Even as the IMF board ponders on its important decision as to who to choose between the two candidates it has before it, the drama in the Eurozone is moving into melodrama. The argument for a European candidate once again for the IMF job is that a European alone can tackle the euro crisis. Apart from being racist (or continentalist), this statement is also wrong. Eurozone decision makers, including the French minister of finance Christine Lagarde, have so far failed to get to grips with the Eurozone problem. They were in denial at first; then tried to deal with Greece in isolation last May and then, when three more countries went under, they were at a loss to know how to tackle the structural defects in the euro monetary system. They have tried to deal with each country on a case by case basis but failed to calm the markets on any one of them.
Christine Lagarde is a big player in this game. France and Germany together are meant to drive the European Union and are major stakeholders in the Eurozone. France only wants to tie the economies in a tighter control grid so that their budgets would be co-ordinated or some central oversight would be possible. Germany for a long time wanted all Eurozone members to behave like Germany did?prudent and fiscally responsible. Then its desire changed to saving the German banks who had a big position in Eurozone debt. Now it is quite clear that Germany thinks, or at least its finance minister Wolfgang Schaeuble says, that it would accept some restructuring, i.e., a haircut being taken by private bondholders.
Alas, the decision-making structure in the Eurozone is not simple; if a camel is a horse designed by a committee, the Eurozone decision-making structure is something worse. The European Central Bank does not like haircuts and cannot hold Greek bonds if they have been reneged upon and will have to sell them in the event of a haircut. This will exacerbate the Greek problem. The IMF, which is also involved in the rescue cases, is blowing hot and cold on whether it will meet its commitment for the next tranche of Greek borrowing of 110 billion euros due next month.
The Greek parliament, in the meantime, is meeting and facing angry crowds (no Anna Hazare on fast here). The government has few options and is now hoping that if it privatises many of Greece?s assets?worth around 250 billion euros?it may have some respite. But this is a tricky political decision for an ostensibly Socialist Party. Even if the government decided to sell, it may not get its hands on the money for a while and a fire-sale may be counter-productive. Greece?s deficit is around 9% of its GDP and the debt-GDP ratio is around 157%.
The tragedy is that even if Greece eliminates the deficit at a great cost in fiscal pain, its debt would only stop rising, not disappear. There is no life after deficit elimination; not until the debt is a reasonable proportion of GDP. Germany went through a decade of austerity when it had to absorb the dysfunctional East German economy after the fall of the Berlin Wall. But Germany had sound finances in its western part and a people willing to work hard and save a lot. Its East German assets proved worthless since no one wanted to buy the junk capital stock of East Germany, but it managed to come through, with its economic health restored.
This is one reason why Germans have no sympathy for the Greeks who they think are lazy, retire too early and pay no taxes. Of course, Greece should never have been allowed to join the Eurozone. But then, political considerations demanded that the euro have many members, so gross irregularities in Greece?s national accounts were ignored. Now everyone is paying for the Greek fiddle.
There is, by contrast, the case of Iceland, which went bankrupt two years ago. Iceland, like Ireland, had a problem with its private banks which built up excessive liabilities by offering an above market rate interest rate on deposits and then crashed when Lehman Brothers crashed. The debt?which were the deposits taken by the banks operating abroad?was left with the Iceland Treasury. But in a referendum the Icelanders voted to renege on the debt and forced the creditor countries, mainly the UK and the Netherlands, to renegotiate. Iceland could let its currency depreciate, which is painful but still lets individual citizens make their adjustments to inflation. Now, two years on, Iceland has come back to international markets and can borrow at 5%, way below what Greece has to pay.
There is a lesson for the Eurozone here. Not every creditor deserves a break. They should have known it was risky to lend to Greece; let them bear the cost.
The author is a prominent economist and Labour peer