22 August 2012

Paul N Goldschmidt: Once again Greece is begging for additional time…. But is the European Union short on ammunition?

The Greek Prime Minister is meeting with Chancellor Merkel and President Hollande in the hope of being offered additional time for his country to implement the promised reforms agreed in exchange for financial support.

Within the context of  the EU entering into recession and the specific situation of Greece, which is now experiencing a depression, this request appears justified as there is a limit to the sacrifices that can be imposed on Greeks who have already suffered dearly. This request should be considered within the more flexible framework of community regulations (exceptional circumstances) which are applicable to all EMU Member States. Indeed, being deprived of the “devaluation” tool as a member of the eurozone, attempting to restore financial equilibrium through the exclusive use of budgetary measures has already exceeded its limits and further reinforcement would only aggravate the situation.

The gesture required from its European partners must be accompanied by a detailed timetable for implementing the agreed reforms and be subject to rigorous monitoring. This is the task of the Troika (IMF, European Commission and ECB). Agreeing to the request is also in the interests of the partners: a refusal would inevitably lead to an exit by Greece of EMU with unforeseeable consequences, unless it was accompanied by an alternative expensive and unavoidable assistance programme in order to limit the risk of contagion. 

The question of the EU’s financial capacity to deal with the sovereign debt crisis affecting several Member States extends far beyond the scope of Greek situation. Right from the start of the crisis, and whatever errors or hesitations may have aggravated its development, the Greek case, considered in isolation, was never a problem that exceeded the capacity of Member States and/or of the stabilisation mechanisms put in place to deal with it. That remains true to this day.

On the other hand, the extension of the crisis to Ireland, Portugal, Cyprus and latterly to Spain and Italy raises the possibility of having to mobilise resources that are far in excess to those currently on hand, all the more that a large part of their availability remains ‘virtual”, at least as long as the ESM is not operational.

The situation is further complicated insofar as the “sovereign debt” crisis, in each instance limited to a particular State, is accompanied by a potential “solvency” crisis of parts of the banking sector which affects institutions throughout the EU (and beyond), in particular those who have credit exposures to the weaker States and/or their banks and enterprises.

It is, indeed, through the channel of interbank connections that the danger of “contagion” is most likely to emerge and it is on this particular aspect that markets are looking for a credible solution which will require, unavoidably, resources that far exceed those currently on hand.

If the situation has so far been successfully contained, it is first and foremost due to the bold and determined intervention of the ECB. The three-year refinancing operation (LTRO), the broadening of eligibility criteria of acceptable collateral and interventions in the secondary market (SMP) have contributed markedly to keeping the banking market afloat (as well as, indirectly, the sovereign debt market). The ECB has thus, on several occasions, provided a breathing space to the Authorities who were supposed to use it to decide and implement the necessary structural reforms (ESM, Banking Union, national austerity programs, etc.)

The declaration of President Draghi, early August, has, once again, “bought” a little time, but he emphasised clearly the limits as well as the conditionality of any further intervention by the Central Bank. This imposes on political authorities to take up their responsibilities very rapidly, as one is fast approaching the limits of what the ECB is able to accomplish unilaterally.

What markets are vying for are credible and irreversible political commitments accompanied by a realistic roadmap for their implementation. Within such a framework, the resources of the EU would appear sufficient to deal over time with the crisis. That requires, however, as quid pro quo for EU/EMU solidarity, the establishment of monitoring and enforcement mechanisms accompanied by the significant transfers of sovereignty implied.

In conclusion, one should distinguish the Greek case from the general question of managing the financial crisis. However, if nothing is decided rapidly, the Greek situation could well become – without being either its only or even main cause – the trigger by which the implosion of EMU could occur. Thus would come to a tragic end, the short history of a currency that had already reached the enviable status of the world’s second reserve asset.

Paul N Goldschmidt, Director, European Commission (ret.); Member of the Advisory Board of the Thomas More Institute

Tel: +32 (02) 6475310 / +33 (04) 94732015

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E-mail: paul.goldschmidt@skynet.be / Web: www.paulngoldschmidt.eu

© Paul Goldschmidt