Europe faces its biggest political tests as Greece heads for euro exit
By Jonathan Eyal, The Straits Times, 15 May 2012
ALTHOUGH few dare say so publicly, most European leaders privately accept that the unthinkable is about to happen: Greece may have to leave the euro zone. Financial markets are already making preparations for an event they nicknamed 'Grexit'.
Still, the manner of the Greeks' departure and the way the aftermath of the crisis is handled will shape Europe's destiny for years. The continent's biggest political tests are beginning.
In theory, Greece can still pull back from the brink. Even if no ruling coalition is feasible, a caretaker government pledged to respect the nation's obligations remains in place.
But the reality is that the battle for the soul of Greece is already lost. Two-thirds of its voters opted for parties determined to stop repaying the country's debts, while claiming that they also wish to keep the euro - in other words a majority wants to have its cake and eat it too.
Those responsible for this curious outcome are Greece's own politicians, who nurtured a collective mood of self-denial. Many ordinary Greeks genuinely believe that their country is a victim of a 'plot' by bankers, who first encouraged Greece to borrow excessively, and are now lending more money at high interest rates in order to recover their debts.
The fact that Greece itself is responsible for its excessive borrowing impresses few. Nor do many Greeks seem to understand that the €200 billion (S$325 billion) in additional help given to them over the past year is the hard-earned money of other European taxpayers; the view from Athens is that these are funds plucked out of thin air by 'fat bankers'.
Germany, which provided the bulk of the bailout money, gets no gratitude either; some Greeks believe that the Germans should offer the cash for free, as 'compensation' for World War II.
It is now impossible to reverse this poisonous Greek narrative. It is equally impossible to see how any Greek leader can persuade his people to stick with austerity policies which have slashed the nation's wealth by a fifth. The conclusion is inescapable: default is looming. More ominously, it is likely to be a messy affair.
Greek politicians such as Mr Alexis Tsipras, the youthful leader of Syriza, the radical left movement which sprang out of nowhere to become the country's second-biggest party, assume that they can blackmail the rest of Europe into continuing to offer cash without preconditions.
The defeat suffered by German Chancellor Angela Merkel in local elections on Sunday is also interpreted as a move away from the policies of austerity which Dr Merkel foisted on the rest of Europe.
But while a weaker Merkel government may lead to a greater German readiness to relax austerity conditions on other European nations such as France or Spain, it does nothing for Greece. German voters, as surveys have shown, are not clamouring to hand over their money to the Greeks and, with Greece accounting for only 2.3 per cent of Europe's economy, the country is dispensable.
Indeed, making an example out of Greece by rejecting any concession is almost certain to be Dr Merkel's way of showing the rest of Europe that Germany cannot be taken for granted.
The Greek default may come as soon as the end of next month, when Athens has to cut another €11 billion out of its government spending - which given the new composition of the Greek Parliament, cannot happen. If the European Union stops offering money then, Greece will default almost immediately.
What follows after that amounts to - as one EU official put it - 'a jump into the abyss without a parachute'. A Greek default could trigger off a Europe-wide panic, leading to the collapse of the euro and a global economic slump.
But there are good grounds for believing that this is too alarmist. Most Greek debt is already in the hands of European governments or the European Central Bank, which means Greece's default will not spell a European-wide banking meltdown.
Greek banks will, of course, collapse. The country will have to issue a new currency, which will promptly crash. It will also have to temporarily close its borders in order to prevent capital from fleeing. And, as unemployment soars, the chances of civil strife in Greece remain high.
The technical difficulties which could be created by a Greek default remain mind-boggling. But European governments have spent months quietly preparing for such an eventuality. Nor would it be surprising to discover that Greece has already printed an alternative currency. It may have not have been coincidental that the Greek national bank upgraded its British-made printing presses last year.
The key for the rest of Europe will be to make sure that a Greek default remains confined to that country. This will mean that other vulnerable nations such as Portugal or Spain, would immediately be offered additional bailout funds even if they don't actually require it; the purpose should be to reassure people that countries which observe their obligations retain the benefits of Europe's single currency.
