Casualty! The eurozone sickness spreads

It seems increasingly likely that Greece will leave the eurozone. But what will this mean for the rest of Europe?

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The Independent Online

Suddenly, there are a lot of Sick Men of Europe. Greece is in intensive care; Spain's waiting for a bed to become available; the drips that Portugal and Ireland are on don't seem to be doing much good; and while the condition of Italy seems to have stabilised a little, France is developing a bit of a cough; and the Netherlands are feeling a bit peaky. It's all a bit like a pan-European edition of Casualty.

And, just to make the episode more interesting, while almost everyone agrees on the underlying causes of the disease, the doctors can't agree on the treatment. This is partly because of the varying states of the patients, but also because the doctors themselves have their own agendas and interests. Some swear by this drug, others by another, and all are afraid of getting too involved with the critical cases in case they get infected. Time, then, for as calm a case conference as we can manage.

What are the sick suffering from?

A surfeit of debt, which, because of the credit crunch, and fears of default in the markets, is costing far more than it once did to service – plus overborrowing in the years of easy credit, a too-rapid expansion of public sectors, and, in the case of Ireland and Spain especially, an implosion of property prices. Greece now owes 160 per cent of its GDP, Ireland 110 per cent, Portugal 107 per cent and France 89 per cent. And, as economies contract, inefficient tax collection means these countries have even less cash.

What are the symptoms?

Of the euro's 17 members, seven are in recession: Ireland, Greece, Spain, Italy, Cyprus, the Netherlands, Portugal and Slovenia. Germany, meanwhile, had 0.5 per cent growth in 2012's first quarter, mainly due to a big rise in exports. Under pressure from Germany, governments have laid off workers, cut pay, reduced spending on social programmes, and imposed higher taxes and fees to boost revenue.

As economies have shrunk, countries' debt levels have worsened. In Spain, the interest rate on 10-year government bonds stood at a worrying high of 6.2 per cent on Friday, not far from the 7 per cent mark that forced Greece, Ireland and Portugal to ask for bailouts. The level of bad loans on the books of Spain's banks has risen to an 18-year high. All those in recession, but especially Spain, Portugal and Greece, now have hideous rates of joblessness. In Spain, one out of every four citizens is jobless.

In Greece, the first shortages are starting to appear. Melina Ferousi, a businesswoman who imports paper and stationery items, said: "French and Spanish suppliers are still selling on credit, but German ones are particularly strict and are refusing to do so." And Greeks, fearful that an exit from the euro would mean their savings would be devalued overnight, have been withdrawing deposits from banks.

What treatments have they tried?

The drug of choice has been Austerity. Most countries have been self-medicating (in Britain's case too much so, says Labour), while Greece, Portugal and Ireland are under the doctor on a bailout regime and having to swallow even greater doses. The unpalatability of Austerity is what caused the revolt by Greek voters on 6 May. Increasingly testy Spanish government officials insist they have put in place a litany of unpopular measures since January that have raised taxes, forced regions to impose deep budget cuts, cleaned up an antiquated labour system by making it easier to hire and fire workers, and required banks to raise the amount of money in place to cover problematic assets and loans. They, like many others, can see the pain all too clearly, but are yet to see palpable gain. And there is a lot more Austerity to swallow.

Why are these not working?

Austerity, if it is the only medicine being taken, has known side-effects, notably drowsiness in economic activity and pain for the jobless. Lack of growth makes debts harder to pay, and pushes up social welfare spending. In Greece's case, the underlying condition is so severe that no dosage of Austerity, however large, will effect a cure.

Is there any environmental factor involved?

The Sick Men all live together in a closed community, which works so long as the members are seen to be inextricably bound together. The fear is that if one departs, or is allowed to leave, others will follow and the community will collapse, taking many banks with it. Investors, fearful that Portugal, Ireland, Spain and Italy will follow Greece's path, would then pull their money out of those countries, too. That would likely be disastrous for the global economy, although it is so unprecedented that nobody really knows.

A vital part of the community is that they all have to take the same medicine. Were they operating as individuals, the inevitable remedy would be a sharp devaluation to make themselves more competitive, but, since the community is based on currency union, one cannot devalue on its own.

Are there other complications?

Two in particular. First and foremost, voters – especially Greek ones. At the 6 May election, they made plain that the prospect of decades of externally inflicted, distasteful Austerity medicine was not something they were going to swallow. Nearly two-thirds voted for parties of the radical left and far right which oppose the terms of the EU/IMF assistance programme. A Greek government could not be formed after the election, hence a return to the voting booths on 17 June. Leading in the polls is the Syriza party, led by Alexis Tsipras, an ex-communist with only three years in parliament, and no background in finance or law. He would withdraw from Nato and close its bases, halt repayment of the national debt, reverse privatisations, seize banks, eliminate sales tax, impose a 75 per cent tax on the rich, and tear up the €130bn bailout.

