Playing with Fire in the Eurozone

                Bloomberg quotes German Vice Chancellor Philipp Roesler as saying “What’s emerging is that Greece will probably not be able to fulfil its conditions. What is clear: if Greece doesn’t fulfil those conditions, then there can be no more payments.” (HT PK) OK, this is just the kind of thing you would expect to be said in negotiations between creditors and debtors. We have been here before, and the rhetoric appeared to work on the Greek electorate. In the Cold War, we mercifully only had a few moments like this, and we were lucky. But if you keep playing this game, one day you will lose control.

                Sometimes it seems as if Germany and its supporters are like a poker player with a very weak hand, who has managed to convince all the other players that their hand is much stronger than it is. But there is a danger that you may get so good at playing this bluff, that you may stop looking at your cards and actually believe you have a strong hand. Or worse still, that although your hand is weak, you deserve to have the better cards, and therefore you do have the better cards.

                Reading the latest IMF report on the Eurozone, it seems to me that the IMF has decided they cannot be a part of this game anymore. The idea that those dastardly Greeks just refuse to take their medicine is absurd. Take a look at what has happened to fiscal policy in Greece, measured in a way that gives a true indication of the extent of policy adjustment that has been made.

Underlying primary deficit in Greece – OECD Economic Outlook June 2012

Of course the slide into deficit after joining the Euro was very bad policy. No correction was going to be easy. But a move from a 10% of GDP deficit to an expected 5.5% surplus in just four years is a cold turkey cure. The patient should be receiving support and kind words, rather than being told that they are not fulfilling their obligations. The worry is that those saying these foolish words have begun to believe them.

                I have talked about why Greece leaving the Eurozone would be much worse for the Eurozone than Greece elsewhere. I’ve also speculated that as a result it will not happen, which may have been a foolish thing to believe. But even if it is not foolish, and the Eurozone gets through all this, the long term damage of what is happening now should not be underestimated.

                A sad example of this was the end of a blog debate between a German economist (Kantoos) and a Greek economist (Yanis Varoufakis). For links to the debate, see this post. At first this debate seemed like an island of reasonableness among all the political and media nonsense. But the discussion has ended on a sour note. Varoufakis put forward (both inside and outside the debate) the following thought experiment. Imagine the leaders of the UK or US being offered a credible magic button, which if they pressed would solve their macroeconomic problems. Of course, he argues, they would press it. If Merkel was offered a similar button that would, among other things, lead to market pressure on Greece and other Eurozone countries disappearing, would she press it? Varoufakis was not sure, in part because of pressure from the German public. He writes      

“For two years now, the German public has become convinced (falsely) that Germany has escaped the worse of the Crisis because of the German people’s virtuous embracement of thriftiness and hard work; in contrast to the spendthrift Southerners who, like the fickle grasshopper, made no provisions for when the tide turns nasty. This mindset goes hand in hand with a moral righteousness which implants in good people’s hearts and minds a penchant for exacting punishment on the grasshoppers – even if punishing them also comes at a cost to themselves.”

                Kantoos was quite shocked at this. He writes

“Yanis, I am sorry, but that is very offensive, and it is fuelling the mutual disdain in Europe. What is more, it misunderstands the concerns of the German public and its attitude towards Europe, but that is common in the international press.”

                Now I’m less interested in who is right or wrong here, as that the debate should have ended this way. (Although I have to say, I’m not sure Varoufakis is right about the UK. That button actually exists, it is called balanced budget fiscal expansion, and it has not been pressed!) When parts of an economy have suffered greatly, and the leaders of other countries appear not to recognise this fact, have any sympathy for it, and at least appear to have a large hand in prolonging that suffering, even the wisest of people will begin to suspect the worst of these countries motives. Whether they are right or wrong does not matter too much, because the damage is done. And if Greece leaves, that experience is likely to be repeated again and again in other countries, if it hasn’t happened already.

                In these circumstances, the idea that a solution to current problems involves moves to greater union become fanciful.  Even if each individual crisis passes, the slow poison of mistrust that these events create may end up killing the project. Those in the Eurozone with more sensible heads on their shoulders need to stop this poker game, quickly.