No doubt Europe's credibility will suffer a permanent blow: it will no longer be possible for it to claim that it is an 'oasis of stability' after allowing one of its members to default. So, for decades to come, Europe will have to pay a risk premium on its borrowing.
Still, Mr Jens Weidmann, the head of Germany's central bank, the Bundesbank, was probably right when he pointed out over the weekend that, 'for Greece the consequences would be much more grave than for the rest of the euro zone'. Investors will conclude that Greece was a uniquely horrible case, and that its fate need not be replicated elsewhere in Europe.
Ironically, however, Greece will not escape from its obligations by defaulting. If it wishes to remain part of the EU, it will still have to repay every cent it owes and may have to do it the harder way, with its own devalued currency. The Greeks will also be unable to borrow, so they will be confronted by the rather unusual experience of having to live within their means.
The nation which invented the word 'tragedy' should grasp this situation pretty well.
FORGET for a moment Mr Francois Hollande, who sent Mr Nicolas Sarkozy packing last Sunday. Set aside, too, the triumph of the radical left and the neo-Nazis in Greece who together captured one-third of the vote.
Look instead at Europe's real mess: the sickly state of the EU-15, the core of the Union, most of which today uses the euro: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Luxembourg, Portugal, Spain, Sweden and the United Kingdom.
In the 1970s, their average growth clocked in at 3.2 per cent, in the 1980s at 2.5 per cent, in the 1990s at 2.2 per cent - and in the last decade, 1.2 per cent. Yes, the 2008 crash was bad for everybody, but Europe is still heading down. This year, growth is likely to end up at an anaemic 1 per cent.
Europe has been falling back for decades, and this is the source of all its trouble. Yesterday's economic wonderland, with its ever growing list of benefits and privileges, is losing it. While the US share of global gross domestic product has held steady at about 26 per cent for two generations, the EU-15's share has dropped to 26 per cent from almost 35 per cent in 1970.
Back to Dark Sunday's elections. You might have thought that the French and Greek parties would have hyped themselves as saviours: 'Anoint us, and we shall lead ye from debt and decline.' Wrong. The winners were those who yelled: 'Stop the world, we want to get off!' Cursed be the market, blessed be the all-providing state.
Markets ended Francois Mitterrand's agenda within two years. The new Socialist President won't have that long.
This is the message of those 52 per cent who voted for Mr Hollande in France. In the campaign, he had targeted 'financial markets' as the enemy of the French social model, while offering to tax, protect and provide. No talk of the real reason why those evil markets and their ratings agencies downgraded France: The national debt has surged to 90 per cent of GDP, from 35 per cent in 1990.
In Greece, the big winner was the Coalition of the Radical Left, or Syriza, which won nearly 17 per cent of votes - almost four times its take in the 2009 elections. Together, the far left and far right have overwhelmed a government that had pledged to slash spending and cut into the bloated state sector. The pro-reform coalition of the moderate right and left has lost its parliamentary majority and may have to go into new elections in a few weeks. Hence, the 'Nightmare of Anarchy', as Greek daily Ta Nea headlined its post-mortem on Tuesday.
Meanwhile, unemployment now averages close to 11 per cent in the euro zone. The odd-man-out in this drama of decay is Germany. Joblessness, which stood at five million a few years ago, has dropped to less than three million. The public budget deficit is heading towards zero. Why this Teutonic miracle? Germany had cleaned house before the crash struck.
Go back nine years, when Social Democratic chancellor Gerhard Schroder launched his 'Agenda 2010'. He declared to the Bundestag: 'We shall reduce social benefits, promote individual responsibility and demand more from each and all.' True to his word, he loosened up labour markets, cut payroll, personal and corporate taxes, and enacted a 'workfare' programme that egged the unemployed off the dole. Dr Angela Merkel is now reaping what her predecessor sowed - efforts for which he lost his job.
Today, elsewhere in Europe, leaders' attempts to change their economies' bad old ways have not met with political boons. Since 2008, a dozen euro-zone governments have fallen like the House of Lehman. Yet, what is the alternative but to pursue the reforms? Where would the cash come from, when Germany is the last man standing among the large countries? Perhaps Europe is still rich enough to keep Greece on the dole indefinitely. But it does not have the resources to put France, Italy or Spain on euro welfare.
