The clock is ticking. The fate of Euro now stands by a thread. Markets are shaking with the prospects of a possible Greece exit from the Euro zone. The next coming days (maybe even hours?!) are crucial. Noted economist Paul Krugman has announced his predictions about the euro (which are seen as being too sensationalist). Yet, European central bank and governments are doing nothing to quell such prospects as this recent news shows. The situation requires an analysis of some aspects that could explain the situation Europe finds itself today in.
The Greece crisis, indeed, opened a Pandora’s box for Europe. A crisis that was thought to stay contained in one country, rapidly spilled over in other European countries such as Spain, Italy, Ireland and Portugal and other states. However, the crisis gained intensity when the cracks started appearing within the zone members . The cracks played out in public, but , did not receive much attention when they were indicative of the future.
Austerity – Too Soon, Too Fast, Too Harsh?
Perhaps, the most disliked word of the year 2012 would be “Austerity” and every single negative connotation will be associated to it.
The Greek debt levels were unsustainable from the beginning. Further, Greece deals with Goldman Sachs coming under intense scrutiny damaged Greece’s creditability. Euro zone members, in particular Germany and France, asked Greece to sort out its house by embarking on the austerity program. The bailout to Greece came attached with condition, similar to World Bank and IMF conditions when they provide financial assistance to countries. The contagion soon spread to countries like Spain, Italy, Ireland and Portugal when their debt levels crossed the Euro deficit limits.
But in the midst of all this, an important question is: did the austerity steps came in too soon and too fast? In economics, theoretically, contractionary policies whether fiscal or monetary lead to certain effects in the economy. But in real life, policies always face a ‘time lag’ – it takes a certain period of time for a particular policy to gain objectives whether it is growth or price stability. In the case of Euro zone, the fiscal austerity is fast leading to fast contraction of the economies as spending cuts and higher taxes eat away the disposable incomes of the people. The more spending cuts and increase in taxes come along, the lower the disposable incomes and the lower the aggregate demand.
On the other hand, ‘Germany’s refusal to allow ECB to create a new money in order to buy government bonds from at risk countries, fearing rampant inflation’ is fueling the crisis. A contractionary monetary policy along with fiscal austerity will only lead to a deeper recession. The riots in Greece, Spain and Italy are testament to the fact that austerity is hurting people, and that a particular part of population is getting more hurt than the others.
The euro zone embarked on austerity way too fast and in the process, it has only become harsh. In times of crisis, austerity is not always the best answer and if it is to be pursued, has to be done cautiously and slowly. Austerity, contractionary monetary policy and structural reforms all at once is a recipe for disaster. Not everything can be done at once and fast, especially, if a different set of reasons is causing the crisis. In Spain, the problem of unemployment, especially that of youth, and the housing bubble burst along with the need to recapitalize the banking sector are the top reasons for their crisis. Italy faces a similar scenario. Greece was another case altogether as the economy was thoroughly mismanaged. France’s President Hollande and ECB President Mario Draghi both realize only now that growth and fiscal austerity must go hand in hand together. Yet, both didn’t pan out exactly how a growth policy would be composed alongside of fiscal austerity and no where is growth policy is in sight. Further, I believe that President Francoise Hollande will actually take the path of austerity, which, will not sit well with French voters.
A Division in Political Realms
When political divisions begin to arise and do not abate, that is a subtle sign that issues lingering from the very day of inception will make a BIG comeback. From the start, Germany was reluctant to help out Greece on a massive platform. “53% of Germany population believes that Euro zone will be better off without debt crippled Greece and that Greece should return to its currency drachma”. The sentiment on the political reflect this thought. In addition to this. Germany’s record of price stability and controlling inflation provides it a superior (and perhaps a dominant) position in the management of a credible monetary policy. And that has created problems.
There is a refusal (or outright denial) on Germany’s part to acknowledge that economic circumstances for each country can be different. Germany’s economy minister Philip Roesler ‘called Athens to surrender control of its budget policy to outside institutions if it cannot carry out the reforms required under the euro zone rescue package” reflects the thinking that Germany considers itself superior in the policy making arena.
Greece had countered back angrily stating that they will not allow any interference in their country’s economic policy decision. The statements made is a subtle indicator that despite known as the ‘Euro zone’, with each member country the concept of national sovereignty still exists and is strong. This notion plays a strong role in political outlook as not many Euro members share the same policy sentiment as that of Chancellor Angela Merkel or Nicolas Sarkozy. This is in contrast to the time when one of the main motive behind EU was ‘the desire for ever greater prosperity”. That prosperity could only be attained through economic integration as the ‘economy was the most promising domain for cooperation’ (and perhaps now is the biggest domain for breakup?). But now the deep and fast austerity measures, in places where it is not required for the time being, ‘entrenches a bizarre halfway integration that’s ultimately doomed to fail’. The collapse of Romanian and Dutch government on failing to agree on cuts and with failure of Greece recent election is a strong evidence that the divide is only getting deeper.
In the times of crisis, when political visions becomes divided in addition to economic issues, it becomes a bomb which upon explosion only brings destruction. Delors – one of the main architects behind the EU has openly blamed Germany as ‘the biggest stumbling block in finding a swift solution to the crisis”. If euro zone members do not unite on the political front, euro’s survival is in questions.
The biggest damage to the union is the admission by Delors that the ‘euro zone was flawed from the very beginning as the political figures at the time were unwilling to recognize such possible scenarios’. The political leaders of the time, perhaps forgot that some scenarios no matter how undesirable or unrealistic maybe, one fine day, would come back to haunt their economies and will the test the union in unimaginable ways.
Chancellor Angela Merkel clearly stated that ‘future of euro is indivisibly linked to unification of Europe”. But so far the signals on the other end have been the opposite. The continuous warnings to Greece, the continuous statement that Greek can default along with the claims that Greece will remain the Euro zone have only strengthened the believe that Greek will default. Greece is under pressure as a recent statement by Christine Lagarde – IMF Managing Director indicates. And the pressure is dictating only one picture: do or die. With tensions at the domestic front along with a political and economic dire situation and that ECB and IMF are preparing for the Grexit scenario, the odds are higher that Greece will exit the eurozone despite it best attempts to remain in it. And there will be consequences for the euro zone. According to Soros, the break up of Euro zone will be catastrophic. The exit of Greece has the potential to bring under pressure (or even spread the contagion) the other weaker economies such as Spain, Ireland and Portugal and could have implication for the euro zone, not only as a region, but also in terms of single monetary union.
The 2 questions at this time: will euro zone break and will euro survive – remain unpredictable. Tables could actually turn if political and economic thinkers come together to avoid the split.
For now, I can only say that the future of Euro zone and Euro is bleak.
AlJazeera (Dec 2011) “Euro Flawed from Start says Main Creator”
Reuters (Jan 2012) “Greek PM Seeks backing for reforms, debt deal near”
Spiegel Online (Feb 2012) “Germany Power ‘Is Causing Fear’ in Europe
Nouriel Roubini (April 2012) “Europe’s Short Vacation” http://www.project-syndicate.com
Economist (May 2012) “The Euro crisis: The Unwinding”
Kemal Davis (May 2012) “Rebalancing the Euro Zone” http://www.project-syndicate.com
Reuters (May 2012) “Greece must stick out to bail out terms: Lagarde”