Is the euro about to be destroyed by the drama unfolding in Greece? You’ll hear plenty of people arguing that Greece has revealed the fault lines in the euro project. It will have to quit the euro, prompting the currency’s collapse. Or a default will plunge the euro area into a financial crisis from which it will never recover. Yet what’s happening in Greece doesn’t pose any kind of a threat to the euro. The world needs a strong, sensibly managed currency, run without political interference. The euro could be just that, so long as it gets this crisis right.
The nub of the drama unfolding in Greece is simple. The country was originally turned down for membership of the euro, on the sensible grounds that its economy wasn’t in any fit shape for a currency union. Two years later, it was mistakenly allowed in, using figures that it now admits were entirely fabricated.
The results were predictable. Interest rates came down dramatically. In the year before Greece joined, rates were above 8%. They came down to 3.5% immediately, and stayed low for the next ten years. With cheap money in plentiful supply and a strong currency, the Greeks went on a debt-fuelled spending boom. The trade deficit soared, public spending rocketed, and ordinary Greeks loaded themselves up with far more debt than they could afford. The economy even recorded one of the highest growth rates anywhere in Europe over the past decade. So it’s not very surprising it all ended in a huge bust.
The Greeks are now running a budget deficit of around 12.5% of GDP (and probably a lot more if they start being honest about the figures). The government is pushing through one of the stiffest austerity programmes the country has ever seen. Amid street protests and strikes, the bond markets are fretting about whether the deficit can be cut, and whether its debts can be rolled over. It’s bad for sure, and yet we need to puncture some of the myths surrounding the crisis.
First, neither the boom nor the bust can be blamed on the single currency. Sure, the Greeks went on a wild spending spree during the last decade. But what happened to their economy isn’t any different to what happened to ours, or Iceland’s. The one difference is that Greece can’t devalue or print money, because it is part of the euro. It has no choice but to confront its problems now.
And that’s a good thing. Devaluation wouldn’t be much of a solution anyway. Nor would printing money. After all, neither strategy has done Britain much good. Our recession has been longer and deeper than the recession in the euro area. Despite a 30% devaluation of sterling, our trade gap keeps getting wider. The Greeks face a lot of hard work to get their economy back on track, but that would be true whether they were in the euro or not.
No, the real problem in Greece is that the bond markets are clamouring for a rescue package from the rest of Europe. The country has run up big deficits, financed by the money markets, on the assumption that the European Central Bank (ECB) would bail out member states rather than face the humiliation of one of them defaulting. That’s despite the fact that the Lisbon Treaty rules out bail-outs between member states, for the simple reason that domestic electorates won’t tolerate them, and they aren’t necessary. Anyone who bought Greek bonds thinking they were buying something as safe as a German government bond, but with a much higher yield, was just being naive or greedy. So what should Europe do?
Not much. The Greeks have to try and get their deficit down, and Greek workers will probably have to accept lower wages for a number of years to make their economy more competitive again. If they can’t do that, the Greeks should organise a managed default: tell bond-holders they can have 50% of their money back, and no more. Either way there is no reason for this to turn into a crisis for the euro.
If Greece defaults, the markets will be nervous about lending them more money. But that would be no reason to stop buying German, or Dutch, or Austrian government bonds. It doesn’t mean those countries are going to default, any more than it would mean Vodafone was no longer a good credit risk if British Telecom went bust. Nor, if Greece defaults, does it mean Portugal or Spain will. Of course, there would be some pain for the banks. That partly explains why you see so many ‘experts’ calling for a bail-out.
So long as the EU stands firm, and resists such calls, the euro will be strengthened. And the ECB will have made it clear that it is a worthy successor to the Bundesbank – a stern guardian of monetary discipline. That would be a far better outcome than a ‘rescue package’ for the Greek economy organised by the French and the Germans. Because that really would doom the single currency.