Which brings us back to the new French President, who in 1981 was a young Elysee staff member when Mr Mitterrand enacted the very programme Mr Hollande has been hawking: buy now, pay later, tax forever. Two years later, Mr Mitterrand's Socialist Party was drubbed in local elections, Saul turned into Paul and Mr Mitterrand started preaching discipline and markets. This time, the Socialist President won't even get his first 100 days.
For one thing, Dr Merkel will not relent. She will not allow Mr Hollande to loosen the debt brakes enshrined in the EU's fiscal pact by inserting the kind of 'growth' Mr Hollande wants - a euphemism for spending Europe into insolvency. She knows that the euro, indeed the EU, is at stake - and that neither will be saved by Keynes-to-the-max.
'Growth' a la Mr Hollande will not heal but feed Europe's disease. The country needs labour liberalisations, with youth unemployment topping 22 per cent. The French job market tells a simple, sordid tale: high wages and lifetime job security are great for insiders and deadly for newcomers.
If Europe's core does not regain competitiveness now, it will sink and fall apart. So what will it be: 'Mitterrand for All' or 'Schroder does Europe'?
Watch the new French President in the coming weeks. My bet is that he will take a page out of Casablanca and sputter: 'I am shocked, shocked to find out about the mess Mr Sarkozy has left.' Then he will blame Dr Merkel's brutishness for forcing him to deliver a 'blood, toil, tears and sweat' speech in which he breaks all his campaign promises.
And if he doesn't yield to reality? The markets will speak.
The writer is editor of Die Zeit in Hamburg, a senior fellow of the Freeman Spogli Institute for International Studies and a fellow at the Hoover Institution, both at Stanford University in California.
EU sends 'brutal messages' to Greek leaders as govt talks fail
REUTERS, BLOOMBERG, AGENCE FRANCE-PRESSE, 14 May 2012
Fresh elections likely; Germany insists bailout terms will not be eased
REUTERS, BLOOMBERG, AGENCE FRANCE-PRESSE, 14 May 2012
ATHENS: Greece looks headed for fresh elections that some say will be a referendum on a painful bailout package after a key leftist party spurned a last round of talks to form a new government.
President Karolos Papoulias must call a new election if he fails to get the main parties to agree to a compromise. Such a poll is expected to be held in mid-June.
With Greece set to run out of money as early as next month and no government in place to negotiate the next aid tranche, investors have begun betting that a long-speculated Greek default and exit from the 17-nation euro bloc will happen sooner rather than later.
Greek shares plunged nearly 5 per cent to a 20-year low in early trading as European markets also fell. The euro dropped to its lowest level in almost four months against the dollar.
Euro zone officials made clear ahead of a finance ministers' meeting in Brussels yesterday that Greece must stick to the tough austerity measures it agreed to in return for the debt rescue.
Germany, the euro zone's paymaster and biggest economy, said yesterday that forming a government was the most important consideration but at the same time stressed that there could be no relaxation in the bailout terms for Greece.
German Chancellor Angela Merkel said it would be better for Greece to keep the euro. She said EU leaders should help it recover, but added such solidarity would cease in what she called the unlikely event of Athens reneging on agreements.
Head of the European Commission Jose Manuel Barroso, meanwhile, still 'hopes and wishes' Greece can remain in the euro zone. But Athens must live up to its commitments, his spokesman said.
'Brutal messages are being sent to Greece: we'll see if that knocks some sense into the leaders of the Greek political parties,' a senior diplomat said.
An opinion poll published yesterday indicated that a majority of Greeks want their country to stick to its current economic financial aid plan and to remain in the euro zone.
Almost 54 per cent of 1,002 people surveyed by research consultancy Rass SA for the newspaper Eleftheros Typos said Greece should continue to implement measures agreed on with the International Monetary Fund and European Union, against 38 per cent who would reject the programme.
