Once Greece goes…
The economic crisis in Greece is the most important thing to have happened in Europe since the Balkan wars. That isn’t because Greece is economically central to the European order: at barely 3 per cent of Eurozone GDP, the Greek economy could vanish without trace and scarcely be missed by anyone else. The dangers posed by the imminent Greek default are all to do with how it happens.
I speak of the Greek default as a sure thing because it is: the markets are pricing Greek government debt as if it has already defaulted. This in itself is a huge deal, because the euro was built on the assumption that no country in it would ever default, and as a result there is no precedent and, more important still, no mechanism for what is about to happen. The prospective default could come in any one of several different flavours. From everybody’s perspective, the best of them would be what is known as a ‘voluntary rollover’. In that scenario, the institutions that are owed money by the Greek government will swallow heavily and, when their loan is due to be repaid, will permit their borrowings to be rolled over into another long loan. There is a gun-to-the-side-of-the-head aspect to this ‘voluntary’ deal, since the relevant institutions are under enormous governmental pressure to comply and are also faced with the fact that if they say no, they will have triggered a proper default, which means their loans will plummet in value and they’ll end up worse off. The deal on offer is: lend us more money, or lose most of the money you’ve already lent.
This is, at the moment, the best-case scenario and the current plan A. It reflects the failure of the original plan A, which involved lending the government of George Papandreou €110 billion in May last year in return for a promise to cut government spending and increase tax revenue, both by unprecedented amounts. The joint European Central Bank-EU-IMF loan was necessary because, in the aftermath of the financial crisis of 2008, Greece was exposed as having an economy based on phoney data and cheap credit. The cheap credit had now dried up, and Greece was faced by the simplest and worst economic predicament of any government: it couldn’t pay its debts.
There is a good moment in one of the otherwise terrible Star Trek movies, in which Spock quotes an ancient Vulcan proverb: ‘Only Nixon could go to China.’ Similarly, it is probably true that only George Papandreou could confront the fundamental economic structure of the modern Greek state, since his father Andreas did more than anyone else to build it. Greece joined the EEC in 1981, the same year that he became prime minister, and subsequently the Greek government created a client state in which direct subsidies and transfers from the EEC were supplemented by easy loans from Western European banks. Money poured into Greece, and was used to fund a huge boom in public-sector jobs, most of them linked to political patronage. Various forms of corruption permeated the system, where cash gifts in fakelaki or ‘little envelopes’ were a fact of life, and where, crucially, the rich regarded paying tax as something that only the poor and stupid would ever choose to do. This latter fact meant that Greece was in certain vital respects a country without a functioning version of the social contract. To outside observers, all this was largely familiar, but the younger Papandreou, on becoming prime minister in 2009, was the first prominent Greek politician to admit it and promise to challenge it head-on. ‘Corruption, cronyism, clientelistic politics; a lot of money was wasted basically through these types of practices.’ Papandreou’s admission was jaw-dropping: everyone knew it was true, but since when do prominent politicians say very unpopular things which everyone knows to be true? The EU lent Greece the money to see Papandreou through his programme of cuts and crossed its fingers that this would buy enough time for the deficit to narrow – the deficit being the gap between what Greece was spending and what it was raising in tax.
That was the old plan A, and it didn’t work. Papandreou made deep cuts across public-sector spending, but two things went wrong. One, the Greek economy kept crashing. Economists have varying theories about the practical effects of ‘austerity’, meaning sharp cuts in public spending. To an outsider, it’s a little alarming how they differ about something so big and basic as the effect of large public spending cuts. But if you ignore the economics and look at the history, it seems to be the case that you can’t simply cut your way to growth. (There are a couple of contentious counter-examples, but this is the broad rule.) Holding public spending flat while other parts of the economy grow is historically a more valid model – and, by the way, holding public spending flat is in itself a huge struggle, being roughly what Mrs Thatcher did in the UK. So the first problem was that the Greek cuts led to a worsening of the Greek predicament: the economy kept contracting, and unemployment hit a record high of 16.2 per cent. The second problem was that those richer Greeks who had never fancied paying their taxes showed no increased desire to do so, and, much worse, the state showed no new ability or desire to make them. Without the ability to raise more tax, the old plan A was invalid.
