With a Greek tragedy looming, the EU can’t continue the way it is

EVER since we were lumped together as PIGs, we in Ireland have been forced to pay more than a passing touristic interest in Greece and Portugal.

Dreams of island churches bleached by the sun and fado nights have given way to sombre discussion of the restructuring of the debt as we take the auspices for some small glimpse of our own possible future.

Much has happened since Greece accepted this time last year a €110 billion EU and IMF bailout. The euro area had mobilised resources on a scale that seemed unthinkable until recently to get Greece over a liquidity bump before it returned to fiscal sustainability. It would soon be able to convince the markets with credible austerity measures and thus continue to access finance at affordable rates.

Well, that was the idea. Since then, the budgetary situation of Greece has deteriorated further, the economy has entered a deep recession, and the Greeks have spectacularly failed to achieve their goals for reducing debt. As far as the European Commission was concerned, things were supposed to be simple. Through a combination of incompetence and deceit, the Greeks had let their deficit to spiral out of control. They now had to put their own house in order with the help of some tough love from the rest of Europe.

In other words, Greece was supposed to be a special case. After all, Greek financial crises are hardly new. It is that little bit of economic Latin America tagged to the bottom of Europe. Since the modern Greek state was founded in 1830, the country has, on average, experienced sovereign default every two years and had been through five major defaults in less than 200 years.

It is now clear that Greece’s 2010 bailout failed to improve the sustainability of its public finances. The risk of another default or — the nightmare scenario — of Greece deciding, or being asked by the Germans, to leave the single currency has spooked investors. The country today, like Ireland, faces record borrowing costs as investors demand a high price for holding risky Greek debt. The markets simply do not believe Greece will grow fast enough to service its debts and the gap between Greek and German bond prices has widened sharply.

But by increasing their debt further, the bailouts have made investors even more sceptical. The outlook for Portugal is similar, notwithstanding the allegedly less Draconian terms of its bailout agreement.

A crisis that began with the previous conservative government in Athens cooking the books, and the reluctance of the Greeks to swallow the nasty medicine prescribed for them, has only highlighted the fundamental weakness of the single currency.

The absence of a centralised budget mechanism, like that in the United States, to move resources from the wealthier regions of the union to the poorer parts begs the basic question: can a common currency be maintained in an economically diverse community? Given the social and economic imbalances across the EU, a second question must be asked: should middle-income countries such as Greece and Portugal have been allowed to join the euro in the first place, competing with rich, industrialised countries under the same market conditions? The elites do not want to face up to this. Greece and Portugal were dictatorships until the mid-1970s. Like Ireland, they understandably joined the European Union and the single currency as a way of proving they had matured politically and were now part of the mainstream. So every excuse is trotted out for the current woes. But questioning the single currency model itself is still verboten.

Greece likes to claim that budget trickery was responsible for their disaster. In Ireland, of course, we blame the banks. In Portugal, however, no such excuses are available. Everyone — citizens, governments, banks — is in massive debt. Over the past decade, growth has been virtually nil. The euro reduced interest rates, leading to an explosion of credit, which now makes their bailout necessary.

Their austerity package will in all likelihood, push Portugal back into recession this year and next, threatening a vicious circle of decline where more austerity is always necessary just to keep up with a contraction of the economy. They have neither the physical infrastructure nor the human resources to make themselves more competitive, but it is in these areas — roads, universities and training – where the axe will fall hardest. What they are being asked to do is to repay the vast debts not just of their public sector but also of their banks while enduring sizeable declines in real wages, and radical reform of their institutions and political culture.

Is it any wonder that the Portuguese are beginning to yearn for the return of the escudo so they can adjust through devaluation? Unlike Ireland, Greece and Portugal will find it very difficult to generate the necessary impetus for exports to offset the impact of continued austerity. Exports account for only relatively small proportions of their GDP — unlike in Ireland’s case — and trade little with countries outside the slow-growing EU. Officially, restructuring the debt of any eurozone country is not even on the agenda. The talk is instead of adjustment in the terms of the Greek bailout — for if Greece restructures or exits the euro, can Portugal be far behind? But never say never. We’ve heard this story before.

RESTRUCTURING Greece’s debts is supposedly a non-starter for European officials — but so too was a bailout a little over a year ago. Initially, the EU will no doubt try and get away with “soft” restructuring, involving a combination of longer maturities and lower interest rates. Some form of full-scale debt restructuring — the polite term for default — now looks all but inevitable, however, whatever the denials.

Whether it works is another matter. A full-scale Greek default with debt write-downs of 50% or more will be akin to something like an economic apocalypse. But even this will not guarantee continued membership of the euro for the weakest countries. If Greece restructures, investors will assume that Portugal is next and then Spain will come under scrutiny again as the contagion spreads.

The euro area will have to inject capital into defaulters’ banks, which have huge holdings of their respective governments’ debts. The impact will be felt far beyond the EU itself. Even this will be just a sticking plaster. What Greece and Portugal need is economic growth but that will require real and profound changes in the structure of their economies. Until then, they will struggle to tap capital markets at anything but prohibitively high rates.

With luck, Ireland might just be able to unhitch itself from the others and manage to convince the markets that it is still solvent despite running a huge deficit. The price will be austerity for years to come although this might be sustainable given that we are now running a current-account surplus, unlike the others, and are not relying on foreign borrowing to finance the deficit.

But for the EU to continue as it is now is not possible, even if it were desirable. Will countries have to leave the euro area (and perhaps even the union unless the current rules are bent), or will a US-type transfer union emerge instead? The way politics is currently, the latter looks like an outside bet.