A fake Greek tragedy and the EMU future

Why Greece shouldn’t be helped in the current financial difficulties? The budget falsification issue and the alleged legal impediment don't provide a convincing justification. The Spain could be the next target of the financial market. The problem arises of EMU policy inconsistency and its permanent deflationist inclination.

In early 2010 the financial crisis has changed its course. Between 2008 and 2009 the banks were at the center of the crisis, either because they were at the origin of the meltdown, or because they were the subject of a general and undisputed rescue by the States. They were “too big to fail”. Today, the wind has changed direction. The financial crisis upsets state budgets, and the same people who preached the need for banks to be bailed-out sparing no resources from the taxpayers, recommend a sharp cut of public expenditure: essentially, a deflationary stance, indifferent to the uncertain economic recovery and mass unemployment.

In short, two different, indeed opposite,  treatments between banks and states. The most striking example is Greece. The budget deficit of this small Mediterranean country  hits nearly 13 percent of GDP. True, a high level, but not so much different from that of many others countries, starting with Great Britain almost matching the same  deficit share.  With one important difference: Greece is member  of Economic and Monetary Union and its deficit represents a very small  share  of the  overall budget deficit of Emu. It would be enough for the European financial institutions to guarantee the service of Greek debt to cool financial speculation. But  the EMU did not show any concrete determination to do this. The consequence of the European absenteeism has been a free ride for the speculation which could only worsen the financial troubles of Greece, which must issue bond for roughly  50 billion of euro in 2010.

That is a very high number. But it is not an isolated phenomenon in the scenario of the global crisis. The OECD forecasts 16.000 billion of dollars  will be raised in governments bonds among its 30, mostly industrialized,  member countries , a sharp increase of 4000 billion in the space of just two years  to face the recession and the bank bail-outs. The difference among countries is that the biggest, such as US and UK can print money, while it is not possible for countries which have shifted their monetary sovereignty to UEM, from which should to be assisted in a phase of financial troubles, But, so far, this assistance is denied. And, without that support, Greece, under the attack of the speculation, has seen a prohibitive increase of the cost to insure its bonds against default from 1 percent in mid-2009 to 4 percent in early 2010: that is an increase in the cost of 300 million to issuing 10 billion euro bonds. Bitter end result of the European institutions lethargy.

To excuse this substantial indifference of the European institutions two main reasons have been claimed. One airs to be moralistic. Greece has been accused of having falsified budget statistics, hiding the true financial accounts. The charge is in some ways surprising, since we know the severity of the Brussels authorities in checking countries’ accounts. But a New York Times report has helped to explain the mystery. In 2001,  Goldman Sacks, along with other investment banks, such as Morgan Stanley and Deutsche Bank, advised Greece about the ways of arranging complex financial transactions that enabled the Greek government to raise cash for budget spending without having to classify the proceeds as public debt. In effect, it was a sample of the innovative finance based on derivative transactions, currency swap and a series of asset-backed securitization deals. All operations that the big American and European banks were used to engineer, being for them the source of big gains. But it has turned out that Greece was not alone in implementing this kind of finance. Other countries followed the same practice. "The games Goldman Sacks (and other banks as well) has been playng - has written Immanuel Wallerstein - has not only been with Greece, but with many, many countries - even with Germany, France and Britain; even with United states". Brussels authorities were aware of these financial operations and considered them legally acceptable.  So the blame on Greece for the misrepresentation of budget accounts loses a good deal of the reason for a specific blame. In any case, George Papandreou, the new socialist prime minister who defeated in last October’s elections by a landslide the previous conservative government, spelled out the correct statistics, giving a clear proof of the new attitude of its government.

Since the budget falsification issue couldn’t  provide a convincing justification to block the assistance to Greece from the European institutions, a topic much more substantial and intriguing was raised: that is the rules under which founding EU treaties ban the bailout of Member States. But even the legal argument is not so strong as it appears. Indeed the Article 122 of Lisbon Treaty, which came into effect in December 2009, has adopted on this topic a looser wording open to different possible interpretations. In fact, there is a clause stating that when a member-state “is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the European Council, on a proposal from the Commission, may grant, under certain conditions, Union financial assistance to the member-state concerned.” On this basis  – writes Tony Barber, Financial Times correspondent from Brussels - how could we define the 2007-09 world financial crisis if not an 'exceptional occurrence'? In other terms,  EU institutions and governments can grant financial assistance to a fellow member-state that is in serious trouble”.  So the argument is not about  an alleged legal impediment, but a political stance.

So, it is worth to come back to the question: Why Greece shouldn’t be helped in the current financial difficulties? Could European Union allow its possible default? This outcome would open a new chapter in the short story of the Union. In a framework of domino-effect other member states could be subjected to the assault of financial markets. Portugal and Spain would be in the current phase- and in perspective Italy too - the next targets of the financial speculation.
In this case, the wave generated by the peripheral Mediterranean countries could  provoke a currency tsunami that could lead to the breakdown of the monetary union. For many economists it would not be a surprise. Martin Feldstein had originally targeted as a mistake the establishment of EMU, given the lacking of a unified labor market and a common fiscal policy. And also Paul Krugman, from a different angle, does not see a future for the EMU, if it doesn’t evolve into a political union: a hypothesis that is not on the actual horizon of the European Union with 27, and still growing, member states. It should be quite clear that, after the troubled ratification of the Lisbon Treaty, no one -  starting with Germany and France, which are the main  drivers of the Union - has any intention of opening the Pandora's box of a new constitutional treaty.

