Green Room

Eurohandcuffs

posted at 8:20 am on February 11, 2010 by

Greece has been the story underneath much of the financial markets this week. The problem is that while everyone wants to solve the problem with Greece’s sovereign debt crisis, nobody wants to put money behind it.

Germany and France will on Thursday promise their support for debt-laden Greece in a vow of eurozone solidarity but they are unlikely to come up with a detailed rescue plan.

President Nicolas Sarkozy and Chancellor Angela Merkel are expected to give a show of political support to Athens at a summit of EU leaders in Brussels, one of the most momentous in the bloc’s recent history, in the hope that it will calm debt market turmoil.

But officials in Paris said there was “reticence” in Berlin about signing up to a bail-out package with further “assurances that the Greek government would undertake the measures necessary” to cut its budget deficit by 4 percentage points a year by 2012.

At the time this is posted, we have only word that they have an agreement to take “co-ordinated measures””if needed to safeguard stability of the euro zone as a whole”, but no details.

If this was a developing country, there’d be no doubt what would happen — Greece would be given IMF assistance in return for a plan from the Greek government to restrain government spending — but this is the Eurozone, and you cannot really do that. And finding a lender of last resort is much harder. Germany, towards whom everyone is looking, seems more constrained these days. STRATFOR reports:

Most investors assumed that all eurozone economies had the blessing — and if need be, the pocketbook — of the Bundesrepublik. It isn’t difficult to see why. Germany had written large checks for Europe repeatedly in recent memory, including directly intervening in currency markets to prop up its neighbors’ currencies before the euro’s adoption ended the need to coordinate exchange rates. Moreover, an economic union without Germany at its core would have been a pointless exercise.

…The 2008-2009 global recession tightened credit and made investors much more sensitive to national macroeconomic indicators, first in emerging markets of Europe and then in the eurozone. Some investors decided actually to read the EU treaty, where they learned that there is in fact no German bailout at the end of the rainbow, and that Article 104 of the Maastricht Treaty (and Article 21 of the Statute establishing the European Central Bank) actually forbids one explicitly. They further discovered that Greece now boasts a budget deficit and national debt that compares unfavorably with other defaulted states of the past such as Argentina.

…As the EU’s largest economy and main architect of the European Central Bank, Germany is where the proverbial buck stops. Germany has a choice to make.

The first option, letting the chips fall where they may, must be tempting to Berlin. After being treated as Europe’s slush fund for 60 years, the Germans must be itching simply to let Greece and others fail. Should the markets truly believe that Germany is not going to ride to the rescue, the spread on Greek debt would expand massively. Remember that despite all the problems in recent weeks, Greek debt currently trades at a spread that is only one-eighth the gap of what it was pre-Maastricht — meaning there is a lot of room for things to get worse. With Greece now facing a budget deficit of at least 9.1 percent in 2010 — and given Greek proclivity to fudge statistics the real figure is probably much worse — any sharp increase in debt servicing costs could push Athens over the brink.

From the perspective of German finances, letting Greece fail would be the financially prudent thing to do. The shock of a Greek default undoubtedly would motivate other European states to get their acts together, budget for steeper borrowing costs and ultimately take their futures into their own hands. But Greece would not be the only default. The rest of Club Med is not all that far behind Greece, and budget deficits have exploded across the European Union.

And that really is the issue: The French and German governments now face the constraints of Maastricht and the ECB charter, which were written to prevent one of those PIIGS from profligacy but never were meant to handle a systemic shock hitting all five at once. A guarantee or pledge of unity for Greece will mean a pledge to all. And the problem then is whether speculators will test the pledge. If they use actual funds they will cause a constitutional crisis in the EU; if they do not, they risk having these countries make an exit from the Eurozone, something nobody is prepared for (even the biggest skeptics.)

Megan McArdle says it’s a design flaw, and she’s right to say “none of the choices are good.” The markets have so far seemed to put considerable weight on the likelihood of a bailout — the scene to the left from Athens indicates that a government austerity plan, if enacted, would be very unpopular. Large cash infusions may be the only way to get the public to swallow the bitter medicine. But markets do not seem aware of the constitutional restrictions placed on a bailout package from EU member states or from the IMF.

Thus it is unsurprising that there will be little more than a statement today from the EU members, with details to be worked out later. But time is of the essence, for as we learned in 2008, when the end comes it can be swift and a less-than-united front could cause far greater harm in Europe than what happened here.

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So the EU fixed the debt problems by loan guarantees and more debt? They fixed the problem by saying they fixed the problem? Like California?

Skandia Recluse on February 11, 2010 at 8:36 AM

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Comments have been closed on this post but the discussion continues here.

Ed Morrissey on February 11, 2010 at 11:03 AM