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Greek Tragedy Averted for Now

The EU has affirmed itself as the last resort to save Greeceā€™s finances, but without making any specific promises and insisting that Greece must first do much more on its own.

When the finance ministers of the 16 nations using the euro met on Monday and Tuesday, the most widely followed item on their agenda was the discussion of the crisis surrounding Greece's finances, which cuts to the heart of European fiscal cooperation in a manner no other recent crisis has done.

According to the EU's new Lisbon Treaty as well as to the statutes of the European Central Bank (ECB), neither the ECB nor the national central banks may bail out EU members through loans or buying their debt. However, a close reading of the rules reveals that bilateral aid from other countries or a package put together by a group of countries is a legal alternative not excluded by those rules.

Following this week's finance ministers' meeting, Austria's Josef Proell underlined that no support had yet been promised, and that ball was still in Greece's court. As Eurogroup chairman Jean-Claude Juncker said, "Greece must know that taxpayers in Germany, Belgium, the Netherlands and Luxembourg are not ready to correct the failings of Greek budgetary policy."

Why Greece is different

The meltdown in Iceland a year ago was not an institutional issue for the EU, because Iceland is not a member, even if certain EU members were disproportionately affected. Last March, outside the eurozone, when the EU's new East European members were beset by balance-of-payments problems, the EU turned down suggestions for a blanket bailout of the region. German Chancellor Angela Merkel declared that all aid should be channelled through international financial institutions such as the International Monetary Fund (IMF), and the situation temporarily stabilized.

As American observer Jacqueline Doherty notes, Greece's debt burden is comparable to California's and the country's GDP is exceeded by any number of mid-sized American states. However, the prospect of a Greek default cannot be regarded as just another isolated incident like Iceland or Dubai, because it is only one of several eurozone countries that are tottering on the edge of fiscal implosion.

The larger problem is that the 'eurozone periphery' (including Portugal, Spain and Italy; while Ireland, slashing spending and wages, is now generally considered to have bitten the bullet) owes $2 trillion, which might need to be restructured. The sovereign debt problem is a big one: much bigger than the problems of Bear Stearns or Lehman Brothers.

Indeed, the comparison could be drawn: Greece is the Lehman Brothers of the eurozone. A default would send ripples throughout the zone and threaten to destabilize still further the EU's other national economies: A chain reaction of EU member sovereign-state default could ensue. Behind this also is the fact that some important eurozone banks are overleveraged and at risk of implosion in the event of another global downturn.

How the crisis developed

Beginning last October, the international ratings agencies began lowering their ratings for Greece's sovereign debt. In mid-December, Greece's newly elected prime minister George Papandreou announced a program to set its public finances in order. A month ago, he presented the general outline of a plan to cut its budget deficit by 2012 from its reported 12.7 percent of GDP in the current year to less the 3 percent maximum set by the European Stability Pact (even though every other country in the eurozone now exceeds that).

Papandreou failed, however, to convince the markets that his country had the ability to solve its debt crisis. This produced an extremely sensitive situation. As David Watt, a senior currency strategist at RBC Capital, observed late last week, "all markets [seemed to be] focused on [ … whether the large EU states will] commit bags of cash to a bailout" or not.

The Greek crisis hit not only the euro but also European banks and some government bonds, necessitating on 11 February a meeting of EU leaders. They announced a political agreement on an aid plan for Greece, but without giving details, which the finance ministers were supposed to hash out this week. In the event, they were not convinced that Athens had yet done enough.

Thus no specific support measures or aid were decided. Instead, the finance ministers underlined the decision by EU leaders last Thursday to offer support in the last resort, while increasing pressure on Athens to take more drastic action.

A never-ending story?

The Greek government has already tried to adopt austerity measures but has met with labor strikes and civil unrest, which will likely only increase. The largely unspoken problem is that no one can have real confidence that they know the actual situation: Greece's statistical reporting problems seem to get only worse as they are more closely inspected.

Yet despite all the talk of Greece leaving the eurozone, such a move would weaken market confidence to an intolerable degree. As such, the finance ministers have set a 16 March deadline for Greece to demonstrate that it is implementing serious measures. Only then would specific support be considered, in order to prevent further reaction by the debt markets.

Greece has been given a further mid-May deadline for a subsequent report, which it will then have to update on a quarterly basis. A request for assistance from the IMF does not appear on the horizon, a "paradoxical" situation as Stefan Ruhkamp has observed, although it is asked to participate on a consultative basis.

The finance ministers seem not to recognize that there will be further tests of confidence in the debt markets. Greece must refinance over €16 billion ($22 billion) in April and May. Juncker believes that the markets' lack of confidence in the euro is "irrational" yet thinks it would be "unwise" to explain publicly "the measures we are putting in place."

Such a view, self-contradictory at least at first glance, tends to validate Paul Krugman's opinion that "the real story behind the euromess" is rather "the arrogance of […] the policy elites who pushed Europe into adopting a single currency well before the continent was ready for such an experiment."

Copyright © Robert M. Cutler unless otherwise noted.
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URL:  http://www.robertcutler.org/blog/2010/02/greek_tragedy_averted_for_now.html
First published in ISN Security Watch, 17 February 2010.

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