GREECE is becoming almost ungovernable. Since last week’s election, three of the political parties have tried to form a government. Each has failed. Now it has fallen on the president to bring the parties together, appealing to them to create a government of national unity.
Most commentators think his chance of success is low and that a further election will have to be called. Greek voters are clearly unconvinced by the austerity programme. Many feel, correctly, those who are suffering as a result of the spending cuts and tax rises are not those who caused the deficit in the first place.
This could not come at a worse time for the euro. Without effective political governance, the chance of debt default in Greece and its disorderly exit from the euro increase sharply. Voter sentiment in Greece may have moved against the austerity programmes imposed by the European Union and the International Monetary Fund. Yet these austerity measures are what the EU-IMF requires in order to fund the Greek deficit.
Without the ¤130 billion that has been promised in the second stage of the EU-IMF bailout, the Greek economy is likely to suffer major disruption.
Already, many depositors are withdrawing their funds from Greek banks.
Replacement of the euro by a sharply devalued drachma would reduce the value of bank deposits. It would also cause sharp increases in the value of foreign debt owed by Greek citizens. Faced with an substantial unexpected increase in the real value of their borrowings, further defaults would be likely. This would clearly cause huge difficulties for Greek banks, but also there would be a contagion effect spreading outwards into the wider European financial structure.
Lenders might also be concerned about other European economies that have been bailed out by the EU-IMF and are trying to meet onerous repayment conditions, including Ireland and Portugal. And in terms of its size, the elephant in the room is Spain, which has embarked on an unpopular austerity programme, but has not stabilised its banks. The solvency of Spanish banks is unclear because the Spanish government does not know the extent of non-performing loans. Last week it forced the banks to set aside ¤30bn against potentially toxic property lending.
Not surprisingly, there are signs that funds are moving towards countries that are regarded as “safe havens”. German government bond yields fell to record lows last Friday, indicating that German government debt is becoming increasingly popular with lenders even though the returns offered are very low. US treasury bond yields were also trading close to record lows last week.
UK long-term debt costs dropped to 1.80 per cent last Wednesday, the lowest level since the Bank of England starting collecting data in 1703. A good sign in one sense, but the signals from Europe are grim.
• David Bell is professor of economics at Stirling University.