Friday, 22 July 2011

The Euro Deal

The deal to save the euro that was announced on Thursday night was not yet another sticking tape to hold together a crumbling system. It was a major plaster cast, with additional wheelchair, splints and crutches. The document signed by the euro heads of state does not solve the crisis, but it is a significant political declaration. I would expect it to salvage the system for at least the next year, and to be the starting point for further measures of political consolidation within the euro group of countries.

Here are the key points of the statement, presented with a little elaboration to explain what is going on:

  • They will “do whatever is needed to ensure the financial stability of the euro area as a whole and its Member States.” This is a political rebuff to the financial markets that have had reason to speculate on the system being under threat.
  • Greece will get further official funds (from the euro countries and the IMF) amounting to  €109bn. Private investors (the banks) are expected to contribute €50bn in the next few years, and a total of €106bn by 2019, in accepting write downs on their assets and lower interest payments over an extended period.
  • This deal is “exceptional and unique” and only for Greece, but the lower lending rates of 3.5% for Greece will also apply to Ireland and Portugal, as will the extension of new loans to a 15-30 years maturity.
  • In order to help Italy and Spain, and any other member country, official euro funds will be available to be used in a “precautionary programme”. In other words, a country need not be in the emergency ward before getting any help.
  • This precautionary programme could involve recapitalising financial institutions and the European Central Bank intervening in secondary markets (ie bond markets) to “avoid contagion”. If this means supporting the prices of troubled countries’ bonds in financial markets, this shows how far European politicians have come from their previous worship of the market!
  • To be able to ignore any credit default that the ratings agencies might declare for Greece, or other countries, “reliance on external credit ratings” will be reduced. The agencies have a powerful role, despite their evident failings, as their credit ratings determine whether investors and banks will hold certain bonds. This is a sign both that politics is going to be more decisive, and that the influence of the US-based agencies will diminish.

The euro politicians’ declaration they will do everything to save the system is not really that surprising. A break up of the 17-member euro system would be a catastrophe for them – the end of a project that has been decades in the making - and for their economies, given the huge trade and investment ties between the different states that are based on the foundation of the single currency. The euro system is also a centre of global power that increases the leverage of its main constituent countries, Germany and France. That was not going to be allowed to fail so easily. However, the political leaders can only pretend to be able to count the likely costs. The evolution of the global crisis is out of their hands, and the next week or so will also see a renewed focus on the US and its debt problems that could add to their existing ones.

The latest deal is also surprisingly generous for Greece, and for other countries hit by the crisis. The euro document even said that they would “relaunch the Greek economy” with European funds and recapitalise Greek banks if necessary! This is what a sceptic would call a ‘brave’ declaration, but it is an impressive turnaround from the earlier stance that demanded unrelenting austerity to pay back all the debts. While there will be a “strict implementation” of economic policies in Greece, the costs imposed on the population are likely to be lower. They need to be. After all the measures, the country’s huge government debt of €350bn, around 150% of GDP, is only seen reduced by around €26bn by 2014.

Tony Norfield, 22 July 2011

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