Maastricht madhouse fuels EMU-wide contagion from Greece
by Ambrose Evans-Pritchard
Originally published 25 Apr 2010
IF THE CHIEF PURPOSE BEHIND THE EU-IMF bail-out for Greece – or for banks exposed to Greece – is to prevent a “full-blown and contagious sovereign debt crisis”, the market verdict must be a sobering surprise. The relief rally fizzled shortly after Greece folded its bad poker hand and invoked aid. Bond risk as measured by Markit’s 5-year credit default swaps jumped to fresh records of 280 for Portugal and 177 for Spain. Irish CDS contracts rose 13 points to 185.
This was an entirely logical response to the twisted events that are unfolding. The rescue obliges countries in trouble to go deeper into trouble. Portugal must come up with €774m as its share of the EU’s initial €30bn package. Ireland must find €491m, Spain €3.7bn. Yields on 10-year Portuguese bonds hit 4.94pc, a whisker shy of the 5pc rate that Lisbon must relend to Greece. Meanwhile, safe-haven Germany can borrow at just over 3pc. The bail-out cost falls hardest on those that can least afford it. It deepens the North-South divide that lies at the root of Europe’s crisis.
In a rational world, Brussels would tap the EU’s AAA rating to issue cheap “Barroso Bunds” to cover rescue costs. But we are not in a such a world. We are in the Maastricht madhouse, a currency union without a treasury, ruled by the “no bail-out” clause of Article 125 of the EU Treaties. Europe is at last paying the price for fudging the true implications of EMU 19 years ago in that Medieval city on the Maas, gambling that it would one day be able to lead Germany by the nose into a debt union. Chancellor Angela Merkel continues to equivocate, demanding “very strict conditions”. Dissent is growing louder in her coalition ranks. Both Free Democrats and Bavarian Social Christians have said it is time to break the taboo and ask whether Greece should “step outside” EMU. Werner Langen, the leader of Christian Democrat MEPs, said the bail-out appears to breach Germany’s constitution.
If so, we will find out soon. Four professors will launch a legal challenge in early May at the Verfassungsgericht (high court). Should they secure an injunction, EMU may fly apart. The Court ruled in 1993 that Maastricht was constitutional only as long as EMU remains an area of monetary order. “A ‘transfer union’ is a bottomless pit and is bound to threaten currency stability. That is what we are going file,” said Tübingen Professor Joachim Starbatty.
When accused of consigning Greece to ruin, he told the Frankfurter Allgemeine that EMU exit and default is Greece’s only salvation. “The truth has to come out into the open. Greece is in no position to pay it debts,” he said. The EU-IMF “therapy” of deflation for Greece repeats the catastrophic errors of Chancellor Heinrich Bruning in the early 1930s and must lead to a depression, he said.
Yet that is what IMF chief Dominique Strauss-Kahn is preparing for Greece, against the better judgment of his own experts. “Greek citizens shouldn’t fear the IMF; we are there to try to help them,” he said over the weekend. Yet a week ago he told Greece that devaluation and default are non-starters. “The only effective remedy that remains is deflation. That will be painful. That means falling wages, and falling prices. There is no other way.” Actually, the IMF pursues other ways often, last year in Jamaica. What Mr Strauss-Kahn means is that the EU will not tolerate any other way. The Greek people must be sacrificed for the Project and to hold the EMU line, like the Spartans of Thermopylae who perished to gain time for the Alliance.
They are to squeeze fiscal policy by 6pc of GDP this year in a slump – a “death spiral”, warns George Soros. They are to do this without the IMF’s devaluation cure. If they do stabilise the debt – to hit 130pc of GDP this year after Eurostat’s revelations – they will be left paying 6pc to 8pc of GDP to foreign creditors for ever. Will Greeks comply meekly, or turn their Spartan blades on Europe?
No country in Western Europe has defaulted since the Second World War. More than €7 trillion has been lent to Club Med states, banks and homeowners in the belief that it cannot happen. EMU shut the warning signals, disguising risk. What investors overlooked is that currency risk mutates into default risk in a monetary union. It makes default more likely, not less. The bond markets have suddenly twigged.
In barely two weeks, the City mood has shifted from ruling out a Greek default as absurd, to accepting that it could happen, to now fearing that restructuring is highly likely. A country such as Portugal with total debt of 300pc of GDP, a current account deficit of 11.2pc, and a budget deficit of 9.4pc should not think it has the luxury to trim spending at a leisurely pace. Portugal has an ugly choice. If it tightens hard to soothe bond markets, it too risks depression. EMU’s Faustian Pact is closing in.