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The Coming Euro Crack-Up

A currency divided against itself cannot stand.

May 9, 2011, Vol. 16, No. 32 • By IRWIN M. STELZER
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To the intrinsic flaws in the euro system​—​a one-size-fits-all interest rate and the inability of the eurozone bureaucracy to control the fiscal policies of members​—​add the news from tiny, previously europhile Finland. In last month’s election, the anti-euro, anti-bailout True Finn party’s share of votes jumped from 4 percent to 19 percent, and its parliamentary seats from 5 to 39 in a 200-seat parliament, enough to insist on inclusion in a coalition government. Just as the Tea Party sent a message politicians can’t ignore, so the True Finns sent a message to the incoming government that it should think hard before casting a vote​—​unanimity is required​—​for the impending Portuguese bailout. As Tony Barber put it in the Financial Times, “Finns are angry because, like the Austrians, Dutch, and Germans, they dislike rushing to the aid of countries that in their eyes have cheated, idled, lied, lived beyond their means, and let reckless bankers run amok.” Finland’s “no” vote is all that is needed to leave Portugal drowning in debt. 

All of these bailouts, and those to come, are premised on the notion that the troubled countries are having a liquidity problem, and a bit of cash will enable them to get back on their feet and repay their debts in full and on time. It is now clear that these countries are not merely illiquid but are insolvent, and that they will one way or another have to renege on their debts, at least in part. Unless, of course, Germany agrees to convert the eurozone into what is called a transfer union, in which funds from the rich countries are regularly shipped to the poorer ones. That route seems to be blocked by the unwillingness of German taxpayers to agree to such an arrangement and the German constitution which prohibits it.

The cold facts are these: 

• Greece, Ireland, and Portugal are now frozen out of credit markets. The yield on Greek two-year bonds is 24 percent and on both Irish and Portuguese bonds of similar maturity around 12 percent. No country can afford to borrow at those rates. Of interest to the White House and Congress might be the speed with which the markets move: Interest rates charged on Greek debt increased by 10 percentage points in the past month. 

• The debt burden on these countries is in excess of the 90 percent of GDP that scholars now agree stifles growth. Portugal’s debt is at 90 percent of its GDP and rising, Greece’s is approaching 150 percent, and “Ireland’s debt now appears to be bigger, in relation to its economy, than the reparations imposed on Germany after the First World War,” according to economist Anatole Kaletsky. 

• These economies cannot grow their way out of the problem. The Greek economy shrank at an annual rate of 4.5 percent last year and is forecast to decline this year at 3.2 percent. Portugal’s will shrink at an annual rate of 1.5 percent, guesses the International Monetary Fund. And Ireland, despite a robust export industry and a corporate tax rate of 12.5 percent that, at half the EU average, remains attractive to foreign investment, might eke out growth of 1 percent. No way these growth rates produce enough tax revenues to meet debt obligations. 

There’s more, but you get the idea: These countries are bankrupt and will have to default on their debts​—​“restructure” them, to use the term spoken in polite European circles. Germany’s finance minister Wolfgang Schaüble was among the first to mention the possibility of default, and more recently Clemens Fuest, chair of the German finance ministry’s advisory committee, said a Greek restructuring is not merely possible, it is inevitable. “Most intelligent people know there has to be a significant restructuring to ease the burden on Greece, and we’re not talking about a painless extension of maturities, but wiping away a large portion of the debt,” said Charles Grant, the highly respected director of the Centre for European Reform in London.

Such a default would be no trivial event for creditors: Estimates are that it would take a “haircut”​—​a write-down​—​of 40 percent to 70 percent to get debt into repayable territory. José Manuel González-Páramo, a member of the executive board of the European Central Bank, warns, “A restructuring would have legal and systemic consequences that are difficult to calculate right now, but would in all probability be bigger than after the collapse of Lehman Brothers.” And a “messy euro debt implosion .  .  . not only would .  .  . hurt the euro, it also has the potential to derail the global recovery,” conclude economists at Fathom Consulting. The more time that passes without a long-term solution, the more likely the consequences of the current mess will go from merely serious to dire.

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