Politics holds the key to the euro’s future.
The euro is a political construct, not an economic one. As it stands, the euro cannot function in the long term, from an economic point of view. The various countries involved are too different.
So the main thing holding the euro together so far is that European voters, by and large, still want it. Voters might be angry at Germany, or angry at their own leaders, or angry at eurocrats in general.
But they don’t yet blame the currency for their woes.
This could be the year that all that changes…
Forget Growth Versus Austerity
Forget all the stuff about austerity versus growth. It’s good column fodder for economists, but it doesn’t get us any closer to understanding what will happen on the ground.
The austerity mob argues that countries need to do what it takes to pay back their debts. Instinctively, this feels like the ‘right’ decision. Most of the time, if you’ve spent too much money, then yes, cutting back for a while and rebuilding your savings is the smart thing to do.
But there comes a point where the hole you’ve dug is simply too big. That’s when your creditors need to share the pain. People seem to forget that when a lender writes a cheque, they’re taking a risk. If they haven’t assessed that person’s credit risk correctly, then the rules of capitalism dictate that they should lose some or all of that money.
So austerity without explicit default cannot work.
The growth mob, on the other hand, seem to think that you can borrow and spend with impunity. This is wrong, and they know it. What the growth guys are really arguing is that Germany should take the leash off the European Central Bank (ECB).
If the ECB is allowed to print money, then Greece and all the other countries can service their debts the easy way – the Anglo-Saxon way, in fact. Over time, these economies will recover.
It does mean that you confiscate money from savers across the eurozone in the form of inflation. It also means that you are implicitly defaulting – you are repaying your debts with devalued currency.
And it creates moral hazard – neither countries nor lenders have any incentive to change their behaviour if they believe that there is always a bail-out at the end of the road.
So these are the choices: an implicit default or an explicit default. In an implicit default, German taxpayers agree to stand behind other nations’ debts (in the form of ECB money-printing, or a common eurozone bond issue – it all boils down to the same thing). That leads to a weaker euro.
In an explicit default, Greece tells its remaining creditors (the ones it hasn’t already defaulted on) that it can’t repay them.
Trouble is, any eurozone country that unilaterally decides not to pay its debts would be stiffing other eurozone countries too. In particular, a whole lot of Greek debt is held by other European banks, as well as the ECB. That’s why it would be hard to default, and also to stay in the euro.
So an explicit default by Greece (or any other country for that matter), involves leaving the euro and going back to the drachma.
So What’s the European Endgame?
Which of these routes will be chosen all comes down to the voters. So what have they said?
The key country is Germany, of course. And they have no intention of budging. As Reuters reports, Volker Kauder, one of Angela Merkel’s ‘closest allies’, said: ‘Germany could end up paying for the Socialist victory in France with more guarantees, more money. And that is not acceptable. Germany is not here to finance French election promises.’
Merkel is only reflecting the desires of her population. So while Francois Hollande can talk about growth all he wants, the best he’s likely to get is some sort of fudged ‘growth pact’ that is all words and no action. That won’t please the French people. But they’re not at the stage where they are ready to jack in the whole euro project as yet.
The Greeks, on the other hand…
In essence, the outcome of the Greek election was a mass vote for ‘anything but this’. Greeks voted for Communists, Neo-Nazis, and all the colours of the political rainbow in between. Putting a coalition together from that lot is going to be tough. In fact, it seems likely that there’ll be another election in June. Although, chances are, that would result in an even more polarised result.
Citigroup reckons that there’s now a 75% chance of Greece leaving the euro by the end of 2013. That seems more than reasonable. The question is, how much damage could it do?
Private debt holders have already had their holdings written down substantially. So it’s hard to believe that losing the rest would deliver a knock-out blow to the global financial system.
However, it would still be incredibly messy. This is the best solution for the Greeks. But it would also get the markets watching for the next candidate to leave – probably Portugal.
The one thing that a Greek exit might do, is shock the rest of the eurozone into deciding that defaulting via money-printing is the best way to go.
John Stepek
Editor, MoneyWeek (UK)
Publisher’s Note: This is an edited version of an article that first appeared in MoneyWeek (UK).
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