The Greek Problem

A storm has slowly been brewing in the press over recent weeks in regards to the state of the PIIGS (Portugal, Ireland, Italy, Greece and Spain). According to some analysts, the Euro area itself might be at risk of break up.

Before going further, it is worth mentioning that the dangers that we are now seeing are hardly unforeseen. I trawled through my own blog and found several of my own references to the problem (but probably missed many others), such as the following in a post from 2008:

Also, an interesting comment from VKP who suggests that the UK and Greece have many similarities. I am not as familiar with the details of the economy of Greece as I would like, but am aware that they are running very large deficits. I have mentioned the possibility of the abandonment of the Euro, and the state of the finances of Greece is one factor in that consideration. I am not sure how much longer Germany will play ball....

And a little later, at the start of 2009:

As an aside, I long ago suggested that the cohesion of the Euro might be strained as the economic crisis progressed, and there have been an increasing number of articles recently mirroring this view. I still believe that the Euro may not come through this crisis, and think the likelihood of either a partial falling apart, or complete abandonment of the Euro is possible. We could yet see the return of the mighty Deutsche Mark. As such, if you hold any Euros, make sure that they are held in a German bank in Germany....

More recently, I described the problems of Greece as an 'outrider' for larger economies - as a foretaste of the coming problems. I have not been alone in these early concerns for the Euro in the economic crisis, but have no references for those that were sharing them (apologies). However, the view that I shared with such Euro pessimists was that it was not possible to have a stable currency with the huge variations in individual government policy and economic structures. It was the tragedy of the commons writ large, with the Southern European states acting as free riders. With no method of effectively enforcing discipline and rules, it was possible to free ride in the system. The economic crisis would just bring these problems to the surface (though I had not imagined in such a dramatic way).

Despite this, the Euro enthusiasts have a counter argument. In a recent outing to a bar, I was speaking with a German on the subject of the risk to the Euro, arguing that Germany would not tolerate bailing out Southern Europe when confronted with its own problems. His response was to highlight the position of Germans as 'good Europeans' (including mention of Germany's troubled history) and that Germany would therefore support the integrity of the Euro area. I expressed my doubts about this, suggesting that Germany would not support profligate spending.

The attitude in Germany is of particular interest due to the economic weight in Europe, such that their agreement is essential for any bailout to proceed. This is from Die Welt:

"The EU has given Greece a long leash for far too long. Now Brussels has no choice. All that is left is the weak instrument of budgetary surveillance and a vague hope that, somehow, everything will go well. Sanctions, such as the freezing of EU subsidies, penalties to the tune of billions of euros or exclusion from the monetary zone are not feasible. Any such step would plunge the Greeks even further into the abyss and weaken confidence in the euro even more."

"Brussels is backing strict austerity measures. That is correct, but also wrought with dangers. The planned massive spending cuts and tax increases could stifle the economy of Greece and lead to deflation -- causing a vicious circle. The Greek drama is far from finished. It may well be that a few euro countries like Germany will soon have to jump in as a savior, offering billions in bilateral aid. That would be bitter pill to swallow."

Variations on these themes can be seen from other news outlets in Germany. I strongly recommend the summary contained in Spiegel Online if you would like to understand the direction of German sentiment.

I emphasise the press reactions, as the basic question that arises from the Greek crisis is not a question of economics. The EU has always rested upon compromise, upon politicians measuring their national interest against the 'great European project'. Such compromises have always been hard to sell to domestic audiences, but the problems of the Southern European states are a scale of a different order. It is very tough indeed to justify, when you have your own problems, why you might wish to bail out those whose problems are largely of their own making. Having said this, the elites within Europe have often managed to their goals in the face of opposition. Might they manage this in the face of crisis? I am really not sure.

The point I am trying to make here is that the Euro is more a political confection than it is an economic unit. The same may be said about all currency, but the existence of the Euro relies upon a continuing process of compromise and tolerance. The indications are that Germany are increasingly unwilling to bail out Greece, despite the potential for a broad crisis for the Euro itself. A search against 'Euro' and 'Greece' paints the picture of the sense of crisis for the Euro. One headline says it all, with the Sydney Morning Herald suggesting that 'Greece Trips, Euro Could Fall'.

The crisis in Europe has profound implications. I have long argued that the continuance of the massive accumulation of government debt in the 'rich world' rests upon a flimsy premise. This premise is that delusion that the Western world (and now Japan) have always been rich, and will always be rich. Iceland could be dismissed as exceptional, Dubai was still not the 'West', but the fall of Greece risks a spreading crisis that will undermine the belief in the 'rich world'. This is a Euro economy, and whatever the particular peculiarities of the Greek situation, the cracks in the edifice of belief will enlarge. As I have also long argued, the deficits of the major debtor economies are structural, and will not disappear. The cracks in belief will refocus minds on this underlying reality, and the closer the reality is examined, the greater the cracks will grow.

Will the crisis in Greece be enough to herald the denouement to the lax and unsustainable fiscal and monetary policies that have supported countries like the UK and US? Much hangs on the response to the crisis, but a response of a bailout will only serve as a delaying mechanism. Furthermore, a bailout might further stretch the economies of those that come to the rescue of the PIIGS, with Ambrose Evans-Pritchard of the Telegraph comparing the potential damage to the absorption of HBOS by Lloyds.

Chickens are coming home to roost. And for those who say that countries who have control of their own currency are in a different situation, the answer is very simple. The only way those with control of their own currency can avoid the same crisis as Greece is if they inflate away debts. However, doing so whilst raising record amounts of debt on international markets looks to be implausible. The US might get a benefit of 'flight to safety', but only for a short while. At some point, investors will realise that they have fled the bear only to hide in the bear's cave. It is an analogy I have used before, as the US is no haven of safety.

The position now is; 'wait and see'. A cobbled compromise might serve to delay the final act of the economic crisis. However, it is possible that the economic crisis is entering the last act. If Greece topples, who will follow?

Note: I have included Ireland in the PIIGS acronym, and Ireland is certainly at risk. However, Ireland is facing the fiscal problems head on, and should really be in a different category. I am not saying that it should be considered and treated as safe, but that it should be viewed as less of a risk than the other PIIGS. I have great respect for the efforts of the Irish government to reign in the deficits, and therefore will be sorry to see that their efforts might have come too late (or the crisis too early???).