“Greece is going to leave the euro this weekend”. The rumour swept the markets on Friday evening, kicked off by a report in German newspaper, Der Speigel. The report cited ‘sources’ who claimed Greece was hammering out a deal to leave the euro at a secret meeting of finance ministers in Luxembourg that night.
The euro plunged against the dollar for the second time in two days (the first came after the European Central Bank was less enthusiastic about further interest rate hikes than anyone had expected at its press conference on Thursday).
Denials swiftly followed. But we all know that eurozone politicians are even more averse to truth-telling than the usual breed. Sure enough, it turns out that – while leaving the euro is a while off yet – there was a secret Greek-related meeting on Friday night.
The conclusion? Jean-Claude Juncker, head of the eurozone’s finance ministers, said that “Greece does need a further adjustment programme.” In other words, the bail-out has to be bigger, one way or another.
This is nothing the markets didn’t already know
All that’s happened here is that eurozone officials have finally admitted what the markets had known for a long time – Greece isn’t going to get out of its current predicament without a lot more help, or without writing off some of its debts.
Here’s the story so far: Greece has agreed a €110bn bailout package from the European Union and the International Monetary Fund. The idea was that this would tide it over, and help it meet its loan repayments, until it could sort out its national finances (by raising taxes, cutting spending and embarking on a privatisation programme). Then it would be able to return to the markets for any money it needed in the future.
That was overly optimistic, to say the least. As the Financial Times puts it: “economic reforms have stalled, the economy is in a tailspin, and progress towards a modern tax collection system has been slow.” That’s a problem, because come next year, Greece will need to raise another €25bn-€30bn.
If the markets aren’t willing to lend to them by then – which they almost certainly won’t be – then the country will either need further loans, or the payback period on existing ones will have to be extended.
For now, a revised Greek plan, as Reuters notes, “could include pushing further into the future the targets for Greece to cut its budget deficit, easing the terms of its emergency loans, and giving it additional money.” In short, Greece needs to buy more time.
The real problem with the eurozone – politics
The trouble is, more time might not be enough. The simple truth is that Greece is in too deep a hole. Reforming an ailing economy when the rest of the world is healthy and demand is strong, is difficult enough. Making changes when global growth is wobbly, your currency – the euro – is far too strong for your needs, and the population already feels crushed and put upon by spending cuts, is nigh on impossible.
So while eurozone officials are still ruling out anything drastic – such as Greece ‘restructuring’ the debt held by private investors (ie not paying them back all of what they owe them) – markets increasingly expect this to happen.
A chaotic Greek restructuring would be a nightmare. You’d end up with a run on eurozone banks, major losses for the European Central Bank itself, and more than likely, a fresh eurozone domino run which this time, might take down Spain.
It wouldn’t have to be a disaster if the plan was spelled out clearly so that everyone had time to adjust. But it would require a level of political cohesion and honesty that has so far been absent from the eurozone.
So for now, “extend and pretend” – lend Greece more money and cross your fingers that it works – will be the favoured option.
But even this isn’t easy. For one thing, countries such as Germany (not to mention Britain), may feel that they are just throwing good money after bad.
But it’s not just the ones funding the bail-outs who feel aggrieved. One Irish minister is already calling for Ireland’s debt to be rescheduled too, if Greece gets easier terms. And Portugal won’t be too happy if it has to agree to terms on its €78bn bail-out that are tougher than Greece or Ireland’s.
It all comes down to the one issue that has plagued the eurozone since its creation. As Wolfgang Munchau puts it in this morning’s FT: “Europe’s political elites are afraid to tell a truth that economic historians have known forever: that a monetary union without a political union is simply not viable.”
Europe either takes a big leap towards becoming a “United States of Europe” or it begins to splinter. We wouldn’t like to bet on the outcome yet. But from an investment point of view, we suspect that the euro is about to experience a sticky patch. If you are interested in betting on the currency markets, you should sign up for MoneyWeek Trader, our free email where veteran spread better John C Burford shares his tips and tactics for improving your profits.