Europe vs. Greece: A Logjam that Threatens the Euro

Source: Chappatte, Eurofree 3

Greece, whose economy has been destroyed over the past five years by vicious austerity policies is now precariously balanced on the brink of financial disaster as Eurozone financial ministers and the (infamous?) "troika" - the IMF, the European Central bank and the European Commission - mull over what to do.

The European Commission has reportedly tabled a proposal to break the logjam, offering the use of the Euro financing facility, the ESFS, created in 2010 as a "temporary crisis resolution mechanism". And recourse to the ESFS is offered in return for pension and labor market reforms in Greece.

Problem solved?

No, it appears that the other two members of the Troika have not approved the EC proposal and perhaps not even read it. So nothing happens. Eurozone finance ministers go from one meeting to the next, week after  week, expressing increasing annoyance at the flamboyant Greek finance minister, Yanis Varoufakis - no doubt because he is telling them the truth.

And the truth is: Austerity Policies Do.Not.Work. Full stop. If you kill employment, no one can pay taxes, it's as simple as that. Greece sinks into an ever deeper hole dug by an ever increasing debt.

Economists know that some debts cannot be paid back, no matter how much belt-tightening you engage in. Precisely because that tightened belt makes you weaker by the day and prevents you from ever making enough money to pay back your debts.

In such cases, the solution is simple: forgive the debt. Strike it out. Start from scratch, give people in debt breathing space so they can climb out of the hole. The Eurozone can afford it, Greece's economy is small, some two percent of total Eurozone GNP.

But it seems that politicians do not know this - especially certain politicians like the German Chancellor. Ms. Merkel is a fine political animal, attuned to her electorate, but she has no knowledge and even less understanding of economics. Strangely enough, so do her main advisers, Mr. Jens Weidmann, President of the Bundesbank, and Mr. Wolfgang Schaeuble, her Finance Minister.

In the case of Mr. Schaeuble, his lack of knowledge is easy to explain; he studied law at the Universities of Freiburg and Hamburg, obtaining from the latter a doctorate in law in 1971 with a dissertation called "The public accountant's professional legal situation within accountancy firms". Surely a subject that couldn't be further away from public finances.  His early career didn't enrich his knowledge of economics: he worked in a tax office in Freiburg and subsequently, from 1978 to 1984, he practiced law in the district court of Offenburg. The rest of his life was spent in purely political activities, reaching as high as the Christian Democratic Union (CDU) chairmanship in 1998, only to resign 15 months later in the wake of the illegal donation scandal that rocked the party.

Mr. Weidmann's obtuseness regarding economic matters is more surprising, since he did obtain a doctoral degree in economics from the University of Bonn in 1997 - but he got his training from a monetary theorist, Manfred J. M. Neumann, a relatively obscure economist who, at present, has left the university and is in the Bundesbank alongside his pupil, in the vest of Research Professor at the Bundesbank Research Centre.

It's a small world - and a small world of people who blindly follow the teachings of Milton Friedman and are true believers in the Washington Consensus - economic theories that have been so discredited that even the IMF has had to abandon them; and of course, the American Federal Reserve, under Ben Bernanke's leadership, has successfully helped steer the United States out of the 2008 Great Recession, pumping money into the economy - an unthinkable course of action for strict monetarists like Schaeuble, Wiedmann and Neumann who do not understand the counter-cyclical use of the public sector.

Yet that counter-cyclical role of government in the economy is really easy to understand: when demand in the private sector collapses (as it did in the 2008 recession), you  spend money in the down cycle to preserve overall demand; and you (the government and central bank) tighten the belt in the up cycle. That's the moment you want to balance the budget and trim deficits. Not before. And certainly never during a down cycle.

But Schaeuble, Wiedmann and Neumann don't understand this.

In fact, the whole of Germany does not understand this: Germans have even worked it into their Constitution that government budgets should be kept in balance every year. And they want the rest of Europe to do the same!

The nonsense is palpable, but how do you explain that to the Germans who are still suffering from memories of the Weimar Republic's super inflation? That was back in the 1920s, ninety years have passed, the Great Depression came and went as Keynes taught the world how to deal with it - but the Germans keep their eyes closed and continue in the childish conviction that a State's budget is the same as a housewife's or a small business'; that it should be balanced at the end of every year, regardless of the length of the spending cycle for government programs, especially in infrastructure building that can last several years, even decades. Small wonder that Germany is now facing a serious problem of under-investment in essential infrastructure!

Back to Greece. The Germans (and the rest of Europe along with the IMF) bailed Greece out expecting the Greek economy to contract by 4 or 5 percent before rebounding - instead, it contracted by over 25% and never rebounded.

On the contrary.

