Thursday, 6 May 2010

Another Greek lesson

The misadventures of the Hellenic Republic continue to roil the financial markets. Despite a considerable stand-by loan package from IMF and the EU, the markets continue to react as if there is an imminent danger of a Greek debt default. Stock markets fall, yield spreads continue to increase, crude oil has plummeted, other commodities are falling, and the Euro is heading south. Junior parliament members are taken as witnesses that the European governments will renege on premises, and all the Euro-sceptic analysts in the entire English-speaking world have come out of the wormholes. There is apparently only one possible reaction: SELL!

I have repeatedly stated my conviction that the initiatives taken by the IMF and the Euro Zone in concert will be sufficient to solve the current situation at least for the next 3-4 years, and it follows that my take on the market reaction is that it is blown out of proportion.

Greece is the black sheep of the Euro Zone, no doubt. 13-14 per cent budget deficit, fudged budget numbers, lax accounting standards, collusion with Goldman Sachs to "hide" debt. The list of misdemeanours is long and impressive. Worst of all, however, is the culture of tax evasion. In a country of more than 11m inhabitants, less than 5000 persons filed a tax return stating taxable revenue in excess of €100,000 in 2008. Apparently large swathes of the population do not pay income taxes at all, and predictably, it tends to be the better off who enjoy this privilege.

No wonder that it will take a while to fix.

But even when the package is in place and the financial markets have caught their breath, there are certainly issues to address. One was raised by Germany's Merkel and France's Sarkozy in concert. Their point is the simple, that in order to make the Euro work better, there has to be a much better budget discipline among the member countries. Their solution would be to strengthen the central oversight – i.e. to create some kind of Euro Zone budget watchdog.

Sounds fair enough, but the question would be what kind of powers would be invested in the new central budget authority. Already, there is a draconian system of fines put in place. But as the Greek adventure has shown, the sanctions are dropped once the going gets tough. So let me guess.

Merkel and Sarkozy want to create a central budget authority that can, could, would kick out countries with an insufficient budget discipline. Such as Greece in three years' time if a comprehensive tax reform is not in place.

Productivity is another issue. Germany built its economic success in the Post-war period on having a stronger productivity growth than all other countries. It gave Germany a huge economic advantage and room to keep inflation down by constantly revaluing the D-Mark against the trade partners.

When Germany purchased the neighbouring DDR at an inflated price it took some 15 years until the German productivity miracle was back. In the meantime Euro had replaced D-Mark and countries with higher inflation and much, much lower productivity growth had managed to gatecrash. And this is the fundamental problem of the Euro, if there ever was one. Combining national states, different languages and cultures, and low labour mobility with pronounced productivity differences and a common currency is not exactly the recipe for success, EU had expected.

Germany, which has been bankrolling EU for decades, is understandably worried about the contingent claims that may be forthcoming. Referring to Germany's success, officials have been busy promoting German budgetary virtues everywhere. But the issue really is not the budget. It is only a beginning. The issue is what it takes to maintain a currency union across huge differences. It may well be that all the political will and all the stand-by loan facilities may not be enough.

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