The sixth “definitive” plan in less than eighteen months for saving the Eurozone and helping the peripheral countries beset by the debt crisis – in particular Greece – was approved two weeks ago. Unlike their American colleagues who have only just managed to reach an agreement about their debt problem, European politicians were able to set off on their summer holidays satisfied.
In this new final solution, a partial (or “selective” as rating agencies would say) payment default by Greece is now clearly set out for the first time. We are far from the bragging of a year ago when any form of default was ruled out and scoffed at as pure fabrication by analysts lacking a sensational story.
Economics is the science of choices, nicknamed the “dismal science” because every choice has a price. This price is often not explicit, but rather implicit, resulting from lost opportunities. Most of the time, once a choice has been made, it cannot be reversed.
The fact that the European sovereign debt crisis has reached such a magnitude is the result of the lack of willingness to make choices. As a result, events have imposed themselves.
Like economists, the general public is now discovering that the European single currency was never an economic project in the first place, but rather a political one. Economists warned before the introduction of the euro that this project would fail unless fiscal institutions were built or, at the very least, more in-depth fiscal coordination was created. They got it right.
Despite the new rescue package for Greece, the Eurozone, as it currently stands, will probably not last much longer. Politicians in Europe have postponed the day of reckoning, but the current strategy of imposing drastic austerity measures on the European periphery has run its course.
On the one hand, less than a month ago the first signs appeared of cracks in a big country that is “too big to be saved,” namely Italy. On the other hand, barely a week later Portugal’s new prime minister, Pedro Passos Coelho, was quite explicit when he stated: “We want to take part in an ambitious European project and make our contribution so Europe can confront its problems in the most ambitious way, but as prime minister I will not stand by and wait for Europe to govern Portugal.” Further austerity measures might push some European peripheral nations to reconsider their participation in the common currency.
In my view, to avoid a breakup there are only three different possible paths out of the current crisis: 1) letting the problematic countries default, at least partially; 2) bailing them out; 3) monetizing their debt.
Letting the countries default could induce contagion effects both in still solid countries in the Eurozone and among European financial intermediaries. It is for this reason that this solution has often been held up to public obloquy by European politicians as having “even worse consequences than the default of Lehman Brothers.” With the partial default of Greece explicitly acknowledged in the latest plan, this alternative is nevertheless becoming the most likely of the three.
Bailing out the peripheral countries by having the “core” countries, principally Germany, fully or partially backing their debt would certainly provoke a moral wrong. The bailed-out countries might see their past fiscal profligacy actually honored. Should this not be the case, core-country politicians still face an extremely hard task selling such a bailout to their populations. In Germany, the controversy following the latest rescue plan for Greece is only just beginning.
Finally, monetizing some of the debt of peripheral countries is currently not allowed by the statutes of the European Central Bank (ECB). The ECB cannot make such purchases, in contrast to what the Federal Reserve did for US debt during quantitative easing, because this action would lead to inflation. However, the fact that bonds of peripheral countries which are already now rated as junk or worse are still accepted as collateral by the ECB shows that its rules and regulations are subject to interpretation.
For Germany and other “strong” Eurozone countries the choice for maintaining the single currency can thus be summarized as putting their financial intermediaries at risk, bearing the burden of a bailout, or provoking an inflationary shift through the monetization of debt. As I see it, the most likely outcome will be a combination of all three. This is the price for keeping the euro.
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