So this is the new plan A: the Greeks borrow another €120 billion, the bondholders allow their debt to be rolled over, Papandreou’s government introduces further austerity measures and privatisations, rich Greeks start paying their taxes, the Greek economy recovers, and by the time the next huge chunks of debt repayment are due – from mid-2012 – Greece can afford to pay back its lenders and the crisis is over.
Does that sound plausible? It shouldn’t. This scenario is somewhere on the spectrum of unlikely to impossible, because while nobody questions Papandreou’s intentions – he is the only politician I’ve ever known to tell his electorate so consistently things they don’t want to hear – the Greeks are showing clear signs that they are unwilling to submit to the programme. Protests against the measures began with furious far-left agitations of a sort with which ordinary Greeks are weary, and which consequently may even have helped Papandreou, but the protesters now include the ‘Indignati’, middle-class Greeks who have had enough austerity already, thanks, and who take a Dario Fo attitude to Greek debt: can’t pay, won’t pay. The vote on the latest round of austerity measures took place in the middle of a 48-hour general strike.
The Indignati are not stupid, and are well aware of two salient points. First, the ‘bailouts’, as they are always called, are no such thing. Taxpayer-funded capital injections into otherwise bankrupt banks were bailouts. The Greek ‘bailouts’ are loans, pure and simple. The money will have to be repaid, and repaid at ungenerous rates of interest: 5.2 per cent for Greece, 5.8 per cent for Ireland. These short-sighted and grasping interest rates, motivated by the need to provide political cover for other governments, make an already critical problem significantly worse. The Greeks know they are being lent money just so they can work very hard for lower wages and higher taxes in order to pay it back at great cost. This arrangement is in place because of the second thing the Indignati know well, the fact that the outstanding Greek debt is mainly owned by French and German banks. This is why the Western European governments are especially keen on the ‘bailout’: it’s helping to keep their banks solvent. The Indignati do not find that a compelling reason to embrace a decade or so of abject misery. They want the Greek government to default, and the banks to accept losses for loans they shouldn’t have made in the first place.
It is that prospect which spooks everyone else in the EU, and the world economic order generally. A ‘voluntary’ rollover would be a polite form of default, which would give the European Central Bank, the IMF and EU governments time to draw up their real plan, whatever that might be. Any abrupt form of Greek default, caused by the lenders’ failing to lend or the Greeks’ missing a bond payment, would be what is known as ‘disorderly’, an eventuality that would play out as anything from a mild local spasm to a full-scale continent-wide meltdown, featuring the collapse first of the euro and then of the EU itself. The collapse of Lehman Brothers in September 2008 was one of these ‘credit events’. It is in their nature that they are chaotic and unpredictable, and all the more so because the fundamentals of the economic order, as constituted in 2008, are still intact. Who owns that Greek debt? As I’ve said, mainly French and German banks. Yes, but banks insure their debt via the use of complex financial instruments. Insure it with whom? Don’t know: some of it is insured with British banks as counter-parties to the risk, but that risk will be insured in its turn, so that the identity of the person holding the parcel when its last layer of wrapping comes off is a mystery. That mysteriousness was the thing that made Lehman’s collapse turn instantly into a systemic crisis.
It isn’t the consequences for Greece of a Lehman-type ‘credit event’ that worry the central bankers and governments: the risk of ‘contagion’, as they call it, throughout the Eurozone is what preoccupies them. The euro was not designed to default, so when Greece does, other European countries who have had to ask for non-bailout bailouts – Ireland and Portugal – will have their ability to repay their debts questioned. If one or other of them undergoes a ‘rollover’, or ‘restructuring’, or ‘rescheduling’ of its debt – all polite words for default – the next country in line will be Spain, and that is where everything changes. The ECB/EU/IMF ‘troika’ can write a cheque and buy the Greek economy, or the Irish economy or the Portuguese economy. But Spain is the world’s twelfth-largest economy, and the ECB can’t just write a cheque and buy it. A Spanish default would destroy the credibility of the euro, and quite possibly the currency itself, at least in its current form.
