May 19, 2010
The stock and bond markets in the past weeks have made one thing perfectly clear: They’re no longer in awe of the European Union’s bailout plan for Greece. When “le TARP” was unveiled last Monday, markets hailed it like a second Marshall Plan. Within a day, investors had an epiphany (from the ancient Greek work for seeing a ghost). Now, a week into the new program, the plan seems to have fewer friends than an empty bottle of ouzo.
The rest of us are left only with questions. Here are some answers:
Q: What went wrong?
After all, the EU plan shared many of the theatrical ingredients of the Troubled Asset Relief Program. It was assembled by sleep-deprived officials over a weekend and unveiled before markets opened on Monday. It puts taxpayers on the line to protect banks from the consequences of bad lending. It commits a very impressive sum (in this case, 750 billion euros, or about $920 billion, compared with $700 billion for TARP) to fixing the problem. TARP was a big success, according to Ben Bernanke and Tim Geithner. Why shouldn’t the Euro version be as successful?
A: For starters, there’s a growing sense that the plan probably won’t keep Greece from defaulting.
Q: It won’t? Wasn’t that the point?
A: It was the point ostensibly, but it was always a long shot. As a condition for receiving the bailout, Greeks will have to get their deficit down to 3 percent of GDP by 2014, from the current level of nearly 13 percent. That couldn’t happen without cuts in social spending that are so brutal and tax hikes so draconian that few democracies would be willing to put up with them. If you wonder whether the modern Greek electorate has an appetite for a Spartan regimen, you might want to review those videos of rioters in Athens.
Q: But hasn’t this kind of intervention saved debtor nations in the past?
A: There are success stories, like Mexico in 1994-1995 and South Korea in 1997 and 1998. The difference, explains economic historian Carmen Reinhart, is that these countries started with much lower levels of debt than Greece has now. They were also able to devalue their currencies — the classic last-ditch act of a desperate sovereign debtor — which tends to stimulate the domestic economy and thereby raise revenues. And, of course, the borrower gets to repay the lender with cheaper currency.
But Greece can’t devalue because its currency is the euro. That leaves it only the grim options of cutting spending or raising taxes. Not only are those politically difficult; they’re also self-defeating, since they tend to shrink the economy and make it harder to lower the deficit as a percentage of GDP. Perversely, the more the Greeks sacrifice, the more their goal recedes. “Before things can get better in Greece, they’d have to get a lot worse,” says Reinhart, “and financial markets are not patient. A rising debt profile does not instill confidence.”
Q: Why launch “le TARP,” then, if its chances of success were so slim?
A: Because even if Greece can’t tow the line, the plan buys time for other European debtor nations like Portugal, Spain, Italy and Ireland and prevents the contagion from spreading. German Chancellor Angela Merkel admitted as much over the weekend: “We didn't do more than buy time to get the differences in competitiveness and budget deficits of eurozone countries in order," she said in a speech to trade unions. In other words, the rescue package isn’t really as much about saving Greece as it is about saving the euro. If investors lose confidence in the continental currency, the whole concept of European union is suddenly in question.
Q: Who really cares?
A: Every country in the European Union has benefited from trading freely in an economic zone larger than the U.S. economy. The weaker economies of southern Europe were able to borrow abroad at low interest rates, as if they were as fiscally sound as, say, Germany. (That’s one reason Greeks were tempted to borrow and spend so much.) Meanwhile, the stronger economies of northern Europe reaped the benefits of growing export markets. “The Germans, who export one-third of their output, and roughly one-third of whose labor force depends on exports, would be badly hurt were the eurozone to implode,” says Jean-Pierre Lehmann, professor of international political economy at Switzerland’s Evian Group. “So the bailout plan is as much about saving Germany as it is about saving Greece.”
Plus, let’s face it, there would be a highly unpleasant financial and psychological chain reaction if indebted countries started to flee the euro so that they could devalue their currency. The euro would plunge even further — as would the value of securities denominated in euros — affecting banks’ willingness to lend and on the global recovery.
Q: What does the European TARP tell Americans about solving our own fiscal problems?
A: The Web and editorial pages in old media are full of predictions that the U.S., with its trillion-dollar deficit, is the next Greece. (Or maybe it’s California or New York, with their overgenerous and underfunded public pension systems.) But in fact, America has a couple huge advantages over Greece. For one thing, the U.S. economy is growing. If that keeps up, debt as a percentage of GDP will fall as time goes by. More fundamentally, the U.S. gets to print its own currency. We will always be able to pay back our debts, even if the Fed has to conjure the dollars to do it.
That doesn’t mean the U.S. is in great shape. As in the case of the Greek bailout, our TARP has bought us time to get our economy going again and get control of our fiscal policy — if we have the political will to do it. Growth alone won’t cut it. We still have to defuse our looming old-age entitlement bomb, and figure out how to close our annual funding gap with some combination of spending cuts and new revenues. States need to bring their public pension promises in line with economic reality.
Throwing borrowed money at a debt problem can fix a liquidity squeeze, but only at the cost of making the long-term solvency problem worse. We’re not Europe yet, but there are no guarantees.
Reporter: Temma Ehrenfeld
Eric Schurenberg is Editor-in-Chief of BNET, the CBS Business Network.