Thursday 3 November 2011

Greece and the Euro - What Next?

The drama of recent days continues unabated.  As of this Thursday afternoon it looks like there will be no Greek referendum on the EU deal, but instead the main opposition party has agreed to support the deal in Parliament.  Much relief all round, at least in Eurozone countries and in the UK government.  It is far too early to know what will in fact happen and how this will develop over the coming days and weeks.  But it is useful to step back a bit and try and figure out what is really behind all this turmoil.
In particular it would be helpful to get away from simplistic blame games.   It is all the fault of Greece shout some, while others equally loudly yell that it is the nasty EU which is punishing the poor Greeks.  It would also be good to disentangle the situation in Greece from the wider problems faced by the Euro.
In the case of Greece it is important to remember that the crisis facing that country is primarily due to the mismanagement of its public finances.  The country faces deep seated problems which previous governments have avoided.  It is to the credit of Papandreou and his current government that it is the first Greek government to face up to this reality and to begin to take measures to modernise the economy.  This is something that Greece needs to do and there is no doubt that this will involve great suffering for many Greeks.  However there is no real alternative.  In passing it is worth pointing out that devaluation (leaving the Euro and going back to the Drachma) would make no difference to this.  Unless a country takes the necessary steps to modernise its economy, devaluation makes no long term difference to a country.
The big problem for the country is that this particular challenge comes at the same time as the rest of the EU and most of the world is in the midst of a massive financial and economic crisis.  The country has also been handicapped by the neo-liberal nonsense that currently passes for economic wisdom in most of the world.  More and more austerity measures simply prolong the suffering of Greek people and postpone any recovery.
The EU and the European Central Bank (ECB) have however done nothing to help Greece.  All this talk of Greek bailouts is just nonsense.  The so-called bailouts are designed to bail out EU banks, in particular those in France, Germany and Belgium, which are most exposed to a Greek default.  The EU lends money, at exorbitant interest rates, to the Greek government, to avoid a default.  The money does not go to helping Greek people, who are suffering from cuts in wages and pensions and high unemployment.  At the same time the EU and the IMF are forcing the Greek government to introduce even more drastic austerity measures, which can only lead to less growth in the economy and thus increase the likelihood of a Greek default.
This whole approach has of course clearly failed.  The latest deal included a 50% loss for the banks.  And most observers reckon that sooner or later Greece will have to default on the remaining 50%.  It is all so depressing.  The solution to the crisis, both in Greece and in the Eurozone as a whole is pretty clear.  Greece needs to have its debt written off and have access to new funds at affordable interest rates.  The country also needs to carry out fundamental reforms to its economy and public finances.  But if this is to work this needs to happen in the context of a growing economy.  Not just in Greece, but in the whole of the EU.  Something similar needs to happen in other Eurozone countries.  Not necessarily a write-off of debt, (Greece is the worst in this respect) but in access to funds at affordable interest rates.
This is not difficult to do.  If the ECB were to act as a normal central bank, like the Bank of England or the Fed in the USA, that is to be a lender of last resort, then the core of the crisis would disappear.  The ECB has the money, it can print as many Euros as it wants.  If it announced that the ECB would buy Greek, Italian, Spanish, Portuguese and Irish government bonds at an announced interest rate, (a low one) then the markets would cease to speculate against these countries.  Not only that, the ECB would probably not need to buy that many bonds.  Once the market realised that the ECB was serious the various bondholders would return to the market.  Where else are they going to put their money - under their pillows?
At the moment some EU countries are opposed to this, especially Germany, which because of its own history is still frightened of the dangers of inflation.  However in the present economic climate inflation is not on the horizon and the real worry is the risk of a deep seated recession.  There is also the problem of creating some kind of supranational governing body for the Eurozone.  It seems the governments concerned have agreed to move towards this, but probably need to to do so quicker.
In many ways all this suffering in Greece and elsewhere is so unnecessary.  The means are there to lessen the impact of reforms and to get the economy moving again.  The lessons are there for all to see going back not just to the great depression in the twenties and thirties, but all the way back to the 1820s as Brad DeLong explains here.  For more on the need for the ECB to act as a lender of last resort see here.

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