This is why the current situation has developed, in which governments are reluctant to lend Greece money because they don’t think they’re going to get all of it back, but they’re determined to do so anyway because they need to buy time. The euro was launched with a fundamental democratic deficit, which didn’t trouble the European elite behind it because they had come to believe in a version of manifest destiny. The idea seems to have been that the new currency would in and of itself lead to a gradual convergence of economies, institutions, banking laws, fiscal policies and national cultures. The currency had a bank but no government and no laws except for allegedly binding fiscal rules that were immediately and very publicly broken by participating governments, with no consequences or sanction. The system had no enforcement, and no reality principle other than the value of the euro on international currency markets, and the rating value of euro government debt.
The need for the Eurozone to have a more robust institutional structure and crisis planning has been obvious since its creation, and especially so since the 2008 implosion. The governments established a €750 billion ‘financial stability facility’ – basically an emergency bailout fund – last year, but fiscal union and political structures to match the monetary ones are still distant. An obvious next step would be the creation of Eurobonds, or packages of debt backed by the Eurozone as a whole. That would look (and be) less like a loan from the strong Euro economies to the weaker, and would also be a step, but a usefully deniable step, towards some form of fiscal union. As for crisis planning, well, we’re about to find out. A great deal of thought must, surely, have been given to the question of a Euro default – how to minimise its consequences, how exactly to execute the ‘restructuring’ or ‘rescheduling’. Surely? And if a country were to be forced to leave the Eurozone because it simply couldn’t any longer pay its debts, how would that work? This isn’t something a country can announce in advance. If Greece said it was going to leave the euro, every single adult in the country would run, walk or crawl to the nearest bank and withdraw all their money – that’s because if they leave their euros put, the euros turn into drachmas which are worth, say, half as much. The mass withdrawal would make every bank in Greece go broke the same day. So the government would have to declare a ‘bank holiday’, i.e. a total freeze on all bank accounts, as the first step towards starting a new currency. But what would happen to all those overseas debts, still denominated in euros? They would immediately be twice as expensive now that they would have to be repaid in devalued drachmas. So maybe the government would have no choice but to declare all its debts void.
That might sound like a recipe for disaster, but Argentina defaulted in 2002, froze the banks, declared its foreign debts void, and cut itself off from IMF funding – and since then, it’s been the fastest-growing economy in fast-growing South America. (The Indignati, by the way, are well aware of this example.) But this is an extremely high-risk strategy, not just for Greece but for the whole of Europe, and to attempt it would require that a lot of planning had already taken place. But we wouldn’t know if it had, because these plans need to be kept secret in advance if markets aren’t to bet on exploiting them. If this work hasn’t happened, extensively and at levels which carry the necessary political clout to execute the plans when the default happens, the euro is odds-on to fail. However complacent and oblivious the European political elite has been, it is hard to believe everyone will turn out to have been that soundly asleep at the wheel.
