Divided Europe, divided Eurozone
Early in the week, eurozone finance ministers reached a deal to deter Greek default. After marathon talks, they were upbeat. "This is not just about money," said eurogroup chairman Jean-Claude Juncker.
"This is the promise of a better future for the Greek people and for the euro area as a whole, a break from the era of missed targets and loose implementation towards a new paradigm of steadfast reform momentum, declining debt ratios and a return to growth."
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And yet, the reality is that the Greek deal was exactly about money. It promises a better future neither for the Greeks nor for the eurozone. Rather than representing a break from the past, it reflects incremental continuity with Brussels’ efforts to contain the debt crisis since 2009-2010. It may also defer the return to growth.
Like the lingering effort to resolve the EU budget debate, the Greek deal does not represent success in resolving divisions in the eurozone, but a prelude to new divisions in Europe.
Debates as harbingers of new divisions
In the EU budget debate, the net payers – in particular PMs David Cameron (UK), Mark Rutte (Netherlands) and Fredrik Reinfeldt (Sweden) – have demanded substantial cuts, hoping to limit the budget to 1% of the EU economic output; or €960 billion. That would require slashing €200 billion from the proposed budget.
In contrast, net receivers – the EU countries that get back more than they pay in – oppose the cuts. In turn, Poland’s PM Donald Tusk has warned London that the current EU budget will remain in force, with a 2 percent increase each year for inflation, if a compromise is not reached.
Meanwhile, German Chancellor Angela Merkel has sought a middle-ground. While she does want some cuts, what Berlin really wants is to get the budget talks out of the way so that structural reforms can be initiated in Europe.
The second debate involves Greek debt. Only a year ago, both Brussels and the IMF said that the then-debt relief plan – which both now would like to revise – was adequate to overcome the Greek challenges. In reality, the expectations were as unrealistic a year ago as they are today.
Moreover, Berlin must toughen its position before the German elections in fall 2013, while the IMF chief Christine Lagarde must deter the perception that the multilateral organization, which has been led by Europeans since World War II, is subject to European pressure.
Both the Eurozone and the IMF want Greece to reduce its debt load from a current level of 170% of GDP to a ratio of 120% by 2020. The IMF, however, insists that Germany and other creditors should again forgive a portion of Greece’s debt - which is not acceptable in Berlin.
Despite Juncker's buoyant words, the Greek deal, which promises to bring down the Greek debt to 124% of its economic output in 2020 and substantially below 110% in 2022, is light on detail. According to the final numbers, Greek debt will decrease to 126.6% of GDP in 2020 and 115% in 2022. In order to compensate for the gap, the IMF will need to believe in miracles, or look the other way.
Both the EU budget debate and the Greek debt deal reflect Europe’s deepening divisions. In the first case, the divide is between the net payers in the West and the net receivers in East Europe. In the second case, it is between Northern Europe, which suffers from bailout fatigue, and Southern Europe, which is struggling with austerity fatigue.
These divisions – divided Europe and divided eurozone – aren’t going away. Like cracks in the window, they are deepening by the accelerating headwinds.
Europe’s spluttering economic engines
Along with diminished economic prospects, the polarising divides reflect increasing political frustration. In the past, Germany’s export engine was still thriving and France avoided stagnation. Now Germany is heading toward stagnation, while France has been flirting with recession.
In the past, Berlin and Paris played together. Now that the economic engines in these core nations are slowing down, friction is increasing. As populistic observers like to put it, ‘Merkozy’ is being surpassed by ‘Merde.’
In Germany, the slowdown of economic activity in the second half of 2012 is likely to morph into recessionary conditions in early 2013.
As its export-led growth is eroding, Germany is hoping to rely on private consumption, but the latter cannot compensate for the slowdown in export growth.
Whether Berlin will be led by the conservative CDU or the social-democratic SDP after the 2013 elections, German voters will oppose ever more vehemently fiscal transfers, debt mutualisation and expansive bailouts.
President Francois Hollande and the socialists have opted for highly redistributionist taxation policies, which will discourage French business, and he is trying to foster budget discipline, which will discourage consumption. Neither the Élysée Palace’s subsequent policy readjustment nor its proposed competitiveness plan will be enough to overcome the impending stagnation.
As the French conservative party has been split into two, the 2013 election pressures are complicating Berlin’s efforts to contain the Eurozone debt crisis.
In turn, the Greek deal is haunted by more fundamental concerns. Even in the positive scenario, the best the Greeks can expect after 5 years of contraction is that – after another 10 years – their debt ratio will be effectively identical with that of Italy right before Rome was swept by market turmoil, the Berlusconi government was ousted and a technocratic regime took its place a year ago.
The question remains: How long will the Greeks comply and will they, at some point, simply consider the medicine worse than the disease?
Toward the next act
In the past few months, tensions have diminished in the eurozone, but primarily due to the liquidity injections of the European Central Bank. In the short term, the ECB’s Outright Monetary Transactions (OMT) can support market recovery. But ultimately, a series of liquidity injections is a quick fix for the desperate; not a long-term boost for the disciplined.
Even in a benign scenario, the eurozone’s slow progress means that the large regional banks may offload $2.8 trillion in assets over the next two years to reduce their risk exposure. That would be a dramatic increase of $200 billion from a prediction only half a year ago, according to the IMF. And it could shrink credit supply in the periphery by 9% by the end of 2013.
Will the Greek debt deal contain the Greek crisis? No. Greek default was averted, but Greek challenges remain. After a few months, new talks are likely to follow.
Dr Dan Steinbock is research director of international business at the India, China and America Institute (USA) and a visiting fellow at the Shanghai Institutes for International Studies (China)