The immediate response of the markets last week was quite muted. They assumed that with Germany in charge of the Euro and Merkel in charge of Germany, the austerity programmes will continue to the bitter end. Simpletons.
Faced with changes in France and another election in Greece, people then started falling over themselves talking about growth. Voters have also spoken in Germany where Merkel’s hard line approach seems to be losing touch. Merkel herself has to go to the polls next year. In Spain a large banking bailout will be required to accommodate all the duff mortgages and construction loans.
Contradictions
People are now openly talking about two things which are contradictory – Greece leaving the Euro and growth pacts. If Greece leaves the Euro, there will be such a flight of money from all Club Med countries that the Euro will find it difficult to work at all. There will be no growth. Investors have already had a ‘haircut’ with the Greek debt and won’t want to go there again. Don’t imagine it will be a civilised divorce, whatever the contractual obligations and treaties.
Apart from the inevitable poverty and chaos that will happen in Greece, the real big losers will be France and Germany, which have invested most in Greece and other Club Med countries. Companies have already started putting money in ‘safe havens’ overnight. There is no guarantee that the money will come back. Remember what happened with Lehman Bros?
If Greece does exit – or is evicted – then while physical Euros currently in Greece will be OK, accounts will be empty because the other banks will not lend to Greek banks at all. Contagion will occur in the other indebted countries. The abyss.
While Greece must bear some responsibility, the banks which lent them money are also at fault. Some of this debt was actually to fund exports to Greece – of military hardware! Both Germany and France are the main suppliers of such goods and have, to some extent, been competing with each other. Presumably these exports were ‘guaranteed’ by the respective governments so if Greece does default it will be German and French taxpayers that will take the largest hit.
Forseeing this possibility, the Euro has weakened and stock markets round the world have taken a trip south. Unless the principles I outlined last week are adopted and the European Central Bank starts behaving like a proper central bank – with all its implications not the least for the redundant national banks – the market will start to view the Euro as not as a stateless currency but a currency working under diverse and incoherent jurisdictions, which it is. Expect then more than a few countries, Euro-denominated bonds and instruments to lose their credit ratings.
It is against this background that Francois Hollande is being baptised in Berlin. He will be aware of the consequences of failing to persuade Germany that its best interests lie in growth and renegotiation. So let’s assume that he succeeds.
Hollande succeeds …
The immediate effect is that the Euro will lose a little more value but if as a result the Eurozone economy picks up, that will be good news all round. Changes will have to be subtle not seismic but a move from austerity to growth will bode well for the Eurozone internally. Investors will be more realistic and accept that to get out of the mess that the Euro finds itself, they will have to be rather more patient.
It will need considerable time and, for fiscal union, political agreement which will need a new Agreement post Lisbon and not be easy. Most importantly, something must be offered now to the innocent people while this re-orientation is going on. There has to be hope.
As far as the consumer is concerned, it will be carry on as before. Some countries may have painful re-orientation, property prices in Spain and Ireland will remain low and a Eurobond with the ECB as banker of last resort will drastically cut the interest payments for all. Maybe not honey and cream but at least some jam.
… or fails
On the other hand, if there is no progress, all hell will break loose. It is likely that social unrest in southern Europe will become a major issue; none of the countries has a passive history. Of course, it may be that a passive and broken population of southern Europe will bow down and accept their fate but it is also possible that pigs will fly. When people are driven to the wall with five years of constant cuts while others walk away with millions, don’t expect acquiesence.
Many people in Greece are already starving and it may soon come to Spain, Portugal and Italy. The only one of the PIIGS which is likely to escape is Ireland because their problems were not in tax collection or overspend but in an overheated property market. It is Club Med that will suffer I’m afraid. Get out now while you can – there may be investment opportunities once everything has settled down but that could be years away.
There will have to be a lots more haircuts. Investors stand to loose many billions or even trillions of Euros which will depress the world economy affecting not only Europe but also the US and China. Therefore it behoves these countries not to rock the boat. Europe needs some re-alignment for sure because the world does not owe it a living. But it has many good things, not only culture but also innovation, science and a certain civilisation that has been exported all over the world.
The UK will suffer. If our major trading partner is not purchasing, our economy will nose-dive as well and it will be impossible to square Osborne’s fiscal circle. There is no room for schadenfreude here.
So what for the rest of the world? Pretty dire for the next 10 years or so. While there are havens and not all countries will be affected, severe recession in Europe will take many years to recover and depress the world economy by many points.
It is in all our interests therefore that Hollande succeeds.
That’s a good take on the situation.
The pendulum swing to austerity being the ‘only’ answer was bound to lead to the view that ‘growth’ is the only answer.
Unfortunately, the extremely frugal mindset has been touted as the only way forward by many supposed experts and can lead to a very narrow view of life, the universe and everything which, in turn, can lead to a sense of depression and even despair.
