Whilst the Greek economic crisis has stabilised a little the ramifications of what has and indeed is happening to her are rippling out not only around Europe but also around the world. She has added a further leg to the Sovereign Debt Crisis and has made other countries take a hard look at their own fiscal position. This weekend saw the Greek Prime Minister even appear on Sunday morning television in the UK as he continues his public relations offensive around Europe. However just before the weekend the man in charge of the national debt management agency Spyros Papanicolaou was replaced by Petros Christodoulou in something of a shock move. As public relations seems to be important to Greece’s political leaders you might think that appointing an ex Goldman Sachs employee at a time when their involvement in Greece’s finances is being reviewed might be something of an own goal. On that subject the Chairman of Goldman Sachs in the Uk was summoned before a parliamentary committee in the UK to explain his company’s actions re Greece but apart from some weaseling and waffling he did not contribute much that we did not already know.
The Greek Prime Minister did give us an objective
“We want to be able to borrow on the same terms as other countries in the euro zone.”
and his Finance Minister was quite critical of his fellow Euro zone leaders
“My guess is that what will stop markets attacking Greece at the moment is a further more explicit message that makes operational what has been decided last Thursday at the European council.”
How can we judge Greece going forward?
Here is a problem because any improvement in her fiscal and financial position will tend to be slow. Investors will also be cautious as Greece’s past history of fiddled financial statistics and inability to properly collect tax revenues will take time to fade from their memories. So a timescale of 12/18 months would seem reasonable for it to become apparent that this time Greece is being honest and transparent. Unfortunately for her this is likely to remain an expensive period as her ten-year government bonds closed last night yielding 6.41% which in terms of an international comparison is 3.16% over that of the German yield which is used as a benchmark. Also economic growth was disappointing in the 4th quarter of 2009 in the Euro zone as it was in Greece herself. Even worse her figures for earlier in 2009 were revised down heavily. This means that Greece has in effect taken a step backwards before her austerity programme has really begun.
I had hoped that the Euro zone might help Greece through this period but so far we have only had hot air. At the weekend there was more talk of help but I have to say that I agree with Greece’s Finance Minister in his quote above. The weekend rumours were that a 25 billion Euro aid package had been agreed for Greece. If so where is it? Plainly a convincing aid package would help Greece and would probably trim her bond yields so why has it not happened? I believe that political horsetrading is at play here and it goes to the heart of the Euro and the way it was constructed.
The bargaining position between Greece and the Euro zone
Greece’s bargaining position is I believe is stronger than you might think. With Europe’s federal project being such a strong objective amongst Europe’s leaders then the nuclear option for Greece must frighten them. The nuclear option is for Greece to leave the Euro. I still think that Greece will not leave but if she threatens to for example in private I believe that Europe’s political leaders will be frightened of the Euro zone breaking up. So in a game of political poker Greece still has a few cards in her hand. This is probably contributing to the delay although let’s face it the Euro zone is perfectly capable of dithering all on its own! So Greece may be able to negotiate better terms than you might think….
Leaving the Euro and then rejoining at a lower rate
Professor Martin Feldstein came up with this idea recently and in theoretical terms it does have its merits. His idea is for Greece to leave the Euro and then rejoin 2/3 months later at an exchange rate which is say 30% lower. However it does have problems. Firstly if Greece tried it there would then be a queue in Southern Europe to give it a go! Also markets knowing this might happen would attack Euro zone countries even harder if they hit fiscal trouble so it would make contagion more likely. Next there might not be a Euro to rejoin as it could lead to a break-up. Also there is the moral hazard for those who are punished by the 30% fall, imagine you lost 30% overnight!
So an interesting idea but seriously flawed in my view.
The Flaws at the heart of the Euro
The essential flaw is that a currency union requires both fiscal and political union to work and the designers of the Euro zone ignored this. Indeed it is surely preferable for political and fiscal union to come first and then set up a common currency. In essence Europe’s politicians hoped that they could do it the other way around with monetary union helping to force a political union.
What this led to was countries losing control over their economic performance. For example across Southern Europe domestic costs are higher than in Germany and have risen relatively by around 30% since the Euro began. So they have been squeezed and crucially they have no way out as they cannot devalue their currency or even issue more of it ( as it is not theirs any more…). If we did not have the Euro then the Drachma, Peseta and Escudo would have all fallen. Let me remind you of a word many economists used “convergence”, I was never clear how this was going to work and it turns out they were wrong and it has not. In some respects countries in the Euro zone have moved further away.
Of this there are two and they are the two polar extremes. The Euro zone can drive forward political and fiscal integration to put it into the position it should always have been or it can break up. It does not have to break up entirely as an inner core could remain. I believe that Europe’s politicians will drive for further integration but will fail. In essence I think that the German taxpayer will be unwilling to shoulder the implied burdens of it and as this crisis develops they will become clearer on what the costs will be.