One can accuse Germany’s finance minister of many things, but not of hiding his views. By saying that a Greek default is possible because the rest of the euro area can now bear it, Wolfgang Schaeuble has simply admitted that the strategy adopted since late 2009 has been designed to protect Germany, not to help Greece. By further suggesting that elections be delayed in Greece and that technocrats replace the remaining politicians holding ministerial jobs, Herr Schaeuble has shown how little he cares about elementary democratic principles.
Greece is being told by the so-called troika -- the European Commission, the International Monetary Fund and the European Central Bank -- to undertake reforms of historical proportions, and to impose ever more cruel fiscal policies. The Greek parliament, elected before the crisis on a classic wishy-washy platform, has no mandate to carry out these policies, no matter how good they might be for the country. It would seem natural to hold an early election that would ask the Greek people what they are willing to stomach, now that they have been duly warned of the alternatives. Such contempt for democracy is deeply disturbing.
Schaeuble’s economic analysis of the situation is equally bad. His views contain no less than six technical mistakes.
First, the view that the rest of Europe is ring-fenced is an illusion. This illusion harkens back to the May 2010 decision to bail out Greece. Schaeuble argued then that this violation of the European Union’s no-bailout rule was meant to prevent contagion and a Greek default. Contagion has happened, with no end in sight. The German minister now supports a default that has in effect become unavoidable, because his prescriptions have failed.
One reason why his policies failed -- his second mistake -- is the imposition of fiscal austerity during a recession, and the denial of any link when things got worse. The troika says it’s surprised by the depth of the continuing decline of the Greek economy and the associated quasi-absence of budget-deficit reduction. There should be no surprise here, this is textbook economics. Yet Schaeuble continues to believe that austerity can enhance growth, against both principles and evidence.
Third, Schaeuble deeply misunderstands the current lull in market turmoil, much as he misunderstood the crisis back in 2010. He has embraced the Good Marios theory, according to which Mario Draghi’s ECB has brought the crisis to an end, and Italy under Prime Minister Mario Monti has definitely turned the corner. Both Marios are doing a great job, but we aren’t out of the woods.
The abundant emergency loans provided by the ECB have simultaneously eliminated the threat of a liquidity crisis and allowed banks to buy bonds issued by Italy, Spain and other countries on the market’s radar screen. Hats off to Mario Draghi.
Mario Monti has pleased Schaeuble by imposing fiscal austerity. As in Greece, Italy’s recession will soon deepen and the deficit won’t improve enough to prevent an increase in the debt-to-GDP ratio. If adopted and enacted, Monti’s reforms will accelerate growth, but many years from now, not anytime soon. Meanwhile, markets will take notice of the rising debt ratio and Italy will look like “unique” Greece and “good” Portugal: fodder for a sovereign default.
The fourth mistake Schaeuble made is to believe that a voluntary Greek default, otherwise known as private-sector involvement, will settle the situation. We now have seen weeks of painful and confused negotiations involving the Greek authorities, the bank lobby and the troika. The stated objective is to bring Greece’s debt down to 120 percent of gross domestic product. This cannot be right. In 2006, just before the crisis, the debt stood at 110 percent of GDP, a level that officials soon declared unsustainable. The same officials now assert that 120 percent is acceptable. It isn’t, obviously.
Once we realize that the Greek government will have to issue fresh debt to bail out its banking system, a more reasonable objective is to aim at bringing the existing debt to, say, 60 percent of GDP. That means an involuntary default.
Fifth, Schaeuble reminds us that Greece is unique and special, meaning that the measures currently under discussion won’t be repeated for other countries. Remember how this exact promise was made at the time of the Greek bailout? That was before the Irish and Portuguese bailouts.
It is very hard to imagine that Portugal won’t follow Greece. Its fiscal policy record is every bit as dismal: Portugal’s budget hasn’t been balanced since 1960, when records start, while Greece had its last surplus in 1972 (under a military junta, unfortunately). The austerity imposed on Portugal will produce the same effects as in Greece. In fact, the troika has already started to express surprise. By the time Portugal defaults, Italy will be ripe to join the ranks of “unique countries.” And when Italy defaults, banks will shake everywhere, raising the prospect of a similar event for the likes of France and, perhaps, Germany.
The sixth mistake of Schaeuble is the idea that a voluntary default financed by the banks will shield German taxpayers. This is fully consistent with his view that Greece must be forced to do what is good for Germany, which, unfortunately, isn’t possible, as argued above. Eventually, as Greece defaults, German banks, euro-area central banks and the European Financial Stability Fund will have to absorb some of the losses. This will happen again when Portugal defaults, and the losses will become very substantial if Italy follows. Imposing austerity on Italy raises the odds of an event likely to push Spain and France into default as well. It is even plausible that Germany will be dragged down if its banks need to be rescued.
At that stage, German taxpayers will ask Minister Schaeuble a few hard questions. Well, this is why the Greeks invented democracy.
(Charles Wyplosz is professor of economics at the Graduate Institute of International and Development Studies in Geneva. The opinions expressed are his own.)
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