Thought du Jour

Two days ago, FT columnist Wolfgang Münchau wrote that the European Council’s rescue package for Greece solves nothing. Martin Wolf agrees.

The ruling idea here is that the weakening of fiscal positions in peripheral countries reflects a lack of fiscal discipline. That is true of Greece and, to a lesser extent, Portugal. But Ireland and Spain had what seemed to be rock-solid fiscal positions. Their weakness lay in private sector financial deficits. It was only when the private sector corrected after the crisis that the fiscal deficit exploded. Since the problem was in the private, not the public sector, monitoring must also focus on the private not just the public sector. ….

Germany can get its way in the short run, but it cannot make the eurozone succeed in the way it desires. Huge fiscal deficits are a symptom of the crisis, not a cause. Is there a satisfactory way out of the dilemma? Not so far as I can see. That is really frightening.

Martin Wolf, “Why Germany cannot be a model for the eurozone”, Financial Times, 31 March 2010.

This crisis extends well beyond Greece. It threatens all eurozone countries, other members of the European Union, and the rest of the world. One way out is for Greece – followed by Portugal, Ireland, Spain and perhaps Italy – to abandon the euro. This will be extremely painful, but might allow remaining eurozone countries to continue with monetary union, and soften the effect of the crisis on the rest of the world.

FT columnist Wolfgang Münchau finds that last Thursday’s “emergency funding agreement” for Greece resolves nothing, and is “mostly smoke and mirrors”.

The aspect that puzzled me most was the announcement that a rescue would come in the form of a loan at market interest rates. This surely must imply that the market would not be willing to lend money to Greece at market interest rates. That is an absurd proposition.

In fact, it is hard to imagine even a hypothetical scenario in which the European Union would disburse the emergency aid. Greece would have to be cut off from the capital markets; in such a situation it is difficult to imagine that a loan from the EU – at prohibitively high interest rates – would solve any problems. ….

When a country adopts an austerity package … it needs some form of relief, simply to make it through the recession. This would normally come either through devaluation or from a low-interest loan, … or ideally both. Greece will have neither.

Under these circumstances … default is the financially superior option, especially since 70 per cent of Greek debt is held by foreigners.

Wolfgang Münchau, “Europe has resolved nothing over Greece”, Financial Times, 29 March 2010.

Mr Münchau’s conclusion is “the politics of smoke and mirrors cannot fool all the people all of the time. This will not end well.” He thinks that Greece will default.

My fear is that Germany, with help from other eurozone countries, will lend money to Greece at “market rates”, but at market rates for German bonds, not market rates for Greek bonds. This would constitute a bail-out, and quite possibly the end of monetary union. Whatever happens, it is very clear that this will not end well. The only way to contain the damage is for Greece to leave a monetary union that it should never have joined in the first place.

Last night (Thursday), eurozone leaders agreed on a rescue package for Greece so that the country can remain in the monetary union. There is a real danger that the bail-out might trigger German exit from the euro.

Twelve years ago four German professors took their government to court in an attempt to get Germany out of the euro, arguing that some member countries had manipulated statistics and failed to comply with entry conditions. In today’s Financial Times, these same professors threaten to sue their government in constitutional court once again “should eurozone governments provide assistance to Greece in a manner that contravenes the no bail-out rule”. The rescue package satisfies this condition.

I have been unable to locate an ungated version of this short op-ed, so copy and past the most relevant parts below.

There is no shortage of proposals to help the Greeks, including assistance from other eurozone governments – a move that would contravene the “no bail-out” rule enshrined in the treaty setting up monetary union. There is, sadly, only one way to escape this vicious circle. The Greeks will have to leave the euro, recreate the drachma and re-enter the still-existing exchange rate mechanism of the European Monetary System, the so-called ERM-II, which they departed in 2001. ….

In a landmark judgment in 1993, the constitutional court ruled that, once it came into force, monetary union had continuously to satisfy the full conditions of the “stabilisation treaty” concluded when the single currency was agreed. If it did not, the court ruled, Germany would be obliged to leave. ….

[In 1998] our suit was rejected. Today, with the plight of the errant euro states and the statistical irregularities recognised by nearly everyone, we believe the outcome would be different. ….

Removing Greece from the euro provides a way of preventing a drama from becoming a tragedy – and of ensuring the survival of monetary union.

Wilhelm Hankel, Wilhelm Nölling, Karl Albrecht Schachtschneider and Joachim Starbatty, “A euro exit is the only way out for Greece”, Financial Times, 26 March 2010.

Three of the writers are professors of economics. One – Karl Albrecht Schachtschneider – is a professor of law.