This article was originally posted on Yanis’ blog today. Republished with the kind permission of the author.
The Agreement reached yesterday by Europe’s political and financial elites is meant to tackle, once and for all, the Greek debt problem. Just as in May 2010 the idea was that intra-eurozone contagion could be prevented by ringfencing Greece (recall the first Greek bailout, the creation of the European Financial Stability Facility, the EFSF, and the ‘radical’ step of having the ECB purchase peripheral bonds in the secondary markets), so too at present our great and good leaders have deemed it necessary to have a second stab at the ‘ringfencing’ problem, given the abject failure of their first attempt fourteen months ago.
Undoubtedly, there are elements in the new Agreement that have merit. For example, turning the EFSF into a TARP-like pan-European fund for recapitalising the banks (and not only those of the ‘fallen’ member states) is a good idea that I have proposed some time ago (and whose practical value will be judged, in practice, by the degree to which banks are forced to take capital from the EFSF in exchange for shares). Additionally, lending Greece at 3.5% and for thirty years seems positively civilised, in comparison to the exorbitant rates of the first bailout (and the laughable four year repayment period). Lastly, a haircut of around 20%, which is what is effectively touted now, for bonds expiring up to 2019, would have probably sufficed in early 2010.
Alas, going through the merits of this Agreement is akin to discussing a decent plan for extending the Maginot line through Belgium after Hitler had taken Paris. In short, the horses have bolted and we are debating the merits of the new barn gates. Am I exaggerating? Read Article 7 of the agreement to see that I am not. After Article 6 states that the haircut concerns Greece and Greece alone (“we would like to make it clear that Greece requires an exceptional and unique solution”), Article 7 adds: “All other euro countries solemnly reaffirm their inflexible determination to honour fully their own individual sovereign signature and all their commitments to sustainable fiscal conditions and structural reforms.” In other words, the pledges that Greece was making till now, the rest (e.g. Ireland) will continue to make independently of their capacity to meet them. This is priceless gift to speculators who love nothing more than testing such unsustainable ‘solemn’ and ‘inflexible’ commitments on behalf of governments and EU bodies with a long history of such declarations that are confirmed more in the breach than in the observance.
The trouble with the new Agreement (one that is not dissimilar in spirit to the Emperor’s Newest Clothes) is that it contains all the right ideas but in precisely the wrong proportions and with woeful timing. The right ideas are: Debt restructuring and a more rational approach to debt management; a Marshall Plan for boosting investment and kick starting recovery; and a TARP-like EFSF that will recapitalise the banks. Tragically, these splendid ideas (which, by the bye, are the three planks of our Modest Proposal for Overcoming the Euro Crisis) are put forward only to the extent that they do not apply to the eurozone as a whole, limiting their scope only to puny, inconsequential Greece. Let’s take them one by one.
I. Greek debt restructuring and management: Who will pay the piper? The EFSF is the answer. And it will have to come up with the bulk of the new bailout loans for Greece while Greece’s creditors suffer a tiny, in the greater scheme of things, haircut (of 21%). Put differently, Germany and France will have to guarantee most of the new loans that will be used to repay, or buy back, Greece’s older debts.
II. Recapitalising Europe’s banks: Who will provide the capital? The EFSF of course. Again.
III. The Marshall Plan for Greece: Who will finance it? The Agreement says nothing on this but, in the absence of any specifics, it is inevitable that the funding must come from the EU’s existing budget. Which means that monies currently earmarked for investments in Ireland and the rest of the periphery will be re-channelled to Greece. Hardly a recipe for overcoming the Europe-wide investment dearth…
Now, if these three steps were enough to ringfence Greece, their implementation cost would be manageable and their outcome desirable. Unfortunately, this type of ringfencing is at least a year too late. Back then, prior to May 2010, the cost of these measures would have fallen below the EFSF’s €450 billion funding base. Today, the cost has skyrocketed to around €2 trillion. For it is impossible to imagine that Greece will be borrowing at 3,5% while Spain is struggling to roll over its huge debts in the money markets at more than 6%. And it is preposterous to imagine that any sensible person will be convinced by our leaders’ oath that the Irish debt will not be restructured when the Greek debt is subjected to a menu of alternative haircuts. Additionally, it is mindnumbingly perverse to think that sluggish Italy can be left to the appetite of the credit rating agencies and at the mercy of the wolves of the money markets who have already scented blood coming from Rome, Madrid even Brussels itself.
All in all, the cost of carrying out policies I, II&III above is prohibitive for the AAA-rated countries that have to bear it; in effect Germany and France. What makes this prospect even less likely is that speculators have just been given, courtesy of yesterday’s agreement, two separate playing fields in which to practise their well honed skills: (a) Attacking peripheral bonds and banks, and (b) testing the water to see if France’s AAA-rating is safe. The moment they make ground with regard to (a), their bets will be strengthened vis-à-vis (b). And once France’s AAA-rating is shrouded in a small cloud of doubt, the question will become: Will Germany ever countenance putting up guarantees for the EFSF amounting to almost half the nation’s GDP? (For this is what Germany will have to do properly to implement I,II&III above once France’s AAA-rating is questioned.) The answer is an unequivocal ‘NO’. And once this answer starts doing the rounds in the hearts and minds of policy makers and money market players, the Crisis will be back with an unprecedented vengeance.
Which brings me to my (predictable) point: If Europe is truly keen to implement I,II &II above it can only do this by adopting our modest Proposal; by transferring, that is, a large swathe of the eurozone’s aggregate debt to the centre (the ECB is my preferred destination), which will service it by means of eurobonds which can then also be used to co-finance the European Investment Bank’s investment-led pan-European recovery program. Until we hear our leaders speak the word eurobond; until the new Marshall Plan spreads its wings over the whole of the eurozone; until the banks are forced to take sufficient capital from the EFSF (and not just the minimum amount that will keep them in a 1990?s Japan-like zombie state), the Crisis will go from strength to strength.
The general response to this Agreement is one of cautionary approval. Most commentators’ verdict is that it is in the right direction but requires larger, more courageous steps. It is not my verdict.
What might have been a decent response a year and a half ago may be the wrong medicine today, well after the disease has progressed to hitherto unaffected organic parts of the common currency area. It may, of course, turn out that, politically, Europe is trying out on Greece policies I,II&III for size before extending them to the rest of the eurozone, once the evidence is in that the Crisis is stubbornly refusing to recoil. But there is another interpretation which, unfortunately, may be more pertinent.
My alternative interpretation is that Mrs Merkel has gone too far down the road of the fiscal transfers that she, supposedly, admonishes. As I argued above, this new package for Greece is hugely expensive on the German taxpayer and, worse still, it creates a fresh chain reaction (in the realm of speculation) that can only inflate that cost exponentially in the coming months. Rather than bringing about greater political union, and a new resolve to homogenise debt and investment, the escalating cost to the German taxpayer will undermine Berlin’s political resolve to stick to the euro.
If I am right, rather than a move toward the logic of our Modest Proposal, yesterday’s Agreement may be a Faustian bargain that pushes Europe a few steps further down the ladder to the hellish prospect of European disintegration. So as to delay further the move to a degree of debt commonality and surplus recycling (in the form of productive investments in the deficit regions), Europe’s leaders seem to have struck a deal with some postmoderm Mephistopheles that will, eventually, lead us to a hideous moment of reckoning. The question then is whether the story’s ending will resemble more that of the pre-modern Marlow or the happier resolution of Germany’s own Goethe.
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