Greece is probably going to default soon, which is hardly a surprise. That was the message we got from Wednesday’s telephone call between Angela Merkel, Nicolas Sarkozy and George Papandreou, who after 25 minutes merely issued a statement saying that Greece is determined to meet its commitments to its partners and will stay in the eurozone. In other words, there is nothing more anyone can do, so Greece will default, most likely within days.
We need to move on from Greece, in order to understand how to deal with the wider crisis. There are three separate problems that must be resolved: the poor state of eurozone nations’ finances, the eurozone banking system, and the euro itself.
The collective borrowing requirements of Greece, Portugal, Spain, Ireland and Italy – to which must be added Belgium and almost certainly France – are simply too big to fund. It is possible that the International Monetary Fund working with the G20 might come up with a package, perhaps funded by the creation of more Special Drawing Rights (SDRs), but that is not being discussed at the moment. So in the absence of such a package and if Greece is somehow bought more time, the markets will almost certainly focus on any of the remaining “PIIGS” (Portugal, Ireland, Italy and Spain). So the rescue of one debtor will encourage a run on the others.
The only way these countries’ public finances can be restored is by substantial cuts in public spending. Greece’s descent into public sector chaos will be a sharp and valuable lesson to politicians and electorates elsewhere. For this reason, there is a benefit to be had from allowing Greece to go to the wall.
The European Central Bank’s task in this is clear: it should concentrate all its efforts together with the national central banks in ensuring the banking system remains intact. This brings us to the third problem: the euro.
The euro is a paper currency with some of the attributes of sound money. It is that soundness that is creating much of the pain, which is why Keynesians have turned against it. Now that they see Greece’s default as inevitable, these Keynesians think Greece should leave the euro, or perhaps Germany and a few others should leave so that stricken economies can arrange for themselves the “benefits” of a weaker currency.
Like most Keynesian ideas, their solutions are not thought out. Breaking up the euro would be chaotic, throwing all debts and contracts into doubt, triggering needless bankruptcies in the private sectors throughout Europe, and destroying credit ratings. It would also hinder and not help the private sectors in all the PIIGS, which is the only place where a genuine economic recovery can come from. The private sector needs sound money if it is to regenerate itself, and that is what the euro can provide.
It will be hard to abandon Greece as a hopeless case, but this must be done in the interests of the whole, and eventually for Greece itself. Rather than thinking about bailing out Greece, the eurozone and the IMF should be working on an emergency funding package designed to fund law and order and other vital services only, conditional on Greece remaining in the eurozone.
Any other approach to dealing with these three problems is likely to come unstuck very rapidly.