There's a full blown humanitarian crisis on-going in Greece: Greek unemployment stood at 25.7% in March 2015 and Greeks under 26 suffer from an astounding 58.3% rate of unemployment (see Eurostat data here and here). That's three out of five young people without a job! And there have been reports (for example, the UK Guardian here) that some 500,000 children suffer hunger; that poor people with chronic diseases like diabetes or heart problems can no longer get the medication they need from the national health system and they can't afford to buy it on the open market because of the high cost; that museums are understaffed and archeological digs stopped for lack of funding; that schooling and higher education are both curtailed. Many rely on handouts and soup kitchen. The Church of Greece distributes daily 250,000 food rations.

In March this year, it was reported that the EU pledged €2 billion ($2.7 bn) to "ease" the crisis. Better than nothing but far too little to make a real difference. Consider the debts Greece has to keep paying: this coming June, €6.74 billion; in July, €5.95 bn ; in August, €4.38 bn etc. I stop, you get the idea.

Soup kitchen in Greece
Source: BBC article

What are European leaders thinking of? Don't they see that the Euro is going to hit the wall any minute now? Don't they care that they have caused an unprecedented humanitarian crisis, something unseen in Europe since World War II except for the 1990s war in the Balkans?

Where is their moral fiber? Their sense of cooperation with European brothers and sisters who are suffering? What kind of Europe is this?

In fact, European leaders are ridiculous. And the ridicule couldn't be greater than at this week's meeting in Riga, bringing them together with the six countries that are part of the Eastern European Partnership (Armenia, Azerbaijan, Belarus, Georgia, the Republic of Moldova and Ukraine). This is a partnership that is anything but. Born five years ago, it was meant to open up Europe to those Eastern countries - much to Putin's dismay, as he promptly demonstrated with his invasion of Crimea and Eastern Ukraine. Not unsurprisingly, the Riga meeting has produced no progress, not even the extension of visa-free travel to more countries - of the six countries, the only one who got this perk a couple of years ago was Moldova; but Moldovans are so steeped into their Soviet dreams and eager to get back in the Russian fold that they are not interested in using it - see the NYT article.

Let me finish this post with a "cherry on the cake": Schaueble's latest advice to Greece. The news just came out today as I write (22 May): according to an RT article, he suggested in a talk in London introducing a "parallel currency" in case the negotiations fail, reportedly citing the example of Montenegro that uses the Euro without belonging to the Eurozone.

Greece like Montenegro?!

Is he serious? When Goldman Sachs analysts suggested three months ago that a "hybrid situation"  could arise in Greece, whereby Greek citizens could use "loan certificates" (or IOU receipts) on the local market, similar to the currency arrangements in Cyprus, Montenegro and Kosovo, nobody gave much credit to the idea. Because it is a fundamentally flawed comparison: those three countries already have their own currency system working for them. 

That would not be the case for Greece. It would have to abandon the Euro and build up a new currency system from scratch. A time-consuming, high-risk endeavor that would require a total overhaul of the banking system. For citizens, it would mean the loss of savings, for local businesses, the impossibility to get loans, for foreign investors, the freezing of their assets.

In short: an economic apocalypse.

Would the rest of Europe get hurt besides Greece? Yes, though perhaps not so much - at least at first.  One thing is certain, a Greek default would mean a straight loss for all creditors, starting with the European Central Bank that has a €110bn exposure to Greek banks and has spent around €20bn on buying up Greek government bonds. It could of course print Euros to cover the loss, but Germany (with Weidmann on the ECB board) is not likely to allow that.

Would the Euro survive?

That is a good question. Because "dropping Greece" is something that signals to the world that the Euro is a currency that cannot be trusted. If Greece gets treated by Brussels in this cavalier way, the same could happen to Portugal or Spain or anyone in the Union. And it could even happen to a bigger Euro member: why not Italy whose debt is simply huge?

The damage in terms of international trade would be enormous. The Euro would sink, making imports (especially oil) extremely expensive for all Europeans, including Germans. Exports (because of the low Euro) might fly for a while, but not for long as many European firms would find that their increased sales abroad do not cover the cost of the necessary inputs they must import to produce their exports. Imbalances would arise. This could be the beginning of a new recession, and as it would happen at a moment of great fragility in the Euro zone that is barely beginning to recover, it could quickly lead to a full-blown depression.

With vast and unpredictable political repercussions.

If Europe sinks into depression, the US and China might not be far behind. Economic recovery in the whole world could grind to a halt.

But for Mr. Schaueble who is an accountant, a currency problem is just a matter of taking out your pen and balancing the accounts, right? He seems totally unaware of the risks. Irresponsible.  Really, the man should be sent home.