The poll also indicated that radical left party Syriza would emerge as the winner if fresh elections were held now, with support rising to 20.5 per cent from the 16.8 per cent it won in the May6 election.
Two thirds of those surveyed, or 66.1 per cent, wanted Greece's political parties to form a coalition government, while the remaining third preferred new elections. About 81 per cent wanted their country to stay in the euro zone.
Some 39 per cent said Syriza leader Alexis Tsipras, 38, bears the most responsibility for the political deadlock since the May 6 election.
Yesterday, the head of another small moderate leftist party, seen as the last hope for a coalition, said there was no chance of a unity government being formed.
'No unity government can emerge,' Mr Fotis Kouvelis, head of the Democratic Left party, said, pointing to the refusal of the Syriza party - which came in second on May 6 - to join a coalition. Mr Kouvelis however attended the talks to try and form a coalition.
The prospect of national bankruptcy and a return to the drachma appeared to be slowly sinking in among some Greeks.
'We have to stay in the euro. I've lived the poverty of the drachma and don't want to go back. Never!' said 70-year old pensioner Maria Kampitsi, who had to shut down her pharmacy two years ago due to the crisis.
Said centre-left daily Ethnos in an editorial: 'Syriza has paved the way for new elections. And this time, whether we like or not, they will be more like a referendum. We will have set ourselves the question whether we prefer the euro or the drachma.'
Euro zone: If Greece goes, what next?
By Chris Giles And Peter Spiegel & Kerin Hope, Financial Times, 13 May 2012
THE idea of a Greek exit from the euro zone is no longer fanciful. After 70 per cent of voters in the election on May 6 supported parties that rejected the terms under which €174 billion (S$287 billion) in international bailout loans was offered to Athens, many investors now see a fissure in the 17-member euro zone as increasingly likely. European governments are furiously thinking through the various scenarios, while still urging Athens to stick to its agreements on austerity and reform. If those hopes are dashed and Greece goes, what happens next?
Is Greece serious about quitting the euro zone?
WHO knows? Opinion polls showing 80 per cent of Greeks in favour of staying in the euro and the election result offer a scene of confusion.
Popular anger is running high at the prospect of three more years of austerity while Athens implements the rest of the reform programme agreed with the European Union (EU) and International Monetary Fund (IMF). 'We desperately need a break... If my pension is cut again, I might as well commit suicide,' says Mr Angelos Syrigos, 85, whose modest income has been slashed by 30 per cent in the two years since the bailout began.
Mr Alexis Tsipras, Syriza's charismatic 37-year-old leader, who emerged as a kingmaker following his party's surge to second place at last Sunday's inconclusive general election, is gaining in support. Opinion polls published at the weekend showed Syriza would win first place in a second election, with 20 per cent to 25 per cent of the vote.
Mr Tsipras insists Brussels and Berlin will not force Greece out of the euro because of the contagion effect this would have on Portugal, Ireland and Spain. He has demanded a reversal of salary and pension cuts imposed by the bailout, as well as the hiring of 100,000 new public-sector workers to reduce the impact of a 21 per cent unemployment rate.
Middle-aged Greeks are afraid of a euro zone exit, fearing a further collapse in property values, the crumbling of the banking system and high unemployment.
'The gravity of the situation isn't appreciated. Some people believe Syriza will change its tune, others that the Europeans make empty threats,' says Mr Takis Michas, a political commentator. 'The only thing that will focus minds is when the money to pay pensions and salaries just doesn't arrive.'
Is Europe ready to jettison one of its own?
EURO zone officials had prepared contingency plans for a Greek exit - or 'Grexit', as some have called it - after Mr George Papandreou, then Prime Minister, proposed a national referendum in October on euro membership. Indeed, Mr Wolfgang Schauble, Germany's Finance Minister, actively urged the referendum to halt the endless questioning once and for all, according to one senior European official.
Even then, such officials were uncertain whether the rest of the currency union could survive the shockwaves unleashed by a return of the drachma - particularly in bailed-out countries such as Portugal and Ireland, where bank runs and market panic could follow on the assumption that others could follow Greece out of the euro zone door.
