Despite recent elusive gains, the Eurozone is teetering closer to the periphery cliff. The impending Greek default is forcing Germany, France, Brussels, ECB and IMF to unite – for the sake of Spain and Italy.
Since the late summer, the uneasy tension in European markets seems to have subsided. Unfortunately, timeouts are brief and sweet.
The Eurozone’s elusive calm originates from the European Central Bank (ECB) opting for the path pioneered by the Bank of Japan (BoJ) and the Federal Reserve. Instead of Japanese-style asset purchases or U.S. mortgage debt pileup, the ECB has engaged in a new bond-buying program, outright monetary transactions (OMT).
The OMT allows the ECB to purchase debt of 1-3 years’ maturity once a country has newly submitted to conditionality or is returning to the markets after a bailout program.
As initially in Japan and in America, these ECB purchases have suppressed yields and thus reduced market volatility. And as in Japan and America, this temporary relief has been misconstrued as gradual progress. In reality, the ECB is simply kicking the can down the road.
In the absence of the ECB’s efforts to compensate for common fiscal policy in the region, things would be far worse. The OMT is needed because the Troika – the ECB, the European Commission, and the International Monetary Fund (IMF) – and the two leading economies of Europe have decided that Greece must be supported – so that Spain and Italy can be saved.
How Brussels failed Greece
Precisely a year ago, the Troika concluded that the past Greek support had been inadequate; that debt restructuring was inevitable; and that the process would take a decade.
In reality, the Troika studies were far too optimistic, and based on far too ambitious assumptions. The idea was that Greeks would be willing to suffer a lost decade, after five consequent contractions, coupled with a huge plunge of living standards. What they would enjoy in return – after 10 years – would be a debt level of 120 percent of GDP, which the Troika called sustainable.
In effect, that is precisely the kind of debt burden that got Italy in great trouble last fall, forced PM Silvio Berlusconi to leave, while paving way to Mario Monti’s technocrats. Unsurprisingly, individual Greeks concluded that the medicine may be worse than the disease.
Today, a year later, after another round of bailouts and restructuring, the Troika has concluded what was evident in fall 2012 – that more is needed.
Currently, the Greek real GDP has contracted some 20% from its 2006 peak and it will continue to contract. What Greece suffers from is no longer a severe recession, but a depression. Concurrently, an entire generation of centrist politicians is being discredited, while electoral support is shifting from the centrist-right New Democracy (whose current support has plunged to barely 20% to the leftist anti-bailout Syriza (25%) and the extreme right Golden Dawn (14%), which has doubled its support in the past few months. At the same time, the support of the center-left Pasok, which only a year or two ago was seen as the most cohesive and majority Greek force, has collapsed to less than 10%.
The writing is on the wall. Any single-minded effort to focus only on austerity in Greece is bound to backfire first in Athens and then to spread across the region.
It is this fear that now unites both Hollande’s growth advocates (who have not specified their growth proposals) and Merkel’s austerity proponents (who know that austerity alone will not just do the job).
Why Greek support is a lesser evil
The Eurozone chaos could be contained as long as it was restricted to small economies, which each accounted for less than 3% of the Eurozone GDP. Everything changed when the contagion effect reached Spain and Italy last year. These two account for almost 30% of the regional GDP.
Like Goldman Sachs among banks, the two core economies are just too-big-to-fail. And they desperately need time to get their economic house in order.
If, under these circumstances, Greece would default, the result would be a contagion effect that would not spare Europe. That’s the take of the ECB, the IMF, Brussels, as well as Paris and Berlin. Consequently, Chancellor Merkel and President Hollande will support Greece for another year or two.
No disruption is acceptable prior to German fall election in 2013. No fundamental change is possible until after election in 2013-2014.
Why the debt relief is politically challenging
However, what makes the situation more complex is that although a similar debt relief in early 2012 allowed the reduction of Greek debt by more than EUR 100 billion, it only required private creditors to comply. In contrast, the new relief plans are predicated on additional taxpayer money and that is bound to cause significant political opposition.
In the absence of its next tranche of aid money (EUR 32 billion), Greece would default by the end of November. As the Troika is about to agree to give Greece two additional years to meet its austerity goals, the delay is likely to require up to €30 billion in additional aid.
The alternative would be a Greek default, which would not be orderly and which, thus, would spread severe contagion to Spain and Italy, and through their trade and financial venues across Europe.
Merkel and Hollande are not about to throw another lifeline to Greece because of their concern for the Greeks, but because of fear that, in the absence of such an intervention, Spain and Italy would be swept by turmoil, which would no longer remain just regional.
It is the contagion fears that are uniting Europe – for now.