It’s a Greek fire but be careful of burns
With markets expecting a Grexit, the eurozone is about to find out that it may have its own house inflames by failing to see that the system caused the Greek fire in the first place
What would you do if your neighbour threated to burn his house down? Would you provide him the matches, stop him lighting the fire, or would you hope the fire doesn’t hit your house?
That is essentially where Europe is when it comes to Greece and the eurozone this week.
As markets and politicians begin to accept the inevitability of a Grexit, the eurozone looks on with puzzlement over the best solution for the area.
If the eurozone bows to Greece’s demands to lessen the austerity measures, it will provide the country with the matches to burn itself.
How can this be? Well, the same old problems will be there for the troubled country, just further kicked down the road. The same debt, heavy state apparatus and spending will still be there in a year or more time except, as we have seen over the last two years, the costs keep rising and the contagion-risks get worse. Greece will be further locked out of the debt market as no-one would be willing to invest in the debt of a country that has blackmailed its way out of measures that it genuinely needs to initiate.
And the other neighbours – in particular Ireland , Portugal and Spain – will not be impressed as they start to wonder why they should carry on with their own measures if the feckless Greeks can get away with it. Let’s not forget the paymaster general, Germany. The doctrine of budget discipline sacrificed on the Greek altar would further feed the sense that perhaps they should stop paying for the euro.
So how do you stop him lighting the fire? Well, in this instance you can’t. That fire has been smouldering for the last couple of years and now, frankly it’s too late. It all depends on whether you are in his house or standing next to it – basically all that changes is the severity of the burns.
So you hope your house won’t catch fire. Unfortunately, the eurozone has to wait and see how big the fire will be.
There is talk of international action – akin to 2008 – where over twice the amount of liquidity already provided by the European Central Bank will flood the system in a bid to create a firewall to protect Le Grand Projet.
Unfortunately, and indeed like 2008, this will solve nothing. Yes money will flood the system initially, equity will go up, the bond markets will see initial exits from ‘safe havens’ and no doubt the euro will rise against the dollar.
But what happens six months down the line?
For the Greeks, a devalued drachma will see their debt rocket and even before the exit, they will have to impose capital controls – if it is not too late already. Banks will have to be nationalised and, having been shut out of the debt market, the country will have to rely on hand outs from the IMF.
However, it will have its own currency and some control over its destiny. Who knows, the restructuring of its state will probably then happen through sheer poverty. However, somewhere down the line, investors will see an opportunity and return. Tourists will eventually be enticed back for a cheap holiday. The timeline could be long and the situation will certainly be rough but even at the bottom, the potential for growth is there.
For the world, this solves nothing. The flooding of cheap liquidity is short-term and fails to address a problem that has existed since Greenspan chipped in following the 1987 crash. The age of cheap credit and cheap money is coming to an end. The merry-go-round is over. What should have occurred in 2008 will have to happen eventually.
In 1987 and in 2008, central banks and politicians made a fatal error – and certainly a non-capitalist error. They kicked correction down the road. In a capitalist system recessions are healthy. They allow rebalancing and correction of the system. The strong grow and the chaff is cut. What emerges is generally a better system. This was not allowed to happen and banks that should have gone to the wall didn’t. What we are seeing now is the payback for the follies of nearly 30 years ago, let alone three years ago. The system needs correcting if it is to survive.
For Europe, the flood of money and the firewalls may appear to keep the eurozone alive. But it won’t. What we have is a fundamentally systemic problem. The argument has never been about austerity vs growth, it has been about a system that doesn’t allow debt transfer. A fiscal union that allows recession hit areas to be propped up by economically strong areas. Germany managed its austerity measures because it had a strong economy; it could survive internal devaluation. For the weak south, without debt transfer and fiscal union, all it gets is the pain and none of the sugar. It doesn’t have the stabilisers to offset the measures that are still needed.
It is Keynesian but in a way that is politically unacceptable to most Germans. They have built up the money for bad times, but the bad times are happening elsewhere in their currency. And this is the key to the euro. It has two choices whatever happens with Greece. Either a full fiscal and, by default, political union has to occur or the euro has to die in its current form. The system as it exists will continue the problems.
Can you stop contagion from the Greek fire? I personally don’t think you can. And if the eurozone believes that it can erect firewalls without fundamentally addressing its system, it will soon find that even if a direct flame hasn’t caught light, its house will soon be on fire through its own making.
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