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WITH THE imperfect political solution arrived at in the US over the contentious debt ceiling averting the threat of default and the resultant turmoil, it has recently been the turn of the Europeans to provide all the drama in the ongoing soap opera that we call the financial markets.
For reasons that are largely irrelevant now, countries such as Greece and Ireland have managed to get into extraordinary amounts of debt over the last three years, to such an extent that it is now virtually impossible for them to borrow further with the interest rates that the bond markets are demanding.
A sovereign nation faces the same quandary as a private individual in relation to the accumulation of debt. If you build up too much of it, lenders view you suspiciously and therefore charge you a higher rate of interest on any further debt. This in turn reduces your ability to pay off the debt in the first place, resulting in still higher rates. This is as true for Greece as it is for a college student with their first credit card. For sure, the Greeks have reached this point and beyond, with the yields on 10-year Greek government bonds currently resting at entirely unmanageable levels.
So what options does this leave the government in Athens, and indeed in Brussels at EU headquarters? In times gone past, a country facing this issue would have simply allowed their currency to devalue, effectively placing a discount on all goods and services produced, and wait for the consequent export growth to dig the economy out of its hole. Countries such as Iceland, Israel, Argentina, Russia and many of the South East Asian nations have done this to great effect in the years since 1995.
Of course there are risks involved with the strategy, namely obscenely high interest rates and also the damage that it can do to the nation’s reputation as a sound place to do business. But generally speaking, the strategy works. The problem for the Greeks – and indeed the Irish – is this little experiment that we call the euro.
Two decades ago, the Eurocrats in their wisdom decided that a single currency was a splendid idea that would lead to all manner of competitive advantage and economic growth for the countries that chose to be a part of it. For one thing, smaller nations like Greece and Ireland would have a currency that could be trusted, while France and Germany would be removing much of the currency risk associated with the import and export sector. All things being equal, the euro was to lead to a more stable growth rate for Europe. The naysayers who said that different regions with different economic cycles needed the ability to have different monetary policy were cast as Luddites, and the experiment went ahead. It seems like the Luddites had a point!
Fast forward to 2011 and Greece clearly cannot devalue its current currency, the euro. So how do the heavily indebted countries that we have been talking about pull themselves out of this seemingly intractable recession? This is where it all starts to get a little tragic.
Probably the best thing for Athens and Dublin to do would be to drop out of the euro, reinstate the drachma and punt and devalue those currencies immediately. They would still have political membership of the EU but would now be able to set their own monetary and currency policy. Certainly there would be tough times ahead, but they would be taking the decisive action required to shorten the pain.
Sadly, this is never going to be allowed to happen. The big boys set the rules in the schoolyard. If the Irish and Greeks were to drop out of the euro, and if it led to the gradual disintegration of the single currency, Germany and France would have a whole new problem.
The reinstated Deutsche mark and French franc would soar in value, unburdened by the weaklings of their union, and export growth would be severely hampered. Furthermore, it would allow Ireland and Greece more latitude to insist on some degree of default on their currently unsustainable sovereign debt. This would further anger the bankers of Paris and Frankfurt, who have significant exposure to this debt. Any write down of such assets and the damage to the banks’ balance sheets would further hamper the ability of the French and German economies to grow.
So instead the peripheral EU countries are being forced to take on debt that they can ill-afford, even at the generous rates being peddled by the Troika (the IMF, EU and ECB). There have already been reports out of Dublin that Brian Lenihan, the recently deceased former Minister of Finance, faced the withdrawal of any short-term liquidity provisions if the Irish government refused to take the “bailout”.
Even the word bailout is deeply pejorative, implying as it does that the Europeans were doing their Celtic and Aegean cousins a favour, a helping hand to a brother in need. Quite the opposite. They could easily be seen to be protecting their own positions with regard to the exposure of the debt their banks held. This is the realpolitik.
Greece and Ireland may well be kicked out of the euro in years to come. Never mind that it is going to lead a decade of unemployment, austerity and economic gloom for the smaller member states. One could argue that the federalisation of US monetary and fiscal policy after the Civil War led to the poorer (and defeated) Southern states never being able to catch up, even to this very day.
In any Greek tragedy, the protagonist bumbles his way to personal doom in such an obvious fashion as to draw the audience in and allow them to feel his pain. The bumbling is there for the Greek economy, the empathy…perhaps not.
By Jeremy O’Friel.