Sunday, May 9, 2010

An atom bomb goes off

An atom bomb was set off yesterday. Only nobody noticed it. Because it was high economics that nobody but the geeks understand. But an atom bomb, it surely was. I am referring to the nearly € 1 trillion “bailout” package for the Euro zone members that was announced yesterday.

Even if you have only a passing interest in economics, you would have heard of the travails of Greece over the last few months. This was snowballing into a crisis that was threatening to spread to the other vulnerable members of the Euro zone - the so called PIGS – Portugal, Italy, Greece and Spain. Hence the shock and awe tactics of detonating an atom bomb. € 1 trillion rescue package. Wow !

Greece started it all. For a long time it was fudging figures that, if done in the corporate world, would have surely sent the Chairman to jail. But it is, of course, perfectly acceptable to do so in politics. Truth will always out, and when tougher financial markets laid bare who was naked and who was not, Greece got caught out. The interest rates on Greek bonds started to rise rapidly. Without the ability to borrow, Greece was in danger of default.

Because Greece is locked into the Euro zone, the traditional route of massive devaluation of the currency was not possible. Everybody assumed that the 1000 pound gorilla in the room – Germany – would rescue Greece out. But Germany these days is in no mood to rescue anybody. Everybody for themselves in tough times. How on earth do you convince the average German voter that he is penalised for being responsible and must stump up the money to rescue the irresponsible Greeks. This was Angela Merkel’s problem, especially with a crucial regional election that was held yesterday. She tried to postpone any decision till after the elections. She couldn’t do so. The result ? A stinging defeat for her party yesterday.

The announcement has huge implications. Firstly it admits that any Euro zone country, however small, is too big to fail. As each weak country is attacked, they have to step in to save them. Secondly, the European Central Bank has to intervene directly to shore up the bond markets; something which it was explicitly prevented from doing when it was set up. Thirdly, it calls into very question the basis on which the Euro came into being. Countries were left free to manage their own economies, but subscribing to basic disciplines of fiscal policy. No country was required to “bail out” another. This is all shot to the wind now. Every country now is bound to be responsible for every other ; how do you do it when each of them still wants to be a sovereign nation ? Fourthly what happens when this malaise spreads. Greece is not alone as a beacon of indiscipline. To varying degrees the others in the PIGS grouping have problems. Greece is small. Spain is big. What happens when bigger countries get into trouble. And perish the thought – if the much bigger Italy, another star in the indiscipline firmament is targeted; we don’t even want to think of the consequences of that. Fifthly, there will be very very painful cuts in Greece and whichever country needs to be bailed out. There are already massive strikes in Greece. How’s the population which has been hooked on to spending without a care going to take the chemotherapy ?

If that was not enough, there’s more worry coming. What about the countries in the European Union which are not in the Euro zone. What about the UK ?? It has run up an incredible deficit, faces political uncertainty, and is in a fair mess.

When bailouts were about banks, it was easy to get all steamed up, hurl invective at them and castrate executives. When its about whole countries, what do you do ??

It’s a gloomy world out there today morning. The skies are darkening over Europe.