Feb

7

Athens and Rome

February 7, 2010 | 6 Comments | Sam Wylie

The possibility of a sovereign default by Greece has called into question the permanence of the Euro monetary union and of the European Union itself.  Fiscal problems of smaller members are not a big enough problem to seriously threaten the survival of the EU.  Nonetheless, the following question remains unanswered:  Has there been no serious political trouble between EU members since 1945 because of the EU, or alternatively, does the EU still exist only because there has been no serious political trouble between its members?

The European Union has never been stress tested, so we don’t know how strong the union is.  The US started out as a very loose federation after the War of Independence ended in 1783.  The 13 colonies were more like NATO than the EU.  They created a constitution, then federal institutions slowly evolved, and a sense of American uniqueness and manifest destiny grew from 1820 to 1850.  But they were still “these United States” until the fearful test of the union by the civil war.

The core of the EU is tight and I think it will survive for many years.  The Treaty of Rome is fundamentally a political rather than economic union.  The aim of its founders was to end the wars for control of Western Europe that raged on and off from the breakup of Charlemagne’s Carolingian empire in the 10th century until 1945.  WWII was to be the final tragic act, and in particular an end to the wars driven by Prussian militarism.   The core of the EU — France, Germany, Italy and the low countries will likely move to a deeper political union over the next decades.

Germany is likely to have a more prominent and assertive role in the EU as WWII moves further into history.  Germans are reminded very day of their national disgrace, because the modern era is defined by the second world war   Whenever the boundary of the modern era is mentioned — most goals scored since WWII; best prime minister since WWII; largest crowd since WWII — these are constant reminders.  However, the modern era will soon be defined by the turn of the century.  That has been true in every century and is particularly true this century because it begins a new millennium.

When the modern era no longer begins with WWII, then the war will seem a long time ago and it will change how Germans see their place in the world.  I am not predicting a return of German nationalism — not at all, that chapter is closed — but I do think that Germany will take a much larger leadership role in Europe.  We can see that already in the discussions over a bailout for Greece.

The smaller countries of the EU are not so tightly attached and some could fly off over time.  Major political disputes between EU member countries have not arisen yet, nor has there been a major conflict within one member country, but these things will happen eventually.  Disputes between, or within, the newer members are more likely since their borders are more recently drawn and less settled.  Moreover, in the smaller newer members of the EU there are emigre populations that can be the source of great friction.

Regarding the fiscal problems of Greece.  Why would the EU bail out Greece?  That would create a moral hazard problem that would only end when an member is allowed to default — so why start down that road?  There has never been any explicit guarantee of Greek Treasury debt holders by German and other taxpayers.

It is probably best if Greece does default.  Greece is not a global financial institution like Lehman Brothers.  A Greek sovereign default would be similar to the Argentinian default.  Debt holders, including banks will suffer.  Greece will be excluded from global capital markets for a while and growth will be low for a decade.  But it will not be a financial catastrophe.  It would not plunge the world into GFC II.  The sooner that Germany states categorically that it will not bailout Greece, and the EU gives Greece the nod to default, the sooner the resolution process can begin.

The alternative to default is problematic.  Working through the debt means many years of low growth and high unemployment.  It is not obvious that democratic institutions can survive in Greece under that strain.  Greece had a military government for seven years until as recently as 1974.  From the EU’s perspective the economic pain of default is probably better than a fracture in the Greek polity.

A third possibility is that Greece sell some assets.  It is a pity that notions of sovereignty rule out the sale of Greek islands.  It might be better for everyone if Greece could sell off a few islands to pay some of its debt.


Comments

6 Responses to “Athens and Rome”

  1. Athens and Rome - Viewsflow on February 8th, 2010 2:59 am

    [...] Has there been no serious political trouble between EU members since 1945 because of the EU, or alternatively, does the EU still exist only because there has been no serious political trouble between its members?Close [...]

  2. EURO CRISIS « DUCKPOND on February 8th, 2010 3:34 am

    [...] Sam Wylie comments at Core Economics on the EU situation with respect to Greece. [...]

  3. Dave on February 8th, 2010 9:05 am

    Sam,
     
    As I understand it, the EU bail out is being considered because it is feared that Greece will leave the Euro otherwise.  The argument seems to be that it would have to turn to the IMF, who will only lend if the economy is restructured and this requires devaluation (to reduce real wages).
     
    The other argument seems to be about contagion.  If Greece defaults, it will increase the perceived default risk of other EU countries.   Better to pay a little money to Greece than to pay much higher interest rates on their own debt.
     
    Do you agree with these arguments?  Or do you think that these concerns – and hence the motivations for the bail-out – are misplaced?

  4. sam wylie on February 8th, 2010 2:09 pm

    Dave
    If Greece suggests that it will leave the Euro then there will be a massive run on its banks.  Greek depositors will want to take their deposits out before they become highly devalued.  The Greek government could simply suspend withdrawals and exchange the Euro deposits for deposits in the new currency at an exchange rate of their own choosing. 

    The Argentinian government did just that in 2001, but it would cause serious political trouble in Greece.   Default is an easier path politically than withdrawal from the Euro. 
    Your comment on contagion demonstrates how large the moral hazard problem is.  If the EU bails out Greece, then where will it end.  The moral hazard problem only ends with the EU allowing a member to default on its sovereign debt.  So, they may as well allow it to happen straight away. 
    There are different degrees of default.  One possibility is for the EU to make loans to the Greek government which can be used to make interest payments on Greece’s debt, but the EU loan must be paid off before any principle is returned to the sovereign bondholders. 
    Sam Wylie

  5. Dave on February 8th, 2010 2:54 pm

    Sam,
     
    Thanks for your response.  Given what you say, I’m surprised there hasn’t been a run on Greek banks already.  Perhaps that is the next chapter of this crisis.  Even if a Euro exit is unlikely, what is there to lose from transferring deposits off-shore?  However, if a run starts, the Greek government will very quickly either have to suspend withdrawals, as you say, or commit unambiguously to the Euro.

  6. Andrei on February 20th, 2010 2:44 pm

     

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    Sam,
    I think the current situation with Greece sovereign debt is in many ways similar to the 2008 situation with Lehman Brothers and other financial institutions which were on the verge of bankruptcy at that time. EU leaders face pretty much the same choice as US leaders had in September 2008:
    1) to bail out under-performing entity and create a moral hazard problem in the mid-term future, or
    2) let the entity fail and, potentially, trigger a chain reaction leading bankruptcy of other entities in a similar situation (Spain, Portugal, UK, USA, and probably others).
    This is not a trivial decision to make. The moral hazard problem may appear to be a less evil solution than the alternative…