Greece: The new Lehmans
It was less than three years ago that the failure of Lehman Brothers sent tremors through the global financial system, threatening the existence of every major bank and triggering the most severe economic crisis since the Great Depression.
As Europe’s policy elite met for fresh crisis talks on Tuesday the dark fear that haunted everyone around the table was this: if the bankruptcy of a middling-size Wall Street investment bank with no retail customers could have such dire consequences, what would happen if the Greeks decided they had had enough and reneged on their debts? Could Greece, in other words, be the new Lehmans?
Given the structure of modern financial markets, with their chains of derivative trades and their pyramids of debt, there is only one answer to this question: it is possible. The likelihood that a Greek default would pose a threat to the eurozone and the health of the world economy means it could be worse than Lehmans. Much worse.
Given that gloomy prognosis, the European Union and the currently rudderless International Monetary Fund know something has to be done, but are not sure what. It’s a tough one. A single currency that involved countries that were broadly similar in terms of economic development and industrial structure might just have worked. Bolting together a group of 17 disparate economies with different levels of productivity, growth, different languages and different business cultures was an accident waiting to happen.
The weaker countries have not been able to cope with the disciplines involved in giving up control of their interest rates and their currencies, with the problem going much wider than the three countries (Greece, Ireland and Portugal) that have sought bailouts. Spain’s housing boom and bust was the result of the pan-European interest rate being too low; Italy’s increasing lack of competitiveness stems from a lack of exchange-rate flexibility.
Instead those countries seeking to match Germany’s hyper-competitive economy have had to cut costs through stringent curbs on wage increases and fiscal austerity. This was the plan A that was wheeled out for Greece last spring, when it became the first eurozone country to run into trouble, and it has been repeated for Ireland and Portugal. Plan A involved providing Athens with a bridging loan so that it could continue to meet its debt obligations, while at the same time insisting on draconian steps to cut Greece’s budget deficit.
Clearly, it has not worked. Greece has found that the belt-tightening has left it with a bigger central government budget deficit in the first four months of 2011 than it had in the first four months of 2010. It’s not difficult to see why. Those who put together Greece’s programme underestimated the extent to which public spending cuts and tax increases would hamper the growth of the economy, particularly given the lack of scope for the currency to fall.
Historically the IMF’s structural programmes for troubled developing countries have involved devaluation so exports became cheaper, but Greece’s membership of the single currency has meant it cannot. But it needs to have the scope to grow its way out of its debt crisis. Failing that, the rest of the eurozone has to be prepared to stomach not just a second, but a third and perhaps even a fourth bailout so Athens can keep up with its debt repayments. Hence the drumbeat of speculation that Greece would be better off defaulting, or leaving the eurozone.
There is no suggestion that the Greek government is planning anything of this nature. Default and devaluation pose big risks, since the debts would have to be in a redenominated currency (like the drachma) that creditors would deem junk. In the short term Greece’s economic and financial crisis would almost certainly deepen.
Athens would prefer the European Union to provide a second bridging loan and to reschedule its debts over a longer period so the interest payments become less onerous. But that is, at best, a stopgap solution because it does not address the structural weaknesses of the eurozone.
For this, there are really only two solutions. The first is to turn monetary union into political union, creating the budgetary mechanisms to transfer resources across a single fiscal space. That would fulfil the ambitions of those who designed the euro and would recognise that the current halfway house arrangement is inherently unstable.
The second would be to admit defeat by announcing carefully crafted plans for a two-tier Europe, in which the outer core would be linked to the core through fixed but adjustable exchange rates. But neither option looks remotely likely. The eurozone’s future will not be decided in Athens or Lisbon but in Paris and, in particular, Berlin.
Both have invested vast stocks of political capital in “the project” and insist that there will be no defaults and no departures from the club. But German Chancellor Angela Merkel is facing strong political resistance to more bailouts. The political calculus is clear—cutting Greece and the other weaker euro area economies adrift would end the dream of a monetary union with a single economic policy. But failing to cut them adrift could cost Merkel her job.—