Europe’s top politicians, led by German Chancellor Angela Merkel, seem determined to repeat the same mistakes over and over again.
Last weekend, the financial crisis seemed to be contained for the moment when the Germans and the European Central Bank agreed to commit 100 billion euros through the European Union’s (E.U.) rescue funds to recapitalize Spain’s faltering banking system. The Spanish government bargained hard, and won an agreement that the bailout would not be tied to new austerity demands of the sort imposed on Greece and Portugal.
But as more details emerge, it’s clear that the cure could be worse than the disease.
For starters, the money is being lent to the Spanish government, not to Spain’s banks. As a consequence, this will increase Spain’s government debt by about ten percentage points of GDP.
That, in turn, will increase speculative pressure against Spanish government bonds. To help the speculators along, the bond rating agencies responded by downgrading Spain’s government debt by three notches, to just above junk bond status. Spain’s borrowing costs are now at their highest level since Spain adopted the Euro.
Thank you, Chancellor Merkel. Just to twist the knife, Merkel’s Minister of Finance, Wolfgang Schauble, insisted on a provision giving Germany first claim on assets in the event that Spain defaults. The premise is that Germany is putting up the lion’s share of the money. But in fact, most of the money is simply borrowed on capital markets and relent to Spain. However the effect of Schauble’s provision is to make investors even more wary of lending to Spain, since Germany will be in line ahead of them.
Given the inevitable deterioration in Spain’s economic and budgetary picture as a consequence of recent events, when the E.U. does its next review of Spain’s deficit and debt levels, it will demand more austerity. So even the claim by Spanish Prime Minister Mariano Rajoy that austerity was averted is hollow. It was only deferred slightly.
Meanwhile, French President François Hollande is expected to propose at the European Summit next week a major policy change to allow funds from the E.U.’s two rescue mechanisms to go to banks directly. That is currently prohibited and should have been done with Spain so that the Spanish government was not made to pay for the sins of the Spanish banks. But Chancellor Merkel is very unlikely to concur.
In the other main stage of this tragic farce, Europe’s conservative press and political leaders are presenting the Greek election as a referendum on whether Greece leaves Europe. However, as radical candidate Alexis Tsipras of the Syriza coalition keeps saying, he wants to stay in the eurozone. He just wants to renegotiate the austerity terms while he fashions a recovery program. The Organisation for Economic Co-operation and Development has just reported that Greek wages in the private sector have fallen by 22.5 percent just between 2010 and 2010. But German leaders keep saying that Greece needs to stick to the austerity program.
So imagine what will play out of Tsipras wins. Markets will tumble. The Germans and the “Trokia” of the European Commission, the International Monetary Fund, and the European Central Bank will warn Tsipris to keep cutting the budget. If he refuses, then the European authorities will face a fateful choice. Do they cut off the flows of aid that has allowed the Greek government to keep paying its bills and Greek banks to prevent runs by panicky depositors? Or do they blink first?
If the European authorities turn off the spigots, then Greece faces a total economic collapse and a humanitarian catastrophe. That is the true meaning of the technical language about Greece “exiting the eurozone.”
Do Europe’s leaders really believe that shoving Greece into a worse disaster will teach a salutary lesson and contain the crisis? Aren’t they aware that the result will be more downgrades by rating agencies and more speculative attacks against the bonds of more countries? It’s hard to believe that the European political elite haven’t learned from past mistakes, but the sheer stupidity of their policy toward Spain suggests no learning curve at all.
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