Wednesday, 24 October 2012

How Do You Solve a Problem Like the Euro?

by Andrew Jones


(source: gramilano.com)

Teetering on the precipice seems to present a pretty accurate picture of the Eurozone's current position. The mid-summer fears surrounding the possibility of a double dip recession became slightly more of a reality when growth figures fell 0.2% in the second quarter. The efforts of France and Germany to drag the Eurozone out of its predicament failed as the economies of Spain, Italy, Finland and Portugal contracted to continue economic tales of woe. At such an economically dangerous point it might be prudent to consider where the solutions may lie and the lessons which the Eurozone could learn to prevent a repeat affair.


Angela Merkel: hostile to bail-outs
(source: eleconomista.net)
 So where might the solutions lie? Perhaps the ECB's current favourite option has been through bail outs to try to shore up weaker economies. These are however attached to difficult conditions which few are able to meet. Recently this approach has been criticised for being too harsh on struggling economies. Christine Legarde recently urged the Eurozone communities to give these economies “ a bit more time.” Might this therefore become the way forward for a Eurozone solution? Such a measure is sure to induce friction between those being bailed out and those paying for them. Germany in particular has remained hostile to the prospect of bail-outs with “softened conditions” as Foreign minister Guido Westerwelle iterated at a meeting of Eurozone leaders. This sentiment is due to the Government being “under pressure not to soften by one single millimetre” according to Stephen Evans. Such a solution is therefore unlikely to become a reality as though it may offer countries such as Greece and Spain a more achievable settlement, crucially it fails to gain the support of key contributors such as Germany. For policy makers in the ECB, the current bail-out plans with strict conditions are unlikely to be a viable method for much longer as they serve to increasingly undermine government support in weaker countries. Therefore whichever strategy is taken, relying on bail-outs, although economically practical to help shore up Government finances, simply leads to unpopular Governments at a time when they really need the support of their people.

The prospect of either a Greek default or, worse, exit from the Euro has been suggested as a possible solution. Though long talked about, this scenario seems unlikely to become reality as individuals on all sides of the table have ruled out the possibility. The Greek Prime Minister Antonio Samaras addressed supporters of such a notion with a stark rebuttal:  “We must make sure that we abide by what we have signed because we believe that what they call a 'Grexit' is not an option for us. It would be a catastrophe.” Whilst those within Europe seem unwilling to consider the act, the warnings of catastrophic consequences have been weakened as Jean-Claude Juncker argued that a Greek exit would be “managable.” Despite this, a Greek exit from the Eurozone remains the most risky and dangerous solution which should really be viewed as a desperate last resort. Fears that a Greek exit could spark a contagion of other exits certainly rings true when one considers the state of Spanish, Irish, Italian and Portuguese economies which fared little better.

Anti-austerity protestors in Greece
(source: cpjournalist.com)
Clearly a Greek exit appears off the cards, but what about a Greek default? Could this be a viable solution? The straight answer is no but it is likely to happen. Using the Argentine major default of 2001 as a comparison highlights certain consequences which could prove crippling for Greece. Subsequent to the default, Argentina was stripped of its position in the Global credit markets, reducing its borrowing capabilities. Jaime Abut, a business consultant in Rosario, observed “You have to pay the consequences, and for a long time. Argentina is no longer considered a serious country.” There was a silver lining to the cloud following the default for Argentina. The economy bounced back remarkably quickly, growing by about 8.5% annually for six years since 2003. Unemployment also was quickly halved, demonstrating real benefits, which could be replicated following a Greek default. Therefore, whilst the long-term credibility of Greece will inexorably be undermined, the economy may be allowed to flourish. Adam Lerrick, who at the time of the Argentine default, negotiated for European and Japanese, has concluded that Greece will eventually have to default or be “enslaved for decades.”

Currently the sentiment within Europe has focused on riding the storm until 2014, when the European Stability Mechanism is due to be brought into force. A newly formed agency, it will possess up to 500bn euros in order to support these struggling economies. There is a serious weakness in this policy in that a Spanish bail-out is estimated to require around 300bn euros, leaving a mere 200bn to deal with future crises, which, judging by the past record, seems the likely case. Exploring how to deal with the Greek economy has been just the icing on the cake with other economies set to decline, taking Europe further down the rabbit hole. Where do they go? The answer, I believe, lies through an international response to shore up the European economies. Observing the ESM's meagre funding helps illustrate that  Europe just does not have the money to solve their problems.

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