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Monday May 3, 2010 - 21:05:10 GMT
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Let's make a European Deal

By Joseph Trevisani, Published: 05/03/2010

The Greek financial rescue signed on the weekend is a multi-year package totaling €110 billion. It is a necessity if Greece is to avoid default on May 19th. As Prime Minister Papandreou said with Mediterranean brio, “What is at stake is the survival of the nation”. Surely not. Many nations have survived defaults, Russia and Argentina to name only the most recent. Survival, in Mr. Papandreou’s terms, means within the European Monetary Union and the European Union. Those memberships might not survive a Greek default.

The Greeks had been defiant as recently as one month ago when Prime Minister Papandreou told his European fellows leaders that if help were not forthcoming then he would go to the IMF for a loan. Mr. Papandreou was counting on European pride; he neglected to consider German practicality. Angel Merkel responded, 'we agree let us go to the IMF'.

We can assume the Greek rescue becomes fact, if not this week then some moment before the May 19th bond redemption. Let us further assume the best political case. The Greek people acquiesce and support the government. The protests in Parliament Square in Athens die out. The anarchists return to Eksarxia. No other revisions are made to government deficits. The world economy continues on its moderate recovery and does not fall back into recession. In those favorable circumstances, what can we expect will be the long-term effects of the Greek debt rescue?

Austerity plans will follow in Portugal, Spain and perhaps Italy. Frightened by the terms that the IMF will impose on Greece, governments in those countries will not want to risk credit market displeasure. There will be protests from unions, civil servants and social welfare rentiers, but the logic of the private debt markets will impress all but the most recalcitrant of the population. It is far better to be in control of your finances than to cede power to the IMF. The logic of the debt market is simple. Governments cannot compel private individuals to lend money the way they can compel tax obedience on their own citizens.

Austerity will keep EMU economic growth below that of its trading partners and below its own long term potential. The IMF predicts that the Euro zone will grow 1.0% in 2010 and 1.5% in 2011. That is less than the projected growth for the United States, 3.1% in 2010 and 2.6% in 2011, the United Kingdom 1.3% and 2.5% and even Japan 1.9% and 2.0%. Individual EMU countries will perform better. Germany and other high value exporters will be relatively prosperous with a recovering world economy, but the EMU as a whole will have an extremely weak recovery.

The ECB will keep rates low longer than the United States. The central bank will have no choice. European governments and the IMF need not only the approval of their legislatures but also the acceptance of their people. With inflation at 0.9% in March and 1.4% yearly and core CPI at 1.0% in March, low rates are a popular concession that the ECB can afford.

Anemic growth in the EMU and the inability of the ECB to raise interest rates will keep the euro on the defensive as the Fed slowly but with the security of moderate GDP growth starts on the long road back to normal interest rates.

The political cost of this three-month wrangle and IMF rescue will be to halt the unification of the EU in its tracks. The Lisbon treaty was already widely unpopular in Europe but at least the accretion of central power to the EU commission could be held up as some kind of logical extension, comparable to the federal union of the US.

In its first real test of operational as opposed to theoretical unity, the EMU and the EU were forced to turn to the IMF for help. The nations of the European Union turn out to be nations first and EMU members second. The EU did not turn to the IMF for liquidity; there was plenty of money available within the EU to rescue Greece. It was for political expediency and cover that the IMF was needed. The IMF was able to force terms on Greece at arms length from the EMU. The fiction was as useful in Germany, where it kept the taxpayers from bearing the entire financial burden, as it was in Greece, where German imposed terms have unfortunate historical connotations.

The Greek debacle will also have permanent ramifications in the bloc of countries that are EU members but not participants in the single currency. The Union has 27 members, the EMU only 16. All EU members are supposed to give up their individual currencies and join the euro as soon as they can meet the convergence criteria of the Maastricht Treaty and satisfy the 3% and 60% deficit and debt limits.

For relatively advanced countries like Poland, the Czech Republic and the Baltic trio of Estonia, Latvia and Lithuania, whose economies can compete with Germany and France, as well as for less developed nations as Bulgaria, Romania and Hungary, whose economies are not ready to compete, the advantage of a separate currency has been demonstrated without reserve. After this crisis they will be reluctant to join the euro. Countries in different stages of development and with different cultures cannot necessarily compete in the world market simply because the political logic of a formerly war torn continent says they must.

By the time the full costs of the prolonged Greek crisis are realized the crisis will have affected almost every aspect of European political and economic life.

It has permanently damaged the ability of the Europeans to accomplish the economic and political agenda that was set forth by the immediate post World War Two generation. It will inhibit European GDP growth for several years, at least as long as the austerity budgeting lasts and perhaps longer. It has undermined the credibility of the ECB and its ability to counter inflation. Finally, it has shown the world that the EU cannot sustain any claim to federal status. Brussels is only a bureaucracy. When politics become difficult the Europeans act as nations with interests and not as generous neighbors.

The US Dollar cannot but benefit. Regardless of the dollar's comparative economic performance in the future, the US currency will retain its preeminent status in the world economy. Its only competitor for reserve status, the euro, is the currency of the EMU, an economic but not yet a political entity.


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