From the worm’s-eye perspective which most of us inhabit, the general feeling about this new turn in the economic crisis is one of bewilderment. I’ve encountered this in Iceland and in Ireland and in the UK: a sense of alienation and incomprehension and done-unto-ness. People feel they have very little economic or political agency, very little control over their own lives; during the boom times, nobody told them this was an unsustainable bubble until it was already too late. The Greek people are furious to be told by their deputy prime minister that ‘we ate the money together’; they just don’t agree with that analysis. In the world of money, people are privately outraged by the general unwillingness of electorates to accept the blame for the state they are in. But the general public, it turns out, had very little understanding of the economic mechanisms which were, without their knowing it, ruling their lives. They didn’t vote for the system, and no one explained the system to them, and in any case the rule is that while things are on the way up, no one votes for Cassandra, so no one in public life plays the Cassandra role. Greece has 800,000 civil servants, of whom 150,000 are on course to lose their jobs. The very existence of those jobs may well be a symptom of the three c’s, ‘corruption, cronyism, clientelism’, but that’s not how it feels to the person in the job, who was supposed to do what? Turn down the job offer, in the absence of alternative employment, because it was somehow bad for Greece to have so many public sector workers earning an OK living? Where is the agency in that person’s life, the meaningful space for political-economic action? She is made the scapegoat, the victim, of decisions made at altitudes far above her daily life – and the same goes for all the people undergoing ‘austerity’, not just in Greece. The austerity is supposed to be a consequence of us all having had it a little bit too easy (this is an attitude which is only very gently implied in public, but it’s there, and in private it is sometimes spelled out). But the thing is, most of us don’t feel we did have it particularly easy. When you combine that with the fact that we have so little real agency in our economic lives, we tend to feel we don’t deserve much of the blame. This feeling, which is strong enough in Ireland and Iceland, and which will grow steadily stronger in the UK, is so strong in Greece that the country is heading for a default whose likeliest outcome, by far, is a decade of misery for ordinary Greeks.
There is one country in particular where this disconnection between the political, the personal and the economic poses an acute threat to the world economic order. That country is Germany. The economists speak of ‘macro-economic imbalances’, the fact that German interests and, say, Greek or Irish or Spanish interests are not in alignment. The German economy is too big and too powerful for the health of its neighbours, unless European monetary policy is somehow ameliorated to help the smaller, weaker countries stay in step.[*] Interest rates which, during the first decade of the euro’s existence, suited German manufacturers, caused toxic credit bubbles to grow in Greece and Ireland and Spain. The consequences of those credit bubbles could take another decade to unwind, ten years of hard times for the citizens of those countries, who will spend most of it sweating to earn the tax money to pay back the German banks whose lending fuelled their bubble. German savings go to German banks to lend to other countries so that they can buy German goods from German companies who then save their earnings in German banks who lend it to … and so on.
This system is not elegant but it is probably sustainable, as long as German taxpayers are willing to pay for the busts and bailouts which will inevitably ensue. Their economy is so big that they can pick up these bills if they want to. As the euro’s troubles go on and the lineaments of this arrangement become clearer, however, the signs are that the German electorate is becoming steadily less eager to go along with it. The downmarket German press has been asking why Germans should work until 69 to fund the retirement of Greek public sector workers who knock off at 55. That’s a loaded way of putting the question, but it is a good question even so, and one to which Angela Merkel is manifestly sympathetic. She has spoken more than once about the need for the private bond-holders who own Greek and other debt to take losses from their holdings and for the entire burden not to fall on ever more reluctant taxpayers. (The markets hate it when she does that, and immediately begin to panic about Eurozone defaults.)
Ultimately, however, the new German attitude has the potential to destroy the Eurozone. If European monetary policy is run according to German national interests, huge structural imbalances will accumulate. The Germans will then either have to pay to correct those imbalances, or agree that the euro should not be run primarily according to German national interests. If they are unwilling to do either of those things, the euro can’t survive. It’s hard to tell exactly what Merkel thinks about all this. She is nobody’s idea of a caricature spendthrift, happily chucking money in the direction of the undeserving poor. Whenever the question of bailouts is mentioned, Merkel acts out an elaborate pantomime of reluctance to dish out more cash. It’s hard to tell whether she is really-o, truly-o this reluctant, or whether she’s hamming up her unwillingness for a domestic audience which strongly dislikes the idea of bailing out work-shy Southern Europeans. The fact is, though, that they are going to have to continue to do that, if the euro is going to continue to exist in its current form. Germany has to put the broader European interest on the same level as its own national interest, or the euro is toast. This, if you think about it from a broad historical perspective, is quite a reversal. During the 20th century, the greatest danger to European stability was Germany’s sense of its special destiny. During the 21st century, the greatest danger to European stability is Germany’s reluctance to accept its special destiny. If the German taxpayer manages, however grudgingly, to accept that it’s her duty to shoulder the burden, the euro will muddle through. But it won’t be pretty.
[*] I first saw this point made by Philip Stevens in the Financial Times on 9 June.