February 14, 2010
In a nutshell, the Greek bailout means that, in good times, countries like Greece, Ireland and Spain borrow German money to buy German-made BMWs, which is obviously excellent news for Germany. However, in times of crisis, we send Germany the bill, which is the payback (a) for us absorbing all the savings the Germans don’t want to spend and (b) for buying their cars and washing machines with their money recycled by our banks.
Until last Friday, Germany seemed to think that the first part of the deal held without the second, but the Greeks have played a canny game and called the Germans’ bluff.
The Greeks realised that, from a financial perspective, Germany regards the rest of Euroland much in the same way as the Pentagon regarded south-east Asia in the 1960s.The ‘domino theory’ guides senior German and European civil servants when it comes to financial crises on the fringes of Europe. During the Cold War, the Pentagon threw all the military resources necessary at Vietnam, not for any great love of the South Vietnamese, but to draw a line in the sand and prevent communism from spreading.
Similarly, Germany will throw its financial resources at an errant country or banking system at the edge of Europe so that the contagion doesn’t spread. This is why Nama could well be called ‘Vietnama’ because, in the eyes of the German government and central bankers, Irish banks last year – and the Greek government now – can’t be allowed go under because it would trigger a defaulting domino effect.
However, the snag is that, despite huge American involvement in Vietnam with the most sophisticated weaponry, the Americans fled because they couldn’t control the facts on the ground against a more determined enemy. It is too early to draw the same conclusion about the European Central Bank’s Vietnam:
The Greeks twigged the German weakness and gambled that the Germans would blink first -which they did. So there is now a precedent and everything in the Maastricht Treaty can be torn up. All the rules, regulations and aspirations regarding government spending are out. There is now what the financial markets should call the ‘Merkel put’.
In the halcyon days of Alan Greenspan, there was a phenomenon called the ‘Greenspan put option’. A put option is an agreement to sell at a certain price. If people believe that the markets will fall, they buy a put option today that allows them to sell at today’s price in, let’s say, three months’ time, when the actual price might be much lower. So, if you want to make money in a falling market, you buy put options and wait.
On the other side of this trade, there has to be someone who is willing to take a bet that either markets will go the other way or there has to be someone who is willing – for some reason – to make sure that the markets don’t fall too much and therefore will put a floor under the market.
The Greenspan put option was used to describe the situation that, whenever financial markets fell, Greenspan would cut interest rates, which would put a floor under how low prices could go. The same can now be said of Germany. If Germany bails out Greece, it puts a floor on how low Greek bond prices can fall. It therefore gives the Greek government the incentive to gamble that it doesn’t matter how much it borrows because Germany will always bail it out.
Over the past few years this column has been making the point intermittently that the euro is the wrong currency for Ireland.
In many official quarters this assertion is met with derision. Might this be because the ‘‘official mind’’ can’t deal with uncertainty? Or is it that the ‘‘official mind’’ is not able to do what we all should do at times, which is to ‘‘think the unthinkable’’. So the next issue is whether the Greek bailout is good news for Ireland?
I know it sounds parochial, but let’s deal with our own backyard first. Does the bailout of Greece, whatever form it takes, mean that the bigger, older countries in the EU now realise that there is a fault-line at the heart of the euro project?
As long as Germany chooses to run huge current account surpluses, this money will be borrowed either in the eurozone or outside it. If it is spent within the eurozone in countries that want to grow but haven’t the domestic savings to do so, there will always be regional booms and busts, as there are now in Ireland, Spain and – ironically, despite its bad press – to a lesser extent Greece.
On the other hand, if the German savings are borrowed outside the eurozone – in the US or Britain, for example – there will be a tendency for the euro to rise against these major currencies. Given that Ireland does far more trade with Britain and the US than it does with Germany and France – and Irish shoppers shop in Newry, not Nuremberg – this creates a tendency for Ireland to boom unsustainably and then fall back suddenly.
This means that the Irish boom/bust cycle is excessively amplified by our membership of the euro. Booms are longer and more effervescent and busts too are longer and more painful.
In away, Ireland is like a jockey riding two horses: a German one and an Anglo American one. When both horses are running together – the current account of Germany isn’t too excessive and the deficit of the Anglo-American world isn’t too delinquent – the jockey’s position isn’t too difficult. However, when the two horses move in opposite direction, the jockey’s groin area becomes uncomfortable. At this stage, this particular jockey is screaming.
Initially, the official architects of the EMU believed that Ireland, Spain, Portugal and Greece just had to put up with it and be good Europeans. This was before it dawned on the bureaucrats that a crisis would lead to the eurozone being undermined more than the individual country in trouble.
The reason they didn’t twig this from the outset is that most of the senior civil servants who designed the euro probably have never taken a risk in their lives, so they don’t understand the mind of the traders who are assessing whether the euro makes sense or not and betting accordingly.
The response to this crisis means that we are moving into a new era, which might be good for us. The worst of all worlds for Ireland is the current half-baked situation of a monetary union without a political union.
This is why this column has argued that, until there is full political union in Europe, Ireland should adopt the Danish and Swedish approach of having its own currency, something that could be done without too much disruption.
However, if this crisis and the German bailout were to accelerate political union, it’s a different ball game because we would have a system like the US’s, whereby the central government compensates states that are in recession by increased government expenditure. At the moment in Europe, we have things back to front because, in a downturn, the governments are being asked to cut spending rather than increase spending. This was one of the elementary mistakes of the Great Depression.
If the Greek crisis has finally changed the view in Brussels about the joint responsibility that is necessary to make the euro work, it will have been a crisis worth having, for Ireland in particular.