For its sheer scale, the euro bailout is breathtaking. To anyone outside the bond markets — where £1 million (US$1.5 million) notes are considered small change — the idea that eurozone countries needed almost 750 billion euros (US$1 trillion) of loans and insurance to survive seems incredible. So now we have a rerun of the banking crisis, except this one has swapped struggling banks for the eurozone’s weakest countries.
The politicians tell us they have learned from the banking crisis. With fixed frowns, they argue the deal hammered out over the weekend, just like the post-Lehman Brothers mega-bailout, will see off the “wolf pack” of speculators licking their lips at the thought of devouring Greece, Spain and Portugal. As a package, the deal is so big and all-embracing it gives no room for speculation.
Spain, which has agreed to take another 1.5-percentage point cut in government spending, will join the austerity club. Greece and Portugal will swallow their own bitter medicine. Job done.
Yet there appear to be plenty of lessons the eurocrats either failed to understand or, fearing a backlash from electorates, were too scared to implement. For instance, why did we wait so long for a rescue plan? For more than eight months, respected commentators have argued that Greece was a train without brakes, coming down the track at breakneck speed. Like the UK bank Northern Rock, it needed to be dealt with to stop any threat of contagion.
The word “contagion” crops up because all EU countries have large debts and have agreed to budgets this year that increase those debts still further. Eurozone countries have total government debt worth £6 trillion. Germany alone has racked up £1.4 trillion of the total, while Greece accounts for £250 billion.
Delay will only make things worse. Only someone who has failed to learn those lessons would wait until Greece’s two-year bond rates hit 20 percent, as they did Friday last week, and fears of instability had damaged its neighbors’ reputations.
The idea of moral hazard, or the fear that a bailout will encourage profligacy in other nations, is another lesson unlearned. German Chancellor Angela Merkel and European Central Bank Governor Jean-Claude Trichet have continually blocked policies because they breach the moral hazard code.
When the banks collapsed, regulators, at politicians’ request, imposed strict capital rules and restrictions on their activities which provoked a massive slump in lending across the EU and hampered a return to growth.
Likewise, with the Greek bailout come draconian austerity measures that cut national income, restrict growth and are likely to provoke the need for more austerity. Greece already accepts it will remain in recession for at least another two years.
EU politicians believe Greece is expendable. Maybe Portugal too. However, if Spain and Britain are forced to make premature cuts beyond what has already been agreed and France and Italy own up to their own massive overspending, the EU is back where it was two years ago, staring at a 1930s-style depression.
If moral hazard means punishing countries that want to prevent high unemployment and low investment from wrecking their recoveries, it is as misplaced as when Bank of England Governor Mervyn King used the term in the summer of 2007.
King quietly dropped the term moral hazard from his speeches when the scale of the problem became obvious. Merkel and Trichet, albeit at the last moment, appear to have followed suit. The markets, however remain wary.
Merkel, like most of her countrymen and women, believes Germany should restrict its support. What if more guarantees are needed? Will the Germans step in again? And then there is the interest rate. Greece will be forced to pay around 5 percent for its 10-year loans. While it may be cheaper than the 8.5 percent it currently pays, it is a good return for German taxpayers when the UK pays 3.9 percent and German bonds pay 2.9 percent.
It is true that most European nations have spent freely over the past 20 years, much of it on the world’s largest credit card, but they need time to make adjustments to their public debt. They cannot cut spending and investment and at the same time grow their economies to pay off debts.
In the UK, we need a further stimulus to push the economy beyond any thoughts of a double-dip recession, boost confidence and drive up tax receipts. To those who say we cannot afford more debt or a delay, what is the alternative? Why not pay off our debts over a longer period? It will already take a generation to get rid of it all.
Will the markets buy that? Just as my mortgage company happily accepts extending my loan by 10 years, there is no reason why not. Of course, I need to stop overspending and cut up my credit card, but forcing me — or Greece — to default helps no one, especially when much of the loan is supplied by European investors and pension funds. Maybe they don’t care as long as they get their money, but they should.
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