Bill Jamieson: Why Greece poses deeper questions for the whole of Europe

Published on Monday 18 January 2010 20:02

FINANCE ministers of the European Union meet this week amid fears of an expulsion of one its members from the single currency.

The concerns have been building over the growing budget deficit in Greece and the lack of confidence in the government's plans to rein in spending.

Such is the worry over a deepening fiscal crisis in Greece that the European Central Bank has issued a legal analysis of what would happen if a country tried to leave monetary union.The paper argues that eurozone exit entails expulsion from the European Union as well. Some see in this move a warning shot, not only for Greece but also for Portugal, Ireland and Spain: fail to marshall public support for Draconian austerity and risk being sent into Icelandic oblivion.

The pressure on other EU leaders, in particular German chancellor Angela Merkel, is growing. German taxpayers have no appetite for bailing out Greece, particularly since the recovery in Germany so far has been anaemic. A poll of German voters by the think tank Open Europe found that 70 per cent of Germans were against using public money to bail out other countries that got into financial trouble.

But the consequences of a Greek default are even more unpalatable. If Greece reneged on its debts, other countries with high debt would all face sharply higher borrowing costs. Risk premiums would shoot up and high-debt countries would find higher interest rates being forced upon them. The immediate concerns after Greece would be Spain, Portugal and Italy.

The high debt eurozone economies are in a box. As Ruth Lea, economic adviser to the Arbuthnot Banking Group, points out, they cannot unilaterally change their short-term interest rates.They cannot unilaterally influence the value of their currency. And they are constrained, theoretically at least, by the terms of the Stability and Growth Pact. which placed (though suspended for now) ceilings on government budget deficits (3 per cent of GDP) and debt levels (60 per cent of GDP).

Since the euro was launched in 1999 argument has raged over its "one size fits all" nature, with fears that temporary convergence would hide major differences beneath – particularly between the hard core members (Germany, the Netherlands, Belgium, Austria) and what became known as the "Club Med" outer circle.

These difficulties were glossed over, while membership of the eurozone was raised from an original 11 to 16. Euro enthusiasts talked of integration and convergence. Sceptics warned of tensions and divergence, but were brushed aside.

Most believe that, despite the depth of the fiscal crisis facing Greece, the country will not leave the eurozone, if only for the strong likelihood that, were it to do so, interest rates on a newly installed drachma would be punishingly high. Indeed some rating agencies would regard departure from the eurozone as a default, with catastrophic consequences.

So if Greece is unlikely to leave, what then worries the markets? It is that, by staying within the eurozone and being obliged to accept severe reductions in spending, the social and political pressures will put a big question mark over political stability in Greece and the ability of its government to survive.

The country's democratic traditions are too recent for comfort. Greece until 1974 was not a democracy but was run by a cabal of colonels. Democratic institutions have taken hold by virtue of generous public spending policies and an ever expanding government payroll, which worked to buy off trouble. Angry demonstrations and riots have already started to return. Now, with spending largesse about to be replaced by austerity, can investors count on the parliamentary system surviving?

Similar dark worries have started to stir over Spain and Portugal, countries whose entry to the democratic fold was cemented by membership of the EU and in due course the eurozone.

It is the social and political implications of the current Greek crisis, not the financial aspects, that most worry investors. The proof, says Stephen Lewis, economist at Monument Securities, can be seen in the behaviour of the "Club Med" government bond yield spreads over the past month. These have widened substantially.

So the big test for Europe is not at heart financial. It is whether the EU can counter the threat to its core democratic values. Fiscal orthodoxy of the type beloved by the ECB could in fact blow Europe apart.