But now, with a new, permanent €500 billion rescue fund backed by the strength of an international treaty with multiple tools to buy sovereign bonds on the open market and inject capital into euro zone banks, some officials believe the contagion could be contained - much as it was after Athens finally defaulted on private bondholders last month.
'Two years ago, a Greek exit would have been catastrophic on the scale of Lehman Brothers,' says a senior EU official involved in discussions about Greece's future. 'Even a year ago, it would have been extremely risky in terms of contagion and chain reaction in the banking system. Two years on, we're better prepared.'
The new euro zone firewall - now backed with additional resources for the IMF - is not the only reason some officials are becoming increasingly sanguine about losing Greece. Spain and Italy, they say, have taken huge steps to put their economic houses in order, enabling them to bounce back quickly if credit markets suddenly dry up and their banks wobble.
Still, uncertainty over how Europe's banks would be affected has continued to be the primary concern.
Witnessing Greek bank customers suddenly having their euros turned into drachmas overnight, depositors in other peripheral banks might suddenly withdraw their cash and place it in seemingly safer euro accounts in Germany or elsewhere. Such a massive run could destroy much of the euro zone periphery's banking sector. 'The ball is genuinely in their court,' says the EU official. 'Those who understand the situation realise their room for manoeuvre is extremely limited. We simply have to wait.'
What would exit from the euro zone entail?
IN A game of brinkmanship, neither Athens nor the rest of the euro zone would want to take responsibility for a Greek exit from the single currency. Recriminations would fly.
Against accusations that it is imposing, in the words of Mr Tsipras, 'barbarous' demands, the core of the euro zone is already positioning itself to ensure any exit is seen as a sovereign decision. 'The future of Greece in the euro zone lies in the hands of Greece,' Mr Guido Westerwelle, Germany's Foreign Minister, said on Friday. 'If Greece strays from the agreed reform path, then the payment of further aid tranches won't be possible. Solidarity is not a one-way street.'
Slippage against the agreed EU and IMF agreements would probably be accepted for a period, so the trigger for exit would be a deliberate rejection by a new Greek government of the requirements for austerity and structural reform in the existing agreement that Athens signed with the 'troika' of the European Commission (EC), the European Central Bank (ECB) and the IMF in February. 'It would be more of a case of Greece walking than of Greece being pushed out,' says Mr Willem Buiter of Citigroup.
Exit would occur because, without disbursements of additional loans, the government would run out of money to pay social security and public-sector wages. In addition, the ECB could withhold needed funds from Greek banks, bringing them down. At this point, Athens would need to pass a new currency law, redenominate all domestic contracts in a new drachma, impose exchange controls, secure the borders to limit capital flight and take steps to introduce a paper currency.
Printing and distributing new notes would be no easy feat. In 2003, the US-led coalition managed to do it in Iraq in less than three months. But that required the efforts of De La Rue, a British speciality printer, a squadron of 27 Boeing 747s and 500 armed Fijian guards to ease the process.
After exit, Greece would have to negotiate continued EU participation. The EU treaties have a provision for leaving the union, but not just the euro zone. That negotiation would be all the more difficult if the new Greek authorities defaulted on debt to the European Financial Stability Facility, the ECB and the IMF.
If the country defaulted on its IMF debts, it would join a small, ignominious club of nations - including only Zimbabwe, Somalia and Sudan - that have overdue financial obligations to the fund.
What economic effects will Greece suffer?
IN ANY exit scenario, the new drachma would depreciate rapidly. How far cannot be predicted but the IMF estimates Greece needs at least a 15 per cent to 20 per cent devaluation against the euro zone average - and considerably more against Germany - just to achieve a current-account balance. Currency moves tend to overshoot, and US investment bank Goldman Sachs has estimated that to stabilise Greece's international debts at a reasonably low level - needed to ensure the country can insulate itself against the risk of capital flight - a devaluation of 30 per cent is needed compared with the rest of the euro zone, and more than 50 per cent with Germany.
