I was sceptical about the eurozone deal agreed last week from the very beginning. In a talk I gave on Thursday, the day the deal was announced, I said that it would either do no good, or be positively harmful.
Firstly, the debt restructuring announced was clearly insufficient to deal with the problem – Greece would still have been left with an unsustainable debt load. For an orderly debt restructuring to work, it needs to be so bold and radical that it convinces everyone the problem has been dealt with. That clearly wasn’t the case in this instance.
Secondly, the bank recapitalisation plans were (and are) dangerously ill thought through. If you force banks to significantly raise their capital ratios by June next year, you’ll get one of two things happening. Either lots of capital will be sucked out of the wider private sector, which means funding going out of productive, wealth-creating industries to prop up dodgy, wealth-destroying banks. Or banks will raise their capital ratios by shrinking their assets – and that means another credit crunch, with a contracting money supply and less funds for businesses. In either case, there’s a good chance that hasty bank recapitalisation will trigger that long-awaited double-dip.
Thirdly, the deal meant more bailouts. And there are two big problems with bailouts. One: they don’t deal with the problem; they just kick the can down the road. Two: we do not have the money to fund bailouts on the scale that is required. Where is the sense in countries that don’t yet have a debt crisis borrowing money to bail out those that do? That doesn’t resolve the debt crisis, it just spreads it to otherwise healthy economies.
Yesterday’s announcement of a Greek referendum – or will it be a snap election? – underlines the futility of the entire exercise. It practically confirms what has seemed inevitable for some time: that Greece will soon undergo a complete and disorderly default. It will nationalise its financial sector, leave the euro and, in an attempt to avoid unpopular ‘austerity’, print lots of its own, new money – raising the spectre of hyperinflation and, in extremis, complete economic and societal collapse. Needless to say, I sincerely hope I am proved wrong about this – but things do look very grim.
Of course, Greece alone isn’t that big a problem to the rest of us. But the potential knock-on effects of a Greek collapse are terrifying. Italy, home to the world’s eighth-largest economy, has to roll over €300bn of its government debt next year. If its borrowing costs don’t fall (the government was recently forced to pay a record 6.06 percent on its 10-year bonds) then it too will face the prospect of default. And then we really will be in trouble.
Ultimtately, this is the entirely predictable outcome of governments borrowing too much money, of politicians buying votes with a larger state than people are prepared to pay for through taxes. As Ayn Rand put it, “We can evade reality, but we cannot evade the consequences of evading reality”.