In this limited but more realistic scenario,  Jürgen Stark, European Central Bank Chief Economist, doesn’t hide his actual worry: ” In the current crisis - he said to Der Spiegel  – we are all moving in unknown terrain…(but) the goal is and must continue to be that all 27 EU countries have the same currency in the end”. It is not only the understandable ambition of a central banker. Germany keeps a fundamental interest in the common currency. As the Financial Times Deutschland writes: “It was designed to insulate (German) industry and trade from the unpredictable ups and downs of international currency markets. How should German automakers fin success in the Italian, Spanish and French markets when they were constantly confronted with the drastic devaluation of the lira, peseta and franc? Without a currency union it would have been impossible”.

In this framework, the issue is not whether Greece will be rescued, but under what conditions. According to the current positions in Brussels, Greece should cut its deficit amounting at about 13 percent in 2009 down to under 3 percent in 2012. A horse medicine dosage. To obtain this result, Greece has to increase taxes, cut wages and pensions, reduce public investments. The measures are typically those generally imposed by International Monetary Fund – reminiscent  of the conditionality imposed on Asian countries in the late 1990S’  and their dismal economic and social consequences.

The argument is the following: Stability depends on competitiveness, which in turn requires structural reforms, starting with the reduction of wages, labor market deregulation, cuts in social expenditures. The goal is to strengthen competitiveness beginning with the cut of labor costs. But this is an illusory purpose since unit wage costs, notwithstanding a domestic deflation, would remain in any case higher then those of the central and eastern countries already members (or candidates) of the European Union.

It must be stressed that Papandreou's government has accepted  to cut the budget deficit by four percentage points this year from 12.7 to 8.7 per cent of gross domestic product. A bitter medicine. Yet the prime minister  is enjoying record levels of popular support despite his government’s commitment to public sector wage cuts, higher taxes and sharply lower pensions.  But even this has not satisfied European  institutions.  More austerity measures are being demanded, such as raising value-added tax and abolishing the 14th monthly salary for public sector workers, while Jean-Claude Juncker, who heads the Eurogroup of eurozone finance ministers, recommends further cuts on current capital expenditure. In other words, a clear path toward a huge deflation with increasing unemployment and social turmoil.

The explanation of this European attitude must be found in the wish to make Greece a case of exemplary punishment. Greece has to be a lesson for any other Member state. Otmar Issing, the German former chief economist of the European Central Bank, is quite unambiguous, when in a column of The Financial Times writes: “Once Greece was helped, the dam would be broken. A bail-out for the country that broke the rules would make it impossible to deny aid to others”.

After Ireland and Portugal, Spain is the most important country that has come under pressure in financial markets. Financial observers have no doubt: “The market consensus is that Greece isn’t the real issue: it’s Spain”. Yet, until two years ago, the financial situation of Spain was enviable. The debt was below the Maastricht ceiling of 60 per cent of GDP – still 53 per cent in 2009 - and the budget in substantial equilibrium. But the housing market bubble has ravaged Spanish economy. The deficit jumped to around 10 percent of GDP and unemployment close to 20 percent of the working force. Prime Minister Zapatero presumes that the first commitment of his government must be the adoption of measures designed to rescue the economy and, on this basis, cut the deficit gradually. But for European institutions this approach is unacceptable. In this case, too, the cure consists of so-called structural reforms aimed to cut labor costs, facilitate layoffs reducing the cost of dismissing workers, increase labor market deregulation and raise pension age to 67 years.

By and large, the aftermath of the global crisis is going to exacerbate contrasts within the European Union. Does it mean that there is a risk of disintegration of the eurozone? The answer, as far as one can see, is: No. The main reason is that the breakup of eurozone does not  match the interests of any present member state, nor those of all new EU member states who aspire to enter the monetary union. The threat to the future of EMU is its permanent deflationist inclination. A dangerous and masochistic vocation in a world in need of economic revitalization, investments, innovation, and employment. The pressing problem is not the budget deficit, an issue that affects the majority of the countries in the world, starting with U.S. and Britain, but a lasting economic recovery.

The true structural problem of EU is represented by the huge trade imbalances in the 16-nation eurozone,  where some countries have very big current account deficits, while Germany, Europe’s champion exporter and the eurozone’s largest economy, permanently runs big current account surpluses. You cannot eliminate this kind of imbalance by raising competitiveness in some countries through domestic deflation powered by cutting wages and public spending. In this framework competitiveness becomes a justification for social dumping among the Union’s member states. This is in plain contradiction with the need of increasing the overall capability of the Union to confront the global competition of emerging economic powers.

Many observers blame the lack of power of European institutions. But this is a flawed argument. Although there is not a political federal framework, the ECB is a powerful federal-like institution, and the European Commission rules firmly on the field of budgetary policies as well as internal market competition. There is not “United States of Europe”, but it is wrong to underestimate the importance of these institutional accomplishments. The problem arises of   economic and social policies inconsistency.. Through the so-called Growth and Stability pact and the ECB obsessive antinflationary stance, the European Monetary Union has been constrained over the last decade into a substantial stagnation. Undoubtedly, Greece and other EMU member states need to improve their competitiveness, but this is reasonable and reachable only in a framework of the overall growth of the Union, starting with the Germany which has shown, after the advent of the Euro, a continuously poor domestic demand relative to its high trade surplus.

The paradox is that, despite its failures, Reaganism has its more faithful heirs within the European Union. As the labor-law jurist  Alain Supiot explains in his following essay in Insight European integration is managed as a tool of social deconstruction. We could say that the Frankfurt-Brussels axis has become the European format of the discredited “Washington consensus”: neo-liberalism mixed with social dumping (see also M. Roccella’s article) in the desperate search for competiveness among member states, instead of the cooperation you might expect within a big Union, totaling half billion people, when it is confronted with a global challenge and risks being marginalized.
In conclusion, the attitude towards the Greek financial crisis is an enlightening indication of the path the European Union is going to choose to deal with the economic and social consequences of the global crisis and the uncertainty about its own future.