One of the longer run consequences of the financial crisis has been the reversal of roles between the North and the South. Time was when the North lectured the South about fiscal profligacy and IMF would be at the door imposing dire conditionalities. Now we have the spectre of the IMF coming to the rescue of members of the European Union. Hungary has been given aid and Estonia was in trouble. Iceland?s economy is technically bankrupt because some private banks did business in the UK and the Netherlands which collapsed and their liabilities have to be met out of Iceland?s paltry reserves. Iceland?s citizens refuse to bear the costs. Now some modality will have to be worked out by which the creditor countries give it some leeway to pay and no doubt the IMF will help out.
These troubles due to banks which escaped regulatory supervision in either the host country or the home country. Hungary and Iceland were potential members of the Euro so foreign capital flooded in on the promise of a sound currency. The European Union is both the problem and the solution. When the Maastricht Treaty was signed EU committed itself to a tough monetary regime. The Euro was established in 1999 and many countries joined it. The entry conditions were strict in terms of debt-GDP ratio and each country had to sign the Stability and Growth Pact which limited the budget deficit to under 3 %.
This was done to make sure that Germany which had the soundest and strongest currency, the Deutschemark, would agree to be part of the system. What went wrong was that in their enthusiasm to get many members, the stringent entry conditions were not enforced rigorously. Italy was a dubious qualifier since its debts were out of control. Somehow it managed to window dress its accounts. But many others, Greece especially, had even less reason to be accepted.
Things were fine, since in its first eight years the Eurozone did quite well. There was growth and fiscal stability. Then the recession hit and it was clear that the strict deficit limits had to be relaxed. The ECB agreed to run a mild monetary policy and even help out by buying in the debt of the member governments. But it became clear that there were weaker countries?Portugal, Ireland, Greece and Spain (PIGS)?which were all in a fragile state. The Eurozone required that they maintain the quality of their public debt at a high standard. But the PIGS were not trusted by the market to be able to service their debt. The rate of interest they had to pay was above the rate at which Germany could borrow.
The ?spread? was highest in the case of Greece. When the election brought in a new Socialist government , the dam burst. It became obvious that Greece had understated its debt position at the time of entering the Euro and ever since. Goldman Sachs seems to have helped the Greek government make its numbers look better by offering some sophisticated swaps trading future revenue for current debt reduction. It now faces US Congressional investigation.
Greece needs some special help from its fellow Eurozone members but the Treaties?Maastricht 1992 and Lisbon 2009?make it impossible for the individual governments to do a bailout. German citizens are unwilling to foot the bill for Greek profligacy. Indeed, any such innovation which lends German resources to Greece may violate the German Constitution itself.
The Eurozone which was the proud achievement of the EU is now in trouble. It was designed with no facility for emergency situations. Yet the members are reluctant to let IMF help Greece out. They fear that once the IMG gets in, the reputation of the Euro will suffer and discipline collapse. Greece needs to cut its budget deficit drastically?by up to five percentage point immediately from a high level of 12 % plus. There are strikes and protests from the public sector workers who will be affected. Rampant tax evasion is a way of life in Greece as is corruption. The Greek government despite its best efforts is caught in a cleft stick.
The old IMF solution would have been to devalue and agree to a fiscal discipline schedule in return for an injection of aid. But the Eurozone does not allow devaluation by individual countries and does not want Greece to drop out of the Eurozone. It is an exclusive club which only the rich can join. Greece has been found to have pretended to be richer than it truly was. Like some Lucknawi Nawab fallen on hard times, it will now have to suffer penury to keep up the pretences of aristocracy. Political strife and fiscal bankruptcy are unpleasant choices.There is no clear end to the Greek tragedy.
The author is a prominent economist and Labour peer