Today’s summit puts euro in the spotlight

Everyone is talking about Greece being on the verge of exiting the euro, after Monday’s summit meeting, but the crisis is not about Greece’s currency arrangements.

The Greeks are not demanding a return to the drachma and few of them are arguing for the competitive benefits of a currency devaluation. There are no formal rules that Greece is breaking that must lead to an exit from the euro because, legally, the euro is a fixed and irrevocable currency union.

This crisis is about more basic things: debt and power.The standoff looks more like the classic gunboat diplomacy conflicts of the 19th century than the currency crises of the 20th century.

Many people will argue that reckless, feckless Greeks are the real villains, cooking books and refusing to reform. Many will focus their anger on Syriza and will say that their election promises were undeliverable and ignored that the official creditors were never likely to offer significant debt write-downs, nor ease their longstanding urge to micro-manage the Greek economy.

But these arguments focus on the smaller tactical issues of how the Greek-debt problem evolved and how the current negotiations are going. They ignore the fact that we have only arrived at this juncture because of the utterly flawed lending decisions of Europe’s governments.

Europe’s governments, and the IMF, made an enormous mistake in bailing out Greece’s private creditors in 2010, and then overseeing a botched debt-restructuring in 2012. In turn, the Greek governments made the mistake of accepting official loans to pay off private creditors, not realising they were jumping out of the frying pan straight into the fire.

Now, the Greeks are learning that defaulting on private creditors is one thing, but defaulting on the governments of rich European countries is quite something else. Blaming the euro for the impasse is strange. The decisions that landed us in the current situation did not need to be taken and were the result of cowardice, confusion and hubris.

Hard-liners in European policy circles had maintained that a bailout would not occur. But by May, 2010, a bailout fund for the euro area, the European Financial Stability Facility (EFSF), had been put in place. Despite Greece’s unsustainable debt, private creditors continued to be repaid over two years, with these debts replaced by loans from European countries and the IMF. By the time Greece’s debt to the private sector was restructured, in 2012, its economy was in ruins and the remaining, un-restructured debts to the ‘official sector’ were clearly unsustainable. The return of gunboat diplomacy had been set in motion.

So why were Europe’s politicians so keen to provide massive loans to Greece in 2010? One answer is that European governments were using the loans to Greece to protect German and French banks, which had built up large exposures to Greek sovereign debt. Still, the figures don’t add up. The exposure of European banks to Greek sovereigns was fairly modest. If the direct impact of a Greek default wouldn’t be great, there were many people in 2010 scaremongering about the indirect effects of such a default. They said Greek default would be “another Lehmans”.

The ECB played a crucial role in presenting a Greek default as a potential disaster for the euro area. From 2010 to 2012, members of the ECB Executive Board, such as Lorenzo Bini Smaghi, regularly gave speeches depicting a potential Greek default as a catalyst for “an economic meltdown.” This stance was maintained right up to the decision to restructure Greece’s debts.

Greece did default and it was declared a credit event. The world simply didn’t care. There was no financial meltdown. The ECB’s analysis was wrong and its influence on the events in Greece had been utterly negative from 2010 to 2012. Time will tell whether 2015’s ECB does any better. My favourite theory as to why European governments bailed out Greece is political hubris. European politicians were so sure the euro was a fantastic political success that a nasty event like a default was unthinkable for a member state.

The strategy for responding to the Greek crisis of 2010 was largely formulated by the Eurogroup of finance ministers. Sadly, under the inept leadership of Jean-Claude Juncker (rewarded, for his many failures, with the European Commission presidency), this response was framed by populism and wishful thinking.

While the vast majority of the money loaned to Greece came from European governments, the involvement of the IMF — initially under the leadership of French former politician, Dominique Strauss-Kahn, and later under the leadership of French former politician, Christine Lagarde — gave an air of credibility to the Greek programmes.

This air of credibility was not warranted. In recent days, Ms Lagarde has spoken of the need to have “the adults in the room” for negotiations (an unveiled dig at Varoufakis). She seems to have forgotten that the IMF were supposed to be the adults in the room, for discussions on Greece from 2010 onwards. While it is too much to expect these governments to put in place a sensible programme of the type proposed by former IMF official, Ashoka Mody, European citizens should expect their politicians to acknowledge their past mistakes and to accept that flawed lending decisions imply financial costs.

As for the euro, I fear that Europe’s leaders have fallen back into smugness and complacency. The constant chant that the euro will be fine after Greece leaves it is based on speculation. Nobody knows how a euro exit would affect other member states. But it will mean that the euro is not a ‘fixed and irrevocable’ currency union. And it will mean that there are unwritten rules that link membership of the euro with willingness to pay back official loans.

Pushing the Greek government further than their current position will generate infinitesimally small financial gains for European citizens, while risking a Greek exit threatens unquantifiable, large potential costs .

Karl Whelan is professor of economics at UCD. He previously worked at the Central Bank. A longer version is available at: karlwhelan.com/blog