Alexis Tsipras’s new Syriza-led government in Athens wants a big chunk of its debt written off. Angela Merkel is saying “nein” to that. If this were a western, Tsipras and Merkel would be the two gunslingers who have decided in time-honoured fashion that “this town ain’t big enough for the both of us”.
But this isn’t Hollywood. There is no guarantee that this shootout will have a happy ending. Things look like getting nasty and messy. The five-year crisis in the eurozone has entered a dangerous new phase.
How can this be? Isn’t Greece a small country, which accounts for less than 2% of the output of the European Union? Wouldn’t it be relatively easy and not particularly expensive for its creditors to write off its debts, mostly owned by governments or international bodies? Isn’t it the case that using Greece as a laboratory mouse for an austerity experiment has been a failure?
The answer to all three questions is yes. Greece is a small country. Writing off part of its debts or easing the repayment terms would be simple and painless. The obsession with deficit reduction has depressed growth not just in Greece, but in the whole of the eurozone.
What’s more, the lesson from the last five years is that those countries that use the euro are paying a heavy price for the lack of a common system for transferring resources from one part of the single-currency area to another. There is one currency and one interest rate, but there is no fiscal union to stand alongside monetary union.
So, unlike in the US or the UK, there is no large-scale method for recycling the taxes raised in those parts of the eurozone that are doing well into higher spending for those parts of the eurozone that are doing badly. Mark Carney pointed out this weakness in a lecture in Dublin last week when he said: “It is difficult to avoid the conclusion that, if the euro were a country, fiscal policy would be substantially more supportive.”
The governor of the Bank of England added that a “more constructive fiscal policy” would help mitigate the negative impact that structural reforms have on demand and would be consistent with the longer-term aim of closer integration.
All this is music to the ears of Tsipras and his finance minister, Yanis Varoufakis, who will be in London for talks with George Osborne on Monday. Varoufakis, judging by his comments on Newsnight last week, thinks Germany should soften its approach not just because the current policy is not working but also as an act of European solidarity.
“Suppose a friend of yours were to come to you and say that he or she had difficulty paying the mortgage because of a reduction in their income – they lost their job or something like that,” Varoufakis said. “They have a great idea on how to solve this problem: they would get a credit card and draw money from it in order to meet the mortgage payments for the next few months. Would you advise them that they should continue to take these tranches of loans from the credit card in order to deal with what is essentially an insolvency problem?” Merkel’s response to the implication that Greece is essentially bankrupt was uncompromising. “I don’t see a further debt haircut,” the German chancellor said.
Seen from Berlin’s perspective, this approach is neither cruel nor heartless but simply good economic sense. Not much attention has been paid to the German perspective in the past week, which is a mistake because in the end the creditors call the shots.
The Germans had reservations about the single currency right from the start. They adored the Bundesbank as the bulwark of prosperity and only agreed to join the euro provided the European Central Bank (ECB) was a carbon copy of their own beloved institution. They raised an eyebrow when countries including Greece were allowed to become founder members of monetary union, because they knew their economies were relatively weak and inefficient. But they expected membership of the euro to act as discipline, forcing countries to undertake structural reforms to make themselves more competitive.
That is what Germany did after entering the euro at a rate that was disadvantageous for its exporters. The labour market was reformed. Workers took cuts in real wages. Welfare was made less generous. Today Germany has an unemployment rate below 5%, runs a budget surplus and exports far more than it imports.
Merkel’s message to fellow eurozone leaders is that if we can do it so can you and that this is what we all signed up for when the single currency was introduced in 1999. Berlin’s unhappiness with the ECB’s decision to begin its own version of quantitative easing goes beyond a visceral German fear of cranking up the printing presses. It also thinks the ECB is letting the eurozone’s backsliders off the hook.
Nor does the argument that Germany is being unreasonable cut much ice with Merkel. Greece, she says, has also had two bailouts, which had strings attached. Asking the German taxpayer to write cheques to help what was once East Germany is acceptable: asking them to write blank cheques to Greece is not.
From the outside, the German approach may look strange or misguided. It makes little sense for Germany to be running a budget surplus while at the same time exhorting other eurozone countries to export their way out of trouble. If Merkel cut taxes, German consumers might start to buy more Greek, Spanish and Portuguese goods. Nor is there any evidence that quantitative easing (QE) programmes have led to inflation. On the contrary, deflation is currently much more of a concern.
But, crucially, this is not the way the Germans see it. They think running a budget surplus is prudent because it is salting away money that will be needed in the future to cope with the demands of an ageing and declining population. And they would argue, rightly, that the long-term effects of QE are unknown.
What does all this mean? It means that Merkel is likely to hang tough in negotiations with Tsipras. It means that Germany will drag its feet on fiscal union, fearing a repeat of what happened with monetary union. It means that the eurozone will stay in limbo, with countries having no control over their interest rates but continuing to run their own budgets.
The most probable outcome is that the eurozone will muddle through, as it has in the past. But there are two alternative scenarios. The first is that Greece leaves. The other, still more unlikely, is that Germany – for all its undoubted commitment to the European project – decides the price of membership is no longer worth paying.
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