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Fault, falter, default

First Published in BusNet on 7 October 2011

The Eurozone crisis is now two years old. It was sparked by the revelation, in October 2009, that Athens had repeatedly misrepresented its finances. At the time, Greece’s annual budget deficit was already more than three times over the 3% limit intended for Euro countries.

Today, the risk that Greece will default on its sovereign debt remains the most incendiary factor in the European financial system. It is ironic that the nation that helped instil theatre in our culture has orchestrated such a protracted drama, complete with deception, sub-plots, masks, trapdoors and dilemmas.

In the first act of this play, romantic Greece has borrowed money to buy flowers for a girl he is wooing (his voters). When the loan falls due, he has no way to repay it. As luck would have it, an elderly lady on the island takes pity on him, and uses her savings (that she has not touched) to settle his debt. So Greece won the mercy of three kind benefactors (the European Commission, the European Central Bank and the International Monetary Fund) and received a €110bn rescue package. It is fairly usual - in theatre and in real life - for a profligate character to be supported while teetering on the brink of bankruptcy. That was Greece’s advantage in being the first to fall into distress, while there was both the funding and the willingness to help it reform.

The twist comes in the second act. Once again, Athens is unable to pay its bills. Now the plot is become more perplexing. The kind benefactors feel obliged to help Greece in order to safeguard the financial stability of Italy and Spain. In order to do so, they need to dig deep into the collective reserves of their community, which have mostly been contributed by Germany and France. Are you still with me?

The notion that societies have a duty to help those in need is part of the theory of distributive justice. However it is only one aspect of distributive justice, which is mainly concerned with how goods are distributed among members of a society at a particular time. Right now, several Euro countries are relying on guarantees from the same reserve fund (the European Financial Stability Facility) to stave off their own debt crises, including two small economies (Ireland and Portugal) and two large ones (Italy and Spain).

There are two common errors when dealing with social justice. The first is to think that fairness depends on the character of the claimant. The second is to think that a fair process will deliver a fair outcome. Since we are only spectators to this drama, let’s ignore these traps, and look at the evidence anyway.

Risking levels of Greek debt are partly the misfortune of enduring three straight years of recession, worsened by corruption, the backlash against austerity and the strikes and violent protests which have hampered those with jobs from getting to work. Perhaps stronger political leadership could have marshalled the population better and driven through deeper budget cuts, but this seems unlikely. Greece’s fault however, was that it took on too much debt in the first place, aided on one instance by Goldman Sachs, who engineered a currency swap deal at an artificially high exchange rate in order to circumvent the Maastricht rules. This was in 2002, the first year that Greece joined the Euro, and makes these bonds even more expensive to repay when they mature between 2012 and 2017.

Furthermore, when Greece’s newly appointed Finance Minister, former constitutional lawyer Evangelos Venizelos, made his stage debut at an emergency meeting in June this year, his first move was to attempt to renegotiate the second bailout package to give Greece softer terms. This angered the point-man in this discussion, the normally mild-mannered Finn, Olli Rehn.

While the audience takes a secret ballot on Greece’s character, let’s examine the second trap – the fairness of the process. It’s often said that ‘the squeaky wheel gets the oil’. Greece has €388bn in debt, which is 143% of its GDP, and its fiscal deficit is adding to their liabilities at a current run rate of 10.5% of GDP. This is squeakier than a panzer division.

European policymakers are intent on shoring up Greece’s finances because unless they do so, the financial markets will deem other Eurozone debt to be unacceptably risky (take Italy as an example, currently €1.9 trillion or 120% of GDP) which will in turn push up the cost of financing those debts, and leave less money in their budgets for spending on education or infrastructure. A quick glance around the playhouse suggests that the audience agrees with the need to preserve confidence in the Euro and prevent the contagion, yet is truly puzzled that buying Greece’s debt is the best way in which to accomplish this.

The curtain rises on the third and final act. For almost 24 months, European Finance Ministers have been holding a burning match, yet they appear to be locked in a state of paralysis. At some point they will need to blow out the match, or drop it before it burns them. Yet perhaps their quandary could be resolved by adopting another Classical precedent – from Sparta, which was the pre-eminent Greek city-state around 650BC. Sparta’s complete focus on military training and excellence gave rise to an unusual social system. When a child was born, the mother bathed it in wine. If the baby survived, the father took it before the council of elders, who decided whether it was fit enough to be reared. Puny infants were thrown into a chasm on Mount Taygetos.

Ultimate leadership is about keeping the rights of the invisible majority firmly in mind while attending to the squabbling demands of those who hold your attention. Our financial leaders do not know how to blow out this match. Their only option is to drop it into a chasm. By inference from Sparta’s primitive ‘eugenics’ ¹ in order to maintain a strong gene pool in the Eurozone, Greece would first face the acid test of whether it will ever be able to repay its current obligations using its own tax revenues. Only once it had convincingly passed that challenge would the council of elders (or the ECB ²) determine the rescue allocation it merits – with full regard to all other potential claimants, present and future. Call this eurogenics. Cruel? Yes it is. Social Darwinism? Yes it is. Fair? You decide what fairness is in this case.

In the meantime, we the audience watch the unfolding drama and try not to shift too much in our seats. Comedy it is certainly not. Satire it could still be, but it will take an amazing piece of stagecraft for this crisis not to turn into an all out tragedy.

1. Eugenics is the applied science of aimed at improving the genetic composition of a population, which became deeply unpopular due to its association with Nazi Germany.

2. European monetary policy is determined by the European Central Bank (ECB). The original mandate of the ECB was cloned from the Deutsche Bundesbank, which was by far the strongest and most responsible of the European central banks at the time that 11 countries (now enlarged to 17) decided to tie their fate together in the Euro. Its DNA still reflected the profound fear of inflation that Germany carries in its collective unconscious due to the indiscriminate ravages of hyperinflation after the Weimar Republic collapsed.

Over the course of this crisis, the ECB has strayed from its guiding objective - to keep inflation below 2% - and has bought €160bn of bonds from peripheral Eurozone countries. This is a major constitutional shift. German delegates Alex Webber (best positioned to have replaced the outgoing head, Jean-Claude Trichet) and Juergen Stark each resigned their seats on the central bank’s six-member executive board this year – long before the end of their respective terms. A recent poll shows that 54% of Germans would like to return to the Deutschmark.