Daniel Korski

Goodbye Euro?

Goodbye Euro?
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I have just visited the two countries that are making the headlines in the European newspapers – Germany and Greece. During my trip, I met officials, journalists, and key advisers to both Prime Minister Papandréou and Chancellor Merkel. Sitting on the flight back to London I have regrettably come to the conclusion that the Euro is probably done for – or that Greece will default inside the Eurozone. Until now, I have dismissed the pessimists, thinking that the Euro would be saved. But after my trip I have changed my view for a number of reasons.

Nothing I saw in Greece has convinced me that the Greek government is able, ready and willing to oversee the kind of austerity programme required to restore faith in its economy. This is a society where the government cannot tell how much money they will be able to gain by raising VAT. People are willing to make some sacrifices – and many have already had to - but nothing like what is required of them. The fact that the PM is still not 100 percent seized by the issue, but continues to believe his government can have other priorities in the next five years than to rescue the country from collapse, only reaffirms my lack of faith in his government’s seriousness.

The second reason why I now think collapse is inevitable is the German reaction. Chancellor Merkel’s government does not seem to realise that the markets do not believe it will back up the Greeks, and that plodding along as they have been, talking about legal niceties, waiting to act after a regional election and wanting to engage with the issue only at the very last minute, will make eventual action irrelevant. That the IMF has to talk of ever-greater sums of money to Greece, as the days go by, is a case in point.

The German government is also assuming that the different conditions in Spain, Portugal and Greece will mean that any contagion from the Greek crisis can be contained. There is only one problem with this argument: the markets aren’t always rational. Portugal’s credit rating has just been slashed as Greece’s was reduced to junk status. The pressure on Spain and Portugal is showing that even though the causes of the countries’ problems are different from those of Greece and their ability to self-finance is much greater, the collapse in one part of the Mediterranean of will lead to collapse elsewhere.

Given my first point – that Greece is not yet ready or able to put in place a serious deficit-cutting plan – it is perfectly understandable that the German government is acting the way it is. The alternative would probably lead to Greece being bailed out not only once, but twice and the bill being even more than the £130 billion that Goldman Sachs has predicted the crisis will cost. It would also be illegal according to German law. But the alternative is clear – a collapse of the Euro or a Greek default or both.

If Greece defaults, Greek banks would no longer have access to the regular monetary policy operations of the European Central Bank and the country would become like Montenegro, i.e. it would continue using the Euro but without officially being a member of the single currency zone. (Presumably the Greek Central Bank head would still sit on the Governing Council of the ECB but most if not all Greek banks would have become insolvent by then). This will have a major effect in Germany, given how much of the Greek debt is held by German banks. In itself, though, it would not kill of the Euro. It could even be good for it. But contagion, which I suspect would happen, will be the death knell of the common currency.

The lessons of this doomsday scenario for the UK should not be overplayed. But nor should they be underestimated. To me, the conclusions are straightforward. Looking at deficit-reduction in the way the Conservative Party has proposed is the only way serious option. And, second, the Liberal Democrats’ talk of the UK joining the Euro at some point is not only economically illiterate but may be downright dangerous for Britain’s economy