Monday, 4 June 2012

Greece has to stay in!

The Greek may not be the hardest-working fellows in Europe, as they like to think of themselves as, they may not be the tax-loving people that Christine Lagarde wants them to be, they may have one of the biggest average salaries in the European Union, but these are not good enough economic arguments to allow for their eviction from the EU. It is not about Greece anymore, Greece is a symptom of a bigger problem: should the European Union push for more integration ?

EU -  time to decide

There is no provision in the European Union treaty to account for the exit of a country from the Euro currency mechanism, without having to leave the EU, thereby discarding all of the advantages that come with membership: free movement of goods, services, labor and capital, not to mention the various sorts of structural funds. Greece abandoning the Euro would come at a great costs: JP Morgan, an investment bank, estimates the costs of a Greek departure at €800 billion. The main losses would be €240 billion of Greek debt held by EU and the IMF, €130 billion of exposure to sovereign debt within the Eurosystem, and a potential €25 billion held by European banks. The rest would result from the contagion effect towards the other PIIGS. 

Greek tragedy

The tragedy of a Greek exit is not a catastrophe in itself, but it would serve as a precedent, showing that a country can indeed exit the European Union, its outstanding debt can be denominated back in its former unit of account and it can default on its debt, or massively devalue its currency. Greek public debt of more than €350 billion (although high as a percentage of GDP) is dwarfed by the ones of next-in-line countries: Spain is expected to reach a public debt of 79.8% of GDP this year, amounting to almost €700 billion, Italian public debt is currently at the unsustainable rate of  120% of GDP, €1.94 trillion in  absolute terms, not to mention Portugal and Ireland which are currently financing their debt from IMF handouts. The immediate effect of a Greek exit would be that that investors that are currently demanding 6% in yields for Spanish and Italian bonds, would wake up to the fact that the level of debts is unsustainable and has to be trimmed out, and they would ask for higher yields. 

At 120% of GDP, and facing a €475 billion of maturing government bonds over the next 3 years, each percentage point added to the required yield means that Italy has to fork up a bigger chunk of its GDP, money that could be better spent on boosting up consumption or on investment projects. Not surprisingly, Italy, Spain, and EU countries that are not "in the hole" yet have to face a paradox: the need to lower the budget deficits (so that they would be able to finance part of their public debt from surpluses) by lowering governmental spending or by stimulating consumption. Doing both austerity and stimulus is close to impossible. From Eurostat:

Ascetic Germany 

Germany, which under the current European capitalistic democracy (those with most money get to decide upon those with less money) became the guiding lighthouse of EU economic policy, argues in favor of austerity. A better term would be increased fiscal burden accompanied with budgetary covenants. These policies are likely to throw back countries that religiously adopt them back into recession, but hey, normal people don`t think about keeping the illusion of prosperity when they have difficulties paying off their interest only mortgage. A recession is not a bad thing in itself, because it is meant to correct past excesses, sort of what a hang-over is to a drinking binge. A badly managed recession, through too much unnecessary government intervention, or no government intervention can leave deep scars.

The way to go

For the European Union to survive this sovereign debt crisis there has to be an unprecedented surrender of sovereignty by members with less economic strength, accompanied with a great transfer of wealth towards peripheral countries. The integration towards a full fledged political union has to be hastened, by pushing for a fiscal union and more financial integration, and by re-designing the EU political system to have more democratic legitimacy. In return,Germany and the Netherlands have to step up to the plate and mutualise  other countries` sovereign debts. With the newly raised money, the EU should inject capital to troubled banks and push for policies aimed at stimulating growth. Easy to say, but this major restructuring at the EU level will only be put into practice if several EU countries will be on the edge of the cliff, starring into the financial abyss.

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