Yet a majority of Greeks consistently support remaining in the euro, and one's hunch is that, if there is a sign the EU leaders will ease up on the Austerity dose a little, then there might, come 17 June, be a return to pro–bailout parties. But the Greeks are not the only voters with a say. A poll published on Wednesday found 59 per cent of Germans reject the idea of borrowing more to stimulate growth.

The second factor in all this is the banks. They don't want patients to die or be so ill they can't work, either of which would mean they could default.

What about the doctors?

These are also either the patients, or potential patients, and their suggested remedies are coloured by their own interests. Germany wants Greece to stick to the old treatment regime, France wants to administer some doses of Growth, and Spain wants Greece to be kept alive in the community for fear that the markets will switch their attack to Madrid if Athens expires.

So will the patients survive?

There is an immediate crisis ahead, with Greece having to make more budget cutbacks next month to get new funds from its international bailout. If it runs out of money before the 17 June poll, some have said that Athens might have to issue IOUs or vouchers to meet salaries and key service bills. An exit, though thought inevitable by many, would be at a terrible short- to medium-term cost, with the country's GDP shrinking by around 20 per cent. Greece imports 40 per cent of the food it consumes, nearly all of its oil and natural gas, and much of its medicine. Salaries and pensions could go unpaid for a while, and its banking system would likely collapse for a time. The government would have to default on the euro-denominated money it owes other European countries, shaking the Continent's financial system.

Will Britain catch it?

Our economy is already somewhat indisposed because of low European demand, but we will not go down with a serious illness unless Spain and Italy default. That would cause problems for our banks, who are exposed to the tune of about £57bn and £37bn, respectively. That could mean 2008 in spades. (Our banks' exposure in Greece is £6bn.)

And what about me?

Your mortgage rate is likely to go up, lending will be made more difficult, but savings are protected by the Government's safety net fund to the tune of £85,000 per institution. And, if you're going to Greece on holiday, take plenty of cash in small denominations.

And the prognosis?

There is no quick cure. This is not 1933 or 1973. It is a globalised world, with transnational banks, and, in the eurozone, a ponderous, committee-style decision-making institution constantly grappling with uncertainty-phobic markets. Wolfgang Schaeuble, the German Finance Minister, has predicted the crisis could last up to two more years, and there is little reason to doubt him. The patients will be ill for a very long time.

Who can save the euro? (A: not David Cameron)

Angela Merkel

German Chancellor

The holder of the purse strings. Everyone is banking on the veteran of financial crises to flex Germany's financial muscle to rescue the euro. But with elections due in the next 18 months, she knows more handouts will go down badly with German voters. Her rumoured suggestion that Greece stage a referendum on remaining in the eurozone has not helped relations.

Barack Obama

United States President

Is so far resisting the temptation to say what is happening in Euroland is nothing to do with him. Growing numbers of world leaders are looking to Obama as a beacon of how growth can be achieved without deep cuts. His hopes of re-election depend on the US economy continuing to grow – something that will be less likely if the eurozone collapses.

François Hollande

French President

Monsieur Normal has dried himself off from the downpour of his inauguration and is now basking in the glow of being the White House's new best friend. His renewed call for an EU-wide financial transactions tax quickly riled David Cameron, but he has the upper hand. Having beaten Nicolas Sarkozy by opposing German-led demands to cut Europe's deficit, the Franco-German alliance is under threat.

Christine Lagarde

Managing director, International Monetary Fund

In reality, the markets will decide what happens to Greece, and the eurozone as a whole, but it will be pronouncements from the IMF which will help seal their fate. Amid all the gloom, the IMF last week declared that Italy – the eurozone's third-largest economy – had made "remarkable progress" in securing its future. A similar pronouncement about Greece seems some way off.

Alexis Tsipras

Leader, Syriza party

The youthful, some say dishy, leader of the Greek left-wing party refuses to countenance austerity and wants to renegotiate Greece's EU and IMF bailouts. If he is the victor of next month's snap elections, a deal will become even less likely. A run on the euro from panicked Greek voters could bring the whole thing to its knees even sooner.

David Cameron

British Prime Minister

With Britain not being in the euro, and Cameron a fan of austerity and no Obama, the unkind would argue that the British PM is in danger of drifting into irrelevance. With only rhetoric at his disposal – eg, telling the eurozone to "make up or break up" – he risks being reduced to giving Eurosceptic soundbites to waiting cameras, while everyone else tries to solve the problem in the building behind him.