Deja Vu - All Over Again

Source: toonpool.com

The words one hears time and time again from European politicians when they talk about the European Union are: “unity,” “cooperation,” and “partnership.” It is always reiterated that by working together we can avert the power shift towards the East, lead the globalisation of the world, and protect the way of life that so many have grown accustomed to here in the West. It is true that being part of the EU brings many benefits for its citizens; it is now easier than ever for citizens to work freely and move wherever they desire.  The single currency has fomented an increase in trade among one another and made it simpler for its citizens to compare prices of products and services. But as many know, in the last year the EU’s foundation has been crumbling and the partnership has turned in many ways ugly, with the “stronger” countries dictating the terms, leaving the “weaker” ones to agree, or be threatened with expulsion from the EU if they do not comply.

Let's take it from the beginning
In the beginning of the financial crisis everyone thought that the Euro was a safe haven in a sea of financial disarray. But that changed quickly when the new socialist government in Greece entered office in late 2009. What they discovered was that the previous government had not only hidden facts about the state’s finances and the current debt, but done so for years, stretching as far back as before the introduction of the Euro in Greece in 2002.

In the Euro group there is a common agreement that the deficit should not exceed 3% of the GDP. They had to revise the expected deficit in 2009 from 6-8% to roughly 15.4%. Greece had to choose between going belly-up (since the open market would only give loans with very high interest rates, over 15%), or to get rescued by fellow EU members. France was eagerly advocating that the EU should do this alone as they saw it as a European affair. Germany on the other hand wanted the IMF to participate since it was against their constitution to provide funds to countries going bankrupt (this is also written into the EU constitution). Despite Germany’s reluctance to participate, all the countries joined in and lent Greece 110 billion euro’s over a 3-year period in 2010. The requirements to gain this loan were connected with a lot of austerity measures which were dictated by IMF and EU member states, and a failure to comply meant a halt in the loan payments.

Germany's hesitation and contribution

An interesting fact here is that the 22.4 billion euro loan Germany had to provide was passed with an overwhelming majority in the Bundestag. This, despite Angela Merkel advocating against any kind of loan or payment; she wanted to protect German taxpayers from Greece’s wasteful spending habits. But what was not discussed in any great detail was what the actual cost would be for Germany if Greece had to default. According to recent calculations done by IMK and Deutsche Bank, Germany and its tax payers would have to swallow a 40.6 billion euro loss if Greece were to need to restructure its loans and write off half its debt now. 

By looking at the picture above we can see how the 40.6 billion euros is divided into three areas that would be affected. 25 billion would be incurred by German banks, 11.4 billion from the ECB loan they gave to Greece, and 4.2 billion for the German state itself.

One might ask the question: If Merkel would have decided not to help Greece back in 2010 would the other countries in the EU have done the same and withdrawn their support? I think most likely yes, and this would have forced Greece’s hand and given them no other option than to default, start negotiations and write off their debt. Debt that was held by financial institutions who were already in a dire state after the financial crisis and were being kept alive by the taxpayers’ money that was being pumped into them. One could say that out of two bad choices, Germany and the rest of the EU took the cheaper way out, and at the same time sacrificing Greece and its citizens to years of possible stagnant growth and a decrease in quality of life.

Deja vu all over again

Source: seekingalpha.com

The problem now for the leaders in the EU is that more and more people from the market are demanding that Greece should restructure its debt since the likelihood that Greece would be able to continue borrowing money is not sustainable. This does not look like an option however, since the ECB chairman Jean-Claude said as recently as this week that these demands are ridiculous. There have also been whispers that Greece is considering leaving the euro collaboration, but this was strongly contended by the EU who said that the topic is “not up for discussion.” This raises some questions: if they are “not talking about it” then why is there an internal memo circulating the German finance department stating that if Greece leaves the euro, their debt level would increase by 50%?

Only path forward
In my view the path for Greece is already set out and it is leading the country towards bankruptcy and default. What most western countries did to lower their debt previously was not to pay it off, and instead have a growth rate that is higher than what they pay for rates on their debt. The problem for Greece here is that the level of interest they pay for the ECB loan is 6.5%. Greece will not surpass that level of growth in the near future and most forecasts suspect it will never even be close. It is unimaginable to think that Greece will ever be able to pay off its debt and despite the harsh austerity measures they have implemented the debt is ballooning out of control.

Possibly the only way forward is what should have been done from the beginning of the crisis. Allow Greece to restructure part of its debt, refinance the rest and keep putting pressure on the politicians in Athens on reforming their economy. The leaders of Europe have to make some tough decisions, even if it is against public opinion in their own countries.