COP: The Euro Impasse

Peter Martino

A Reuters poll of economists taken across Europe last Friday showed a 65% chance that Greece will default on its debts. Half of the respondents said it will do so within 12 months. Without additional loans from the International Monetary Find [IMF] and the 16 other European Union countries which, like Greece, use the euro as their currency, Greece will run out of money by late October.

In the strongest countries of the eurozone, frustration with the Greeks is growing. In May 2010, Greece obtained a loan of €110 billion from the IMF, the eurozone and the EU. Last July, the eurozone agreed in principle to bail out the Greeks for a second time with another sum of over €100 billion. In return, Greece is required to impose tough austerity measures, but so far it has only halfheartedly introduced these. The targets have not been reached and eurozone countries, which have imposed austerity measures on their own populations, have become reluctant to pay additional installments of their bailout package to the Greeks. As for closely monitoring reforms, and handing out bailout money only as those reforms have taken place, that is exactly what is supposed to happen. The bailout sums are paid in installments every quarter, with the EU and the IMF authorities making these payments dependent on how well Greece implements the required reforms. Greece, however, consistently fails to implement reforms satisfactorily, which is why the EU and the IMF pay only grudgingly; but they have to pay, otherwise Greece would default and the euro might collapse.

The governments of France and Germany, the two largest economies in the eurozone, have reaffirmed their support for Greece. Their leaders are paying a heavy price for it. They are becoming increasingly unpopular at home. French President Nicolas Sarkozy is uncertain of reelection next year. In Germany, 82% of the electorate opposes the euro policies of Chancellor Angela Merkel's government. Vice Chancellor Philipp Roesler, the leader of the Liberals, the junior partner in Merkel's coalition, is wavering. Roesler publicly declared that a Greek default can no longer be ruled out as one of the options.

The Dutch, Finnish and Austrian governments also feel the pressure from their own public opinion. In Austria, over 90% of the people oppose sending new money to the Greeks. In the Netherlands, the government wants the EU to introduce new rules that allow forcing countries who refuse to keep their budget deficits under control out of the eurozone. Finland demands that Greece offer collateral for the money it borrows from the Finns. Greece had already offered to deposit a sum in a bank account of the Finnish government as collateral; if the Greeks failed to pay back their loan, the Finns would be allowed to keep it. However, as the collateral has to be paid with money which Greece borrows from other eurozone states, as Greece has no money, the other eurozone countries grew upset and vetoed the deal. The result is that other collateral arrangements will have to be found. But now the Dutch and Austrians want collateral as well. The matter still has to be solved. The Finnish government needs to demand collateral because the government agreement among the coalition partners states that no money can be spent on bailouts of foreign states without collateral.

Germany, the Netherlands, Austria, Finland and Luxemburg are the only eurozone countries with a triple-A credit rating. The creditworthiness of the euro depends on their willingness to bail out less creditworthy members of the eurozone club. With this willingness dwindling fast, a growing number of Europeans are beginning to regard a Greek default as inevitable. Greek credit default swaps have priced in a more than 90% chance of default.

No one doubts, however, that the process could be messy; some even warn that a Greek default might bring the whole euro down with it. At default would raise pressure on Portugal and Ireland -– two countries which are also in bailout programs. It could force the government of Cyprus to bail out its banks, which are closely intertwined with the Greek banks. This would, in turn, force Cyprus to turn to its fellow eurozone members for financial assistance. A Greek default could also pose problems for eurozone banks, especially French banks which are heavily exposed to Greek debt. Last week, Moody's, citing its exposure to the Greek economy, cut the ratings of two of France's largest banks. And it would raise pressure on Spain and Italy, two other eurozone countries facing huge financial problems. Italy is simply too big to be bailed out. Its debt amounts to €1,900 billion and is the third largest debt in the world. French banks are also the biggest holders of Italian debt. Hence, even France could be a domino that would go down. And if that happens, Germany and even the US are in for disaster.

Ambrose Evans-Pritchard of the London Daily Telegraph warns that Germany and Greece are flirting with mutual assured destruction. German populism, he writes, "is pushing Greece towards a hard default, risking the uncontrollable chain reaction so long feared by markets."

As many European banks have turned to American companies, such as AIG, for insurance against loan defaults, the European sovereign debt crisis could inflict further woe on America's struggling economy. AIG was badly hit during the 2008 financial crisis and required a Federal Reserve bailout. Last week, US Treasury Secretary Timothy Geithner attended a meeting of the eurozone finance ministers and central bankers in Wroclaw, Poland. Geithner urged his European colleagues to commit more money to the European Financial Stability Fund (EFSF). The EFSF is the fund which the eurozone countries use to tackle the escalating debt crisis and to bail out countries. The fund currently has €750 billion, but needs to be doubled, tripled, perhaps even quadrupled, in case Italy and Spain need to be kept afloat.

The Europeans clearly resented Geithner's message. Austria's finance minister, Maria Fekter, commented on the unpleasant exchange between Geithner and his European colleagues: "He conveyed dramatically that we need to commit money to avoid bringing the system into difficulty … [but] [Germany's finance minister, Wolfgang] Schaeuble made him very aware that it was unlikely to be possible to push that onto taxpayers, and especially not if [the burden] is imposed mainly on the triple-A countries."

The European politicians are caught between the devil and the deep blue sea. They realize that on the one hand the euro is dragging them down not only economically but politically: saving the euro exacts a huge price which their electorates are increasingly unwilling to pay, while on the other hand they cannot get rid of the euro and allow Greece to collapse because the cost to the economy might be tremendously damaging. It is the perfect scenario for a Greek tragedy.

The introduction of the euro ten years ago was a classic example of hubris. Europe, envious of the United States, wanted to transform itself into a United States of Europe, with a common European currency, which some hoped would replace the dollar as the world reserve currency. Especially France hoped to restore its old dreams of grandeur in this fashion. Paris imposed the introduction of the euro on Berlin as a price for French approval to the reunification of Germany. To their horror, the Germans now find themselves in bed, not only with their East German spouse, but with the entire "garlic belt" of Greeks, Italians, Spaniards and Portuguese. The Dutch and Finns wonder how they could ever have been so stupid as to go along in this scheme, and regret not having followed the example of the Danish and the British who refused to join the euro. The Dutch and the Finns boarded the Titanic, confident that it could never sink, and failed to check whether there were any lifeboats on board.