State of play in the Eurozone

20 Jun

Over the weekend, a resolution was found to a disagreement that had pitted France and the European Central Bank against Germany. In deciding how to continue with Greece’s ongoing borrowing needs, Germany’s leader, Angela Merkel, has increasingly been pushing to involve private investors in the new round of loans, perhaps even forcing them to renew their lending on less favourable terms. This, according to the European Central Bank, is tantamount to a default and would lead to meltdown in the markets. France’s President Sarkozy, who is firmly pushing for the ECB position of only asking for purely voluntary rollovers of debt, met with Merkel last week and together they agreed for the softer option. Soft, at least, in terms of the demands made on private investors; far from soft for Greece. The way newspapers reported this disagreement was in terms of a German-backed debt exchange plan versus the so-called Vienna initiative, a purely voluntary plan backed by France and the ECB. The Vienna initiative, judging by the reports in the weekend press, has won out.

It is worth asking why the ECB is so firmly against any attempt to forcibly include private investors in the cost of offering Greece more time to get its debt back under control. Cynics would say it’s because French banks are most heavily exposed in Greece, to the tune of just over 40 billion US $ (see chart below) and Jean-Claude Trichet, current head of the ECB, is a Frenchman. Yet Germany is also highly exposed (over 10 billion US $) yet is making the opposite case.

The explanation seems to be based on a fear that if private investors are forced to accept what would by all accounts be a partial default by Greece then this will open up the possibility of similar partial defaults by other crisis-ridden Eurozone countries such as Portugal and Ireland. As recipients of Eurozone bail-outs, the argument for refusing to renegotiate the debts of these countries will become much weaker. And loans to these economies will dry up as everyone imagines that further down the line they may not get all their money back. As repayments in the Eurozone unravel, then so will the credibility of the currency. Hence the ECB’s firm line against any forced debt swaps.

What is at stake here? Why does any of this really matter? More immediate issues are certainly pressing. EU finance ministers have now decided to make the payment of the next piece of Greece’s bail-out conditional upon the acceptance by the Greek parliament of the most recent Papandreou plan. These ministers, it would seem, have woken up to the fact that perhaps, regardless of their own actions, Greeks will simply not accept the plan being proposed. The current plan, for instance, requires that the Greek privatization process be run by an outside agency, not by the Greek government. Some EU officials were demanding that outside tax-collectors be brought in and the Dutch wanted future Athens assets to be securitized so that they could be used as collateral (reported in the June 18/19 edition of the Financial Times; subscription required for access). This means that if Greece defaulted, lenders would gain something tangible, like an airport or a national utility. The plan currently in the balance in the Greek parliament contains only the internationally-run privatization plan but there is a chance parliamentarians will refuse to ratify it. So Eurozone finance ministers have opted to tighten the screw.

Behind the immediacy of the current Greek plan, there is an important point about the incorporation of private investors in any second Greece bail-out plan. Whilst France and Germany disagreed over whether it should be imposed forcibly or voluntarily, the principle seems to have been accepted that some sort of private investor involvement is required. This is a marked shift from previous positions but it is hardly ground-breaking stuff. The parameters of the whole Eurozone crisis debate seem remarkably narrow. That private investors should be involved somehow seems obvious: they were the ones making money from the loans to Greece in the first place. Why should they expect to make money at no risk to themselves? But it is also worth asking whether there is any real basis for the ECB’s belief that anything resembling a default by Greece will lead to market – and Euro – meltdown. Is the problem not that the ECB, and EU finance ministers as well, do not believe in their capacity to undertake anything that might run against the immediate interests of financial markets?

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