the need to provide political cover for other governments, make an already critical problem significantly worse.”

French and German banks hold a large share of the Greek debt. The need for these countries to keep their banks solvent is not lost on the Greeks.

“The Indignati do not find that a compelling reason to embrace a decade or so of abject misery. They want the Greek government to default, and the banks to accept losses for loans they shouldn’t have made in the first place.”

The thought of such a default is frightening to the rest of Europe—and to the rest of the world as well.

“Any abrupt form of Greek default, caused by the lenders’ failing to lend or the Greeks’ missing a bond payment, would be what is known as ‘disorderly’, an eventuality that would play out as anything from a mild local spasm to a full-scale continent-wide meltdown, featuring the collapse first of the euro and then of the EU itself.”

Why such dire and uncertain outcomes? Lanchester says it is because the world financial sector is little changed from the situation in 2008.

“Who owns that Greek debt? As I’ve said, mainly French and German banks. Yes, but banks insure their debt via the use of complex financial instruments. Insure it with whom? Don’t know: some of it is insured with British banks as counter-parties to the risk, but that risk will be insured in its turn, so that the identity of the person holding the parcel when its last layer of wrapping comes off is a mystery. That mysteriousness was the thing that made Lehman’s collapse turn instantly into a systemic crisis.”

The direst of the possible outcomes arise if a Greek default puts other countries with debt problems at risk.

“The euro was not designed to default, so when Greece does, other European countries who have had to ask for non-bailout bailouts – Ireland and Portugal – will have their ability to repay their debts questioned. If one or other of them undergoes a ‘rollover’, or ‘restructuring’, or ‘rescheduling’ of its debt – all polite words for default – the next country in line will be Spain, and that is where everything changes. The ECB/EU/IMF ‘troika’ can write a cheque and buy the Greek economy, or the Irish economy or the Portuguese economy. But Spain is the world’s twelfth-largest economy, and the ECB can’t just write a cheque and buy it. A Spanish default would destroy the credibility of the euro, and quite possibly the currency itself, at least in its current form.”

Lanchester is also worried that the frustration experienced by the Indignati is shared with a number of states where austerity has been imposed.

“....the general feeling about this new turn in the economic crisis is one of bewilderment. I’ve encountered this in Iceland and in Ireland and in the UK: a sense of alienation and incomprehension and done-unto-ness. People feel they have very little economic or political agency, very little control over their own lives; during the boom times, nobody told them this was an unsustainable bubble until it was already too late. The Greek people are furious to be told by their deputy prime minister that ‘we ate the money together’; they just don’t agree with that analysis. In the world of money, people are privately outraged by the general unwillingness of electorates to accept the blame for the state they are in. But the general public, it turns out, had very little understanding of the economic mechanisms which were, without their knowing it, ruling their lives. They didn’t vote for the system, and no one explained the system to them....”

“Greece has 800,000 civil servants, of whom 150,000 are on course to lose their jobs. The very existence of those jobs may well be a symptom of the three c’s, ‘corruption, cronyism, clientelism’, but that’s not how it feels to the person in the job, who was supposed to do what? Turn down the job offer, in the absence of alternative employment, because it was somehow bad for Greece to have so many public sector workers earning an OK living? Where is the agency in that person’s life, the meaningful space for political-economic action? She is made the scapegoat, the victim, of decisions made at altitudes far above her daily life – and the same goes for all the people undergoing ‘austerity’, not just in Greece.”

Everyone who comments on the current economic difficulties arrives at the same conclusion: Europe needs greater fiscal unity. As in the United States, there are stronger states and weaker states, and funds necessarily flow from the strong to the weak. The United States can issue bonds with the backing of the entire country, Europe needs to be able to issue bonds backed by the Eurozone as a whole.

Lanchester singles out Germany as having the dominant role in these issues.

“There is one country in particular where this disconnection between the political, the personal and the economic poses an acute threat to the world economic order. That country is Germany. The economists speak of ‘macro-economic imbalances’, the fact that German interests and, say, Greek or Irish or Spanish interests are not in alignment. The German economy is too big and too powerful for the health of its neighbours, unless European monetary policy is somehow ameliorated to help the smaller, weaker countries stay in step. Interest rates which, during the first decade of the euro’s existence, suited German manufacturers, caused toxic credit bubbles to grow in Greece and Ireland and Spain. The consequences of those credit bubbles could take another decade to unwind, ten years of hard times for the citizens of those countries, who will spend most of it sweating to earn the tax money to pay back the German banks whose lending fuelled their bubble.”

Most business for Germany’s vaunted export sector is derived from its European neighbors.

“German savings go to German banks to lend to other countries so that they can buy German goods from German companies who then save their earnings in German banks who lend it to … and so on.”

“This system is not elegant but it is probably sustainable, as long as German taxpayers are willing to pay for the busts and bailouts which will inevitably ensue. Their economy is so big that they can pick up these bills if they want to.”

The current indications are that the German taxpayers do not wish to assume this responsibility. Lanchester sees this as a dangerous tendency.

“....if the euro is going to continue to exist in its current form. Germany has to put the broader European interest on the same level as its own national interest, or the euro is toast.”

Lanchester finds a great deal of irony in the current situation.

“During the 20th century, the greatest danger to European stability was Germany’s sense of its special destiny. During the 21st century, the greatest danger to European stability is Germany’s reluctance to accept its special destiny.”

Many things have to fall into place, and many sacrifices have to be made by both nations and individuals if Europe is to emerge from this situation in a healthy state. The alternatives are not ones one would wish to contemplate.

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