The Government’s financial
European governments, with assistance from the International Monetary Fund ended a package large enough for a default by Greece to avoid, at least for the next two to three years. This does not mean that the future of the euro is permanently ensured, but it suggests that the immediate financial crisis is probably over. In the longer term, investors will continue to worry about the ability of the Greek government’s debt service, but their concerns will not have any impact on real economic conditions, as the Government’s financial needs for the next two to three years was secured. The only thing that can now be a Greek standard allows a failure by the Government to its promises so blatantly that the EU and the IMF will cease distribution of the promised € 110000000000 bailout. But while armchair analysts have always loved to speculate about a breakdown of public order and descent into anarchy, the experience of IMF austerity programs in the countries of Thailand, Indonesia and Mexico to Latvia, Romania and Hungary that ordinary people surprisingly willing to accept casualties when the government runs out of money.
As Valdis Dombrovskis, the Prime Minister of Latvia, remarked last Friday at the Munich Economic Summit: “Real reform begins when the government funding stops.”
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Mr Dombrovskis knows what he is talking about. His country had just made the biggest fiscal consolidation ever recorded. About 30 percent of public sector jobs have gone, the wages of government workers who remained cut by 25 percent and a government deficit of 20 percent of GDP into a surplus of 8 percent in just two years . It is approximately five times the pace of consolidation is required in Greece. But while Greece currently has escaped its immediate liquidity crisis, the country’s bonds remain as a junk credits, and the prospect of sovereign default in the euro zone is no longer unthinkable.
Consider three implications of this sequence of events. The first will be that other weak governments in the euro zone would be considered a serious credit risk. Portugal, even though it is much less debt than Greece, will sooner or later suffer some Greek-style funding problems – which in turn will raise questions about the effects of the Spanish Government. At that point, a second implication of this week’s rescue plan comes into play: other Club Med countries will not be bailed in the same way as Greece. After all the controversy in Germany over Greek rescue, the German political system simply could not come up with another bilateral loan to Portugal, never mind five or ten times as much money for Spain.
In this sense, it was Greece Bear Stearns crisis, the euro, with Portugal playing the part of Lehman Brothers. The question then will be how to save Spain. That country is clearly too big to fail in the same way as AIG and Citibank, and will be bailed out regardless of cost. But this brings us to the third implication of the Greek package. Greece was easy for Europe to bail out, despite the reluctance of German voters, because it was a small country. But Spain is too big to save, at least with a direct loan from other European governments. Europe’s only serious hope of strengthening Spanish debt would have been a common solution, with the EU as a whole would members need fiscal support to consider.
That’s what it did for Latvia, Hungary and Romania last year, when it authorized the sale of € of EU securities guaranteed by all EU governments 50 billion. This was the solution I in the case of Greece expected. But by opting for bilateral aid from individual governments in the case of Greece, EU leaders missed the chance of a joint mechanism for the eurozone fiscal bailouts create – and the opportunity is now gone forever, for a reason that almost nobody has noticed. A conservative-led government will almost certainly take over, there will be no prospect of Britain agreeing to a new bond issue by the EU as a whole, the kind that could have been, perhaps a month ago . Since the euro group on its own is not the “right personality” necessary to issue bonds, a collective salvation for the next troubled country is now out of the question.
What will happen if investors in another Club Med stock market decided to go on strike? While Europe has no political or fiscal institution strong enough another rescue after bailout of Greece to rule, it is a monetary institution with unlimited firepower. If Portugal and Spain in trouble, the European Central Bank move forward as a buyer of last resort for all Club Med bonds. By following the Federal Reserve Board and the Bank of England announcement of a quantitative easing program, worth about 10 percent of the eurozone’s GDP, the ECB could easily finance all the Club Med countries’ budget deficits for the next year or two. This is exactly what the Bank of England did in monetising all of the British government’s borrowing requirement over the past 12 months. Central bank lending directly to governments are legally prohibited by the no-bailout “clause in the Maastricht Treaty, but the ECB could easily get through the lending of Spanish and Portuguese banks, which in turn would give up their national governments. More precisely, the Spanish banks to buy their government bonds without limit as the ECB is guaranteed this as collateral to accept without regard to credit risk.
It was basically the terms offered yesterday by the ECB to a euro-area banks that their Greek government bonds in exchange for cash. In future, Greek bonds are exchangeable at par with the ECB, irrespective of any credit downgrades the government could suffer. Significantly, the ECB has justified this unprecedented relax its credit standards by citing the “strong commitment of the Greek government to fully implement the [fiscal] program. The Council of the program has determined and believes that it is appropriate” after this decision for Greece. Will it only a small step for the ECB to extend the same concession to Portugal and then to Spain, provided that their governments take “appropriate” programs. For the ECB, unlimited loans to the Portuguese and Spanish governments, disguised behind the fig leaf of loans to their national banking systems will be considered the nuclear option. European central bankers would be extremely reluctant to use it. But if the alternative is disintegration of the euro, the ECB would surely put this ultimate weapon, rather than just giving up the markets.
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