After a frantic few weeks, it appears that the Greek can has been kicked down the road. The Greeks have agreed to cuts while the rest of Europe will keep the bail-out money flowing. Changes to the law will make it easier for the bondholders to be forced into line. There are even plans to send tax collectors from Germany to Athens – which should boost revenue.
The yields on Italian, Spanish and Portuguese debt has fallen. The money supply also increased after falling in December.
However, the Irish have thrown a spanner in the works.
Ireland and the fiscal treaty
As part of the deal, all the European countries agreed to a fiscal pact. This aimed to make it harder for countries to run up the large debts that caused the crisis. Not only would nations face penalties, the rules would be directly written into national law.
This is seen as a power grab from national governments – and is therefore unpopular. The hope was that this could be agreed without a popular vote.
However, Irish law requires any loss of sovereignty to be voted on. Therefore the Irish government has reluctantly agreed to hold a vote.
In itself, this decision is not that important. In 2008 Ireland rejected the Lisbon treaty. It was then ‘asked’ to re-run the vote, which then produced the ‘correct’ decision. Current polls indicate that people would narrowly back the deal. And even if Ireland votes no, the deal only needs the support of 12 out of 17 nations.
However, the Irish vote will have several effects. It will take up to three months to organise a referendum – creating uncertainty in the markets. A strong defeat would send a message to Dublin about Irish anger at current policies.
Will other countries follow Ireland?
Even the fact that the Irish people will be consulted is likely to lead to calls for similar measures in other countries.
In France, Nicolas Sarkozy has come under a lot of pressure for his decision not to let the people decide on the treaty. With an election only weeks away, he may be forced to change his mind – or see his already slim chances of re-election vanish. Francis Hollande, who leads the polls, has promised to renegotiate the pact if he wins.
The Greeks may also use the Irish ballot to call for the referendum on the deal that was promised, then suddenly withdrawn, after pressure from the EU.
The other concern is that if the Greek deal works, European countries will start asking for their debt to be written down. Ireland has already attempted to get its debt reduced. It was also made to drop plans last year to force some Bank of Ireland bondholders to take ‘haircuts’.
However, Enda Kenny may yet be forced to demand a Greek-style debt restructuring. Social protection minister Joan Burton has already argued that concessions on notes issued to fund the AIB bail-out are needed to get a ‘Yes’ vote.
Other clouds on the horizon
Ireland is not the only potential fresh problem in the eurozone.
Citi has argued that Portugal will fail to meet deficit targets, putting at risk its money from the EU and IMF. Even with another bail-out, Citi believes that debt will rise to 146% of GDP by 2015-6. Given that this is clearly unsustainable, Lisbon may yet demand that private sector bondholders take losses.
And then there’s monetary policy. Up until now, the main policy response of the European Central Bank (ECB) has been to buy up government bonds. This has pushed down interest rates and boosted the money supply – though it has created moral hazard.
However, the ECB has signalled that it has stopped doing this (though there is speculation that it may make a limited exception for Portugal). Instead, the new focus will be on another round of the Long Term Refinancing Operation (LTRO2). This aims to lend large amount of cheap money to banks, with the hope that they will increase the amount of credit to firms and households.
This has got investors excited about yet another central bank ‘printing money’. However, the strategy has some major flaws. Lending money to banks, rather than buying assets (as the Bank of England and Federal Reserve have done), is a relatively indirect way of increasing the money supply.
Evidence from the first LTRO at the end of last year suggests that banks have used it to double down on Spanish, Irish, Italian and Portuguese debt. This will make the banking system more vulnerable to any debt problems in those countries.
Finally, Standard Chartered has pointed out that the need to increase capital reserves to 9% by the summer will limit banks’ appetite for further loans. It therefore thinks that, “investors looking for this episode to be as powerful as LTRO1 in providing a durable boost to risk appetite are likely to be greatly disappointed”.
Too many moving parts
Overall, the problem is that for the euro to survive without any formal defaults or exits, everything has to go to plan. To use an analogy – it’s possible to climb Mount Everest without oxygen. However, one bit of bad luck – such as bad weather – could mean instant death.
This is why a Greek exit and formal default is only a matter of time. We could well see fear over the eurozone creep up to derail markets yet again later this year.