Such a devaluation would restore competitiveness, but it would be far from the end of the story. A new administration would probably repeal a law that prioritises debt interest over other forms of government spending, and a new default would occur on the remaining private-sector debt and on official sector debt owed to European institutions and the IMF.
Even if all interest payments were stopped, additional austerity would still be needed for a period because tax revenues still fall short of its public spending - a primary deficit.
The IMF estimates that even if there is no exit, there will be a primary deficit of 1 per cent of national income this year, a figure that would almost certainly rise in a recession deepened by uncertainties surrounding exit and a bust banking system.
There are two plausible scenarios. In the brighter one, a responsible government is able to restart the banking system, run a balanced budget and persuade the public to accept sharp declines in living standards as import prices rise quickly. After a period of deep austerity, rapid growth might be possible.
Under the alternative scenario, a government takes office that seeks to use its new powers of monetary autonomy to offset the effects of devaluation and spend its way to prosperity. The danger is that hyperinflation after short-term relief would be followed by further currency depreciation and money printing.
Is Greek business ready for an exit?
THE blunt warning this month from Mr Evangelos Mytilineos to shareholders offered a rare insight into the thinking in the boardrooms of Greek businesses with international operations. The chief executive of Athens-based industrial group Mytilineos said that the headquarters of Metka, a subsidiary that builds power plants in eastern Europe and the Middle East, may be moved abroad. 'Our Greek background is not very helpful when it comes to competing internationally,' Mr Mytilineos said.
While some large businesses have prepared contingency plans in case of a 'Grexit', medium-sized companies are waiting to see what happens, say Athens-based consultants.
'I think it's too early to start thinking about drachma-isation,' says a Crete-based hotelier, citing the wildly diverging exchange rate estimates for a new currency. Last year, he rejected a contract amendment proposed by Tui, a German travel operator, relating to financial obligations in the event of the return of the drachma.
Even those not planning to move are making sure any money earned abroad stays there. One basic lesson of the crisis 'has been to make sure that your receivables are not brought back to Greece', says one exporter. 'I keep almost all my funds abroad.'
Businesses serving the domestic market are downsizing after two years of trying to keep costs down amid a dramatic plunge in sales. 'We're planning to close half of our outlets by the end of the year,' says the general manager of one retail chain. 'If we go back to the drachma, we'll keep only a flagship store in Athens.'
Analyst Solon Molho says the disastrous consequences of leaving the euro were not yet fully appreciated. 'You would most likely decide to shut down operations, sell the business if you could find a buyer, and perhaps leave the country altogether.'
Can the euro zone contain the contagion?
THIS is the biggest unknown. If the euro zone authorities could persuade investors and the public that Greece was a special case, the effects of an exit could be contained. If not, a Greek exit would soon become a disorderly break-up of the euro project.
The inevitable question after a departure is: 'Who's next?' Eyes would turn rapidly to Portugal, which followed Greece into the bailout club. Investors would sell Portuguese bonds, seek to extract money from the country's banks and take euros across the border for fear of an exit and devaluation. Currency risk has been evident in the European banking system since late last year, but the incentives to move deposits into German banks from those in Portugal, Ireland, Spain and Italy would be clear.
If the political will to hold the single currency together exists, the euro zone has a big weapon in its arsenal to contain the contagion: unlimited action by the ECB. It could restart bond-buying at very high levels to limit rises in sovereign bond yields and offer unlimited liquidity to peripheral nation banks to offset a run on deposits. This would worry Berlin, which feels the ECB has already gone too far in underwriting bank and sovereign debt in peripheral countries. But the alternative is worse, as the EU has no other sufficiently powerful defence against a systematic bank run in such nations.
The answer, therefore, is that the euro zone could limit contagion, but it is highly uncertain whether it would. If it did not, the end of the euro would be nigh.
In either case, the outlook for the European economy is highly risky. After the Lehman collapse in 2008, it was not a dearth of bank lending that plunged the region into its worst recession since World War II, but a collapse in confidence and spending as households and companies decided simultaneously to tighten their belts in fear of what might happen next.
Unless the European authorities are extremely skilful in ring-fencing Greece, a similar scenario would be a severe danger.
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