Hamish McRae: This scheme might just work but significant hurdles remain
Analysis: An eventual break-up of the eurozone cannot be ruled out – indeed many would say it was inevitable
Tuesday 27 September 2011
There is a plan. We don't know the details, nor its likely effectiveness, nor even whether it can indeed be agreed by the politicians. But we can see in outline how the European authorities will seek to cope with a Greek default and yet manage to keep the eurozone intact.
The plan has several elements. First, Greece will be allowed to default on its sovereign debt, with holders getting back perhaps half of the face value of the loans. The rest they lose forever. This may sound shocking but such an outcome has been implicit in the price of Greek debt for several months. So it merely confirms what is already known.
Second, the many European banks that hold this debt and will as a result of the write-down be bust will have to raise new capital. Much of this will have to come from the various national governments – rather in the way our own government had to recapitalise Royal Bank of Scotland and Lloyds Bank after its takeover of HBOS. This is embarrassing because only a few weeks ago nearly all these banks were declared sound by the European authorities – but they only passed the so-called stress test because it was not politically acceptable to acknowledge that Greece might default on its debts.
Third, the funds that the eurozone has available to support members in difficulty will have to be radically beefed up. The structures of these are of Byzantine complexity. There is a temporary fund called the European Financial Stability Facility, which has lent to Greece, Ireland and Portugal, and which is in theory about to make another loan to Greece. There is the European Financial Stabilisation Mechanism, which raises money on the markets but with an EU guarantee. There is a plan to create a permanent fund, the European Stability Mechanism, supposed to come into force in 2013, and replace these temporary arrangements. Quite how this is all to be done is not at all clear, but these may involve some central European bonds, guaranteed by all eurozone countries.
Fourth, in any case these European funds will need to be further supported by the IMF, which has already helped with money for the rescues. There may be other direct international help from the US and China, but that is just a suggestion.
Finally, the European Central Bank can, on its own authority, do two things. It can and has been lending to countries short-term by buying their bonds on the markets. And it can and will almost certainly need to cut interest rates, and it can also flood the eurozone with liquidity. It can, so to speak, print the money – and if things go really badly, it may have to.
There are three troubles with all this. The plan sketched here, or something like it, is doable. But problem one is that it is very complicated and requires a lot of politicians, central bankers and national legislatures to agree. It is not just that German taxpayers have to pay part of the costs for Greek mismanagement. It requires all eurozone citizens to take some responsibility for other countries' present and future debts.
Problem two is the limited time frame. The deal has to be done in the next few weeks because Greece will not be able to pay interest on its debts and so will be declared in default anyway. An orderly default becomes a disorderly one.
Problem three is that it may not work in the medium term. Much of southern Europe is uncompetitive vis-à-vis the north. To correct that requires not bailouts but large falls in prices and wages. But even were that possible, it would make the debts, particularly of Italy, even harder to service and pay back. An eventual break-up of the eurozone cannot be ruled out – indeed many would say it was inevitable.
So what will happen? People talk in apocalyptical terms but catastrophe is improbable. One small country cannot alone destroy the world economy. The problems of a badly designed currency zone, on the other hand, will continue to weaken it.
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