GREECE’S SILVER LINING

GREEK prime minster George Papandreou’s decision to hold a referendum on the bailout deal agreed as part of last week's EU summit outcome was courageous.

He had taken the economic emaciation of his country as far as possible: the threat of political instability, and of it spreading across Europe, is a very real one.

The legitimacy conferred by a referendum is long overdue. The first Greek bailout last year reflected years of fiscal imbalances that certainly preceded their acceptance. The terms and conditions of the bailout were draconian and, quite wrongly, were compressed into far too short a time period. It was never going to be possible to correct the sins of generations in half a decade. The result was predictable. The Greek economy collapsed. The burden of debt proved impossible to service. Greece found itself in an even worse position.

The problem was that, by this stage, the “Greek disease” or, more specifically, the economically destructive response by the troika to deeply embedded structural imbalances in the Greek economy, caused a crisis of credibility on the part of the markets in other vulnerable countries.

The balance sheets of the banks of even large countries have become waterlogged a second time around. The European Central Bank found itself doing precisely what its constitution prohibited it from doing — bailing out eurozone countries. This problem was supposed to have been solved in May 2010, again last July and a third time last week. It never gained much traction in the markets and now the proposed Greek referendum has dealt the interconnected package an almost certainly fatal blow.

The markets wanted closure on Greece and the banks were encouraged to take a 50% haircut. That is now in question.

Secondly, the size of the European Financial Stability Facility (EFSF) cannot be calibrated with any certainty because Italy remains vulnerable.

The third element of last week’s summit, further capital-raising by banks, is now even more difficult.

The bottom line is that, however much banks raise from the markets or from governments, it will not go into the real economy. That is where the problem lies: when the economy goes into recession, governments raise less revenue and spend less; they make cuts that hobble businesses and bleed economies with spare capacity — and leave many unemployed. In the eurozone, they are doing this in an artificial timeframe and in the teeth of data which demonstrates that it is not working.

This leaves the fourth element of last week’s agreement — accelerated EU integration. What does it take to convince these leaders that the eurozone countries are not ready nor, as the Greek referendum will almost certainly show, is there a public mandate for all that such an integration would require?

Papendreu is wise to call a referendum at this time. The terms and conditions imposed by the troika have wiped out the capacity for growth. At the same time, he has secured the best deal he can from those who bear some responsibility for the manner which the crisis has been mishandled from the outset. That is why, having pushed the people of Greece to the brink of political instability, he is right now turn to them to legitimise — or reject — the bailout.

The same argument applies here. The general election has not given the people the opportunity to express their view on whether, or not, the bailout makes sense. The troika team were in Dublin last week. They are nice people doing a difficult job. But they are selling an economic policy that is not working — not in the eurozone and not in Ireland. It is not enough to be patted on the head for ticking the boxes when the economy in which we live and work is being deconstructed.

Let us be very clear on what is happening in Greece, in Ireland and across the eurozone:

*We have had two stress tests on Europe’s banking system; they have failed to deliver the credibility that the markets demand. Between €100 billion to €150bn more capital must still be found;

*Banking stabilisation policy is all over the place. Basle II, overseen by the Bank for International Settlements and by the EU, was supposed to be the definitive bench mark for capital adequacy. It has been blown away;

*Most important of all, forecasts for economic growth — on which the whole bailout programmes were based — have been continually revised downwards. Most recently, both the International Monetary Fund and the International Labour Organisation, are projecting little or no growth in 2012. If economies do not grow, they cannot service their existing debt burden, much less additional borrowings.

The trend in the data, and the dynamic now gaining unstoppable momentum, suggest that we are entering an economic Ice Age.

Governments cannot continue to print money. The armoury is all but empty. The results of eurozone policy since 2008 have been more sovereign downgrades, a breakdown in labour markets and an extension of contagion to Italy and France.

Recent statements from US president Barack Obama indicate that the US is seriously spooked by the effects on the western financial system of the unravelling of the eurozone. It should be — this has all the feel of the breakdown of the Breton Woods system in the early 1970s that brought in a decade of floating exchange rates and instability.

There is now a real crisis of confidence. Eurozone leaders have had to outsource their internal problems to the G20, while the funding of the EFSF is critically dependent upon China. The irony is that this bailout fund is dependent on that very leverage that helped much of the western banking system to the very edge of the cliff.

The prospect of the Greek referendum has ratcheted up the chronic instability in the markets. The debate in Greece is likely to focus on the fact that eurozone policy has not delivered: it has been characterised by denial, procrastination and a failure to generate growth as the single most important priority for business and for stabilising a highly unstable currency union.

The entire burden of adjustment has fallen on the labour market — on adults and young people with a capacity to work but who are trapped inside a now rogue adjustment strategy that will now be judged by the Greek people.

Something had to give. Something just did, in Greece. When the referendum is lost, the words of German finance minister Wolfgang Schhaeuble last year will be recalled as common sense: “Should a eurozone member ultimately find itself unable to consolidate its budgets or restore its competitiveness, this country should as a last resort exit the monetary union while being able to remain a member of the EU”.

Perhaps then the Irish people will be extended the same privilege of a referendum — and the process of rebuilding the economy, as I have previously argued, outside the eurozone but within the EU, can finally begin.

*Professor Ray Kinsella is on the faculty of the UCD Smurfit School of Business.