It would be nice if the pendulum could spend a short while at rest between the two ‘only’ ways. Just long enough to stop the knees jerking and give people hope.
Wishful thinking, of course.
@Pat
The intermediate way which I didn’t want to go into is for Greece to print some New Drachmas and work with two currencies while defaulting on its Euro obligations. To do this a Greek central bank would have to be enacted with the power to create money and it would take time to get the notes and coins out. De La Rue estimated 3-4 months and I don’t know how they would be paid so it would have to be done domestically.
New Drachmas would be essentially worthless outside Greece but it would enable them to feed themselves for the moment. And of course tourists could provide some proper exchange so that fuel and other things can be bought. Greek Euro bank deposits would either be lost or have to be converted.
De facto they would leave the Euro but could still claim to be within it, a typically European solution that puts off the evil day. Unfortunately the Eurozone is so lacking in leadership that any fudge is possible.
The Greece situation (and likewise, the Italy situation) has long confounded me; how can a government think it can survive merely by enacting austerity measures, and not by increasing taxes? (I know taxes are a touchy subject for the Greeks…)
I remember when the Euro Zone as first created, and a lot of economists thought Britain was wacky not for joining… their own austerity measures aside, the English now look pretty smart.
@Elizabeth – thanks for stopping by!
Part of the problem in Greece is that ordinary people are already paying quite a lot of tax on income but the others have been getting away with paying very little. I recall that in Italy in (I think) 1992 they published a list of people who paid very little tax to shame them into declaring their proper income. I don’t know how well it worked but it would not be a bad idea for Greece now.
Like many I thought the Euro was a good idea until a comment by Oscar LaFontaine in 1998 pointed out the necessity of fiscal union. When I thought it through, it was obvious that it would not work unless essentially we were run from Brussels (or Frankfurt or wherever). One currency cannot work with different legislative regimes, particularly if the central bank is crippled and cannot act as a proper central bank.
The problem the UK has is that 40% of our trade is with the Eurozone yet we can’t really influence it, particularly with a Eurosceptic government (well, half a government really) which has blotted its copybook in Brussels. 🙁
I always questioned how well the Euro would work. Like Elizabeth said, I remember the negative remarks about England when they decided to not convert, yet in the end they have turned out to be better off. The EURO is one of those things that works on paper but in reality doesn’t pan out.
@Miss T
The UK (it’s not just England of course!) is better off in that sense but as I said to @Elizabeth, some 40% of our trade is with the Eurozone.
The rest of the world is not immune. Total goods and services US exports to the Eurozone is about $300 billion in very round numbers. China exports to the Eurozone is similar although this is a larger proportion of the Chinese GDP.
A collapse even of some parts of the Eurozone will have global consequences. I think that not only internal EU pressure needs to be brought on all parties but external pressure to put the Euro house in order from North America, China, India, the IMF and World Bank (to mention a few).
The abyss isn’t only on this side of the Atlantic.
Oh goody! I just realised! There’s a G8 meeting coming up tomorrow at Camp David. Perhaps Barack can read the Riot Act although he has been reticent to get involved. Merkel better listen and leave finance minister Schaeuble in his kennel.
Clearly the risk to the US, China and other major EZ trading partners is immense. The world really needs leadership and in the absence of any European leadership, we as usual look to the US.
Mervyn King (chairman of the Bank of England) is warning of a 1 trillion Euro cost if Greece is dumped or dumps itself from the Euro. Horrific.
4 days in a row the market in the US has been up and down and then down and up. For the most part we are growing again but Greece is creating a real cloud here. Come on people…
Hi Jai. This you will have to say to the boneheads in Berlin!
It is not so much Greece that is causing the problem – it is after all a country of only 11 million people – but decisions taken even back in 1992 that are coming back to roost.
I suspect that this turbulence will carry on at least through this summer by which time some sort of resolution will have happened. It won’t be the proper solution because that would take the laggards in the EU years, even if they arrive at it (and have read this blog)!
Decisions taken in Washington were (a) coherent and (b) generally pro-growth. That doesn’t make them perfect but at least the US is beginning to grow again. Lucky you!
John for Chancellor – LOL
Mind you a healthy dose of common sense and straight talking is what has been missing from this whole issue from the start.
Books need to be balanced, changes implemented and choices made – and that is hard at a personal level never mind “National” one. But is still needs to happen before any change in results can be seen.
In the meantime we do what we can in our own “economies” – keep our heads down and worry what comes next – which has the net result of stifling expansion, creation and growth.
Worrying times
@Elaine
Did you mean The Rt Hon Member for Tatton or the one in Berlin? It’s the latter that matters for the Euro! The former just seems intent on closing down the UK. 👿
Good overview. I hope our countries see the dangers in growing the government so large and making obligations it can’t possibly keep.