Notes On A Greece Fire

The financial crisis is putting the euro - and the EU - to the test. Greece is having trouble with its burgeoning debt. From a useful backgrounder in The Economist, here is a plot of Greece's budget deficit: and its current account deficit: As the charts show, several other european countries appear to have similar problems, so if Greece goes, one wonders who the thundering herd of global finance would turn on next...

In the Journal, Simon Johnson and Peter Boone write:

Germany and France are cooking up a belated support package for Greece, but they have made it abundantly clear that Greece must slash public sector wages and other spending; the Greek trade unions get this and are in the streets. If Greece (and the other troubled countries) still had their own currencies, it would all be a lot easier. Just as in the U.K. since 2008, their exchange rates would depreciate sharply. This would lower the cost of labor, making them competitive again (remember Asia after 1997-'98) while also inflating asset prices and helping to refloat borrowers who are underwater on their mortgages and other debts. It would undoubtedly hurt the Germans and the French, who would suffer from less competitiveness—but when you are in deep trouble, who cares?

Since these struggling countries share the euro, run by the European Central Bank in Frankfurt, their currencies cannot fall in this fashion. So they are left with the need to massively curtail demand, lower wages and reduce the public sector workforce. The last time we saw this kind of precipitate fiscal austerity—when nations were tied to the gold standard—it contributed directly to the onset of the Great Depression in the 1930s.

The option of calling in the IMF offends European pride, but Jeff Frankel argues it is Europe's the best option to let the fund play the bad guy:

Things are not yet bad enough to require a Greek default. Quite likely, by now, they are bad enough to require outside intervention. But shouldn’t Greece have to draw on the IMF first, rather than drawing on Germany and France? The IMF could impose conditionality, thereby helping the current government with the Sisyphean task of making the necessary cuts stick. No doubt the government in Athens will promise Frankfurt or Brussels, as conditions for a loan, that it will clean up the Augean stables of its pension system, tax evasion, and the rest of its finances. But there is no use in pretending that such promises could be enforced in the future. Enforcement is not credible, given the politics and given what has come before. But conditionality is what the Fund does for a living. For all the criticism it sustains, the IMF is a better mechanism for tying Odysseus to the masthead than is any other institution.

Europeans worry that if Greece were put into default, troubles in Portugal and Spain would appear as quickly as heads on a hydra. Perhaps it is glib for an American, on the other side of the Atlantic, to discount the financial strains that Greece is placing on Europe — including Mediterranean contagion, loss of prestige of European institutions, and depreciation of the euro. But in fact it is the northern Europeans who should be most eager for the IMF to come in. They should be the most worried about what they are going to say to Portugal, Spain, Italy and Ireland — not to mention the Eastern Europeans, if instead they have just bailed out Greece.

The Times reports that the episode has created some angst in Germany about the whole euro project (and Ambrose Evans-Pritchard suggests Germany consider abandoning it). It is also contributing to doubts about the euro in candidate countries like Latvia - as if Latvia's own experience pegging its currency to the euro wasn't bad enough.

In the FT, Thomas Palley says "Euroland is being crucified upon its cross of gold," but, of course the Germans prefer it that way. But Germany and its trade surplus are part of the problem, according to Martin Wolf.