A couple of weeks ago the economist Paul Krugman said he was “both terrified and bored” by the eurozone crisis. I know what he means.
On one hand, a study by the Swiss bank UBS estimates that if the eurozone collapsed, a strong economy such as Germany would lose between a fifth and a quarter of its output in the first year.
On the other hand, the European Union (EU) is moving millimetre by millimetre towards the large-scale response to the crisis demanded by the financial markets, the International Monetary Fund (IMF) and the US.
Last week there was supposed to be a millimetre’s forward progress when the German parliament endorsed the latest eurozone “rescue” for Greece. This was billed as a triumph for Angela Merkel, the German chancellor.
In fact, this package was certain to pass since it was endorsed by all the main parties except for Die Linke on the left. All the drama was to ensure that Merkel won the support of most parliamentary deputies belonging to her ruling conservative‑liberal coalition.
But, more important, the package was obsolete by the time it was passed. It contains two important provisions. The first was to beef up the European Financial Stability Facility (EFSF), which was set up by the eurozone when Greece was first “rescued” in May last year.
The second—insisted on particularly by Germany—was that Greece’s creditors should accept a cut in the value of their loans, although there is a lot of controversy about how much this “haircut” would actually be.
But the crisis has got a lot worse since this package was agreed back in July. Everyone thinks Greece will default on its debts. The Greek government has just announced that it will not meet the target for cutting its budget deficit imposed by the “troika” of the European Central Bank, the European Commission and the IMF.
The main reason for this is that the Greek economy is projected to shrink by 5.5 percent this year and 2 percent next year. Economic contraction means that the state receives less in tax revenues and has to pay out more to support the unemployed.
Unmoved by the failure of their policy and the suffering of the Greek people, the “troika” is trying to squeeze yet more cuts out of the government of the wretched George Papandreou.
Still, Greece will default. Over the summer the markets started targeting other eurozone states, including Italy and Spain. The spread of financial contagion threatens the European banks, the most important lenders to these countries.
These banks are already in deep trouble because of bad loans they made during the credit bubble of the mid-2000s. The IMF estimates that the eurozone crisis has added some 200 billion euros to their losses.
The meetings of the IMF and the World Bank in Washington DC a fortnight ago mooted changes to the package agreed in July. Greece’s creditors would lose half the value of their loans.
This would make the banking crisis worse, so the EFSF’s fund would also be expanded from 440 billion euros to perhaps two trillion euros. Its original size was criticised from the start as too small if the debt crisis spread to big economies such as Spain and Italy, as it now has. A bigger, stronger EFSF could be used to provide banks with the new capital they need to survive.
But there are two problems with this solution. First is how actually to expand the EFSF’s funding. Two trillion euros is a lot of money, even by the standards of the bank bailouts. Guaranteeing the fund would reduce the credit ratings even of a state as powerful as France.
There are also barriers in EU law. So there are proposals to fund the EFSF by the kind of financial engineering that led to the crash in 2008. But, secondly, the German government is in any case opposed to expanding the size of the EFSF because it would undermine the austerity drive.
The reality is that the eurozone is paralysed in the face of what is becoming an existential crisis. Expect a lot more tedium and fear.