All roads lead to Berlin

Michael Burke: The details of the latest EU Summit remain sketchy and on the surface overwhelmingly relate to Greece alone. The Agreement reached by the Euro Area heads of state only relates directly to both Ireland and Portugal via the cut in interest rates being applied. At the same time, there was great emphasis laid on the declaration that the other measures, including ‘haircut’ for bondholders was a wholly unique event, applying to Greece once and once only, and never to AN Other EU member state.

President Sarkozy was particularly adamant on this point. But it should also be clear that he doesn’t run in the EU, nor does M Trichet. Chancellor Merkel does, and what she says goes.

This is because the EU and especially the Euro Area is a project which allows a tremendous development of production across a continental scale. In a host of industrial sectors, even the German economy alone is too small to compete with key international rivals, the US, Japan and now China. The creation of a single market facilitated the development of transnational industries within Europe and the single currency deepened that integration not least by ruling out competitive devaluations.

Germany is the main beneficiary of that increased potential, even if it and others fail to realise it. The leadership of the main German political parties were all united that the Euro Area would not be broken up because German industry has the most to lose.

As a result, Mrs Merkel got her way that the private sector would take the haircut, against the fierce opposition of Messrs Trichet and Sarkozy, who represent the EU banks and the French banks exposed to Greece respectively. This is a start, a small beginning in rational policymaking in Europe.

At the time of writing, the heavens have not fallen in and the world still turns on its axis. This is despite claims both in Ireland and in continental Europe that similar calamities would follow any losses for the banks. In addition, the Agreement initiates a preventative measure to recapitalise ailing banks in the non-crisis countries. The banks in this jurisdiction are long past saving, and this State is very much in the thick of the crisis. But what the measures (of unspecified size) mean is that default can take place without bringing down the whole of the European banking system.

Trichet and Sarkozy may regard Greece’s selective default as equivalent to The Fall. But the political and banking systems cannot return to a pre-lapsarian state. Default is now on the table.

The actual size of the cut in the interest rate for Ireland is the subject of much heated debate over at Irish Economy. Karl Whelan has come in for some particularly harsh criticism merely for pointing out that the interest rate reduction owes nothing to the prostrate negotiating position of the Dublin government. He is correct. Instead, it arises from the fact that Italy was being drawn into the maelstrom and Chancellor Merkel does not want to allow the break-up of the Euro Area.

Separately, Michael Taft has a series of very useful suggestions as to how the possible €800mn to €1bn annual windfall could be used to stimulate economic growth and thereby increase tax revenues and reduce welfare outlays.

Clearly, that too would be a rational innovation. We shall see, but point 4 of the Agreement refers to the need to stimulate growth and create jobs. Unfortunately, this remains couched in terms of competitiveness, which for the EU Commission usually means deregulation, privatisation and wage cuts- which are the opposite of a growth and deficit-reduction strategy. What is clear is that deficits are rising in all the ‘bailed-out’ economies. Public spending cuts have had the opposite effect to that claimed- the deficit has risen as the economy has deteriorated.

So will this package work for Greece and stop contagion? In my judgement, not a chance.

First, while bondholders get an estimated 21% haircut on the face value of their bonds (if they participate - the FT reports that many won’t) Greece will only see an estimated 7% reduction in its total debt. This arises because Greece will participate in the recapitalisation of its own banks and from other measures. If a 7% debt reduction were enough, there would have been no crisis.

Second, the growth-sapping cuts remain in place. They will be joined by privatisations, leading to lay-offs and bigger welfare outlays, while removing revenue streams from the government’s accounts (but probably not the state-owned enterprises’ debts). The latest Italian cuts will only produce weaker growth and higher deficits. Spanish and Italian yields are still pushing up towards 6% again.
After Britain (equivalent to US$ 135bn) German banks have the highest exposures to Irish debt (US$118bn). Leaving the Euro and disorderly default would be a disaster for this economy. We know that the British Tory ‘friends of Ireland’ insisted their bilateral loan at punitive rates could only be repaid in Euros, and no other currency. It seems likely that others have as well. Irish indebtedness would soar with a Euro exit.

But the same scenario could equally prove disastrous for German banks; a lose-lose calamity. Chancellor Merkel is willing to face down powerful opponents to ensure that does not happen. A government of the Irish Republic worthy of the name would use all these new developments to the advantage of its own citizens: negotiated default, an end to cuts, stimulus measures, job-creation.