January 28, 2010
We’ve heard a lot about banks that are “too big to fail”. Perhaps a more immediate question is whether the sovereign nation of Greece is too big to fail. The risk of default and the threat of Greece quitting the eurozone would have profound implications for Europe’s monetary union, for other European countries wrestling with similar budget problems and for the EU as a whole. Meanwhile the markets continue to speculate on these worst-case scenarios.
ECB president Jean-Claude Trichet describes the idea of a eurozone break-up as an “absurd hypothesis”, but he well knows that the Greek budget crisis is the greatest challenge faced by the eurozone since its creation, given the likely knock-on effects of any kind of default. Banks in Germany and elsewhere would be severely hit if Greece were to renege on its liabilities, other eurozone members like Ireland, Portugal and Spain would have to pay substantially more to fund their own deficits and the credibility of monetary union would be severely dented. What’s more, Greece itself could be plunged into an even deeper political crisis.
Greek finance minister George Papaconstantinou has insisted that Greece can solve its own problems without need for external bail-out and has categorically excluded the possibility of Greece leaving the euro area. ECB council member Axel Weber insists that IMF help will not be needed, while ECB board member Jose Manuel Gonzalez-Paramo describes talk of a Greek bond default as “absurd”. Everyone is talking the talk to build confidence.
There is some good news. A Greek government bonds issue on January 25 was in much stronger demand than expected, raising €20bn rather than the expected €4bn, albeit at a high interest premium over German bonds. This had a positive effect on the interest rate premiums for other eurozone countries under pressure like Ireland and Spain and was taken as a sign that market confidence was improving, but any optimism was quickly reversed on rumour and then denial that China had been approached to make a big investment in Greek bonds.
Credibility is the key, but credibility is in short supply, given the creative accounting that allowed Greece to join the euro and the consistent under-reporting of its budgetary situation over subsequent years. “Never again will we accept budget figures that do not reflect the facts” says Trichet, which would seem to be a warning for those member countries outside the eurozone which wish to join. Nor will it make life any easier for Iceland for whom eurozone membership is the key motive for joining the EU.
Greece will face a further major test in April and May, when it must sell sufficient bonds to meet half of total borrowing needs for the year. Ironical that default insurance for Greek bonds is now at the same level as it was for Iceland before the collapse of its banks. These months will provide the acid test for the credibility of the Greek austerity plan to bring its deficit down from 12.7 per cent of gdp to 3.0 by 2012.
The Greek crisis coincides with a new phase in the life of the eurozone. Jean-Claude Juncker has yet again been voted president of the Euro Group, but this time for 2½ years under a Lisbon Treaty protocol which gives the Group a formal status “to discuss questions related to the specific responsibilities they share with regard to the single currency”. He’s made it clear that he wants to beef up the status of the group and is likely to seek formal representation in the G-20.
Successful handling of the current crisis would certainly strengthen the Group’s chances of wider representation, although Germany will be cautious of any policy initiatives that threaten the autonomy of the European Central Bank. Current G-20 members like Spain will wish to protect their own seat at the G-20 table, while the non-Europeans will question why the EU should have such strong representation.
However, if the eurozone can weather the storms of the next two or three years it should be set fair for the long term and will strengthen its case for a bigger say on global economic issues. Whether its members will be able to agree what that “say” should be is, of course, another matter.