Euro-turn, Greece tests the mettle

Today, there will a conference of EU leaders to discuss what should happen to try to secure the Euro-zone and handle Greece’s budget deficit. It is also the first to be hosted by Herman von Rompuy.

 

Greece is running a very high deficit at 12.7% (similarly to the UK) of GDP but has little means of paying off the debt other than drastic and unpopular cuts. If they had a floating currency they could devalue and then inflate their economy, but the Euro closes that option for them.

 

The stakes are high. If at the end of today, the EU issues a communiqué saying that Greece has a plan of attack and the EU shows confidence in it then it will be clear that they  cannot agree on a plan of action and Greece is toast. If they say that they have a fund which could be used to aide Greece, the markets will test it until the fund has to be used. If they say that they have started aiding Greece, markets will judge the scale of help and decide whether to continue battering Greece or hold back.

 

It all depends on the market’s verdict on the help. Incidentally, the Maastrict treaty which set-up EMU made it illegal for the EU to help out countries which became debt ridden. Only bilateral agreements can be used, which in effect means Germany. I guess that the EU will neatly forget that, and who is going to prosecute?

 

If Greece is allowed to fall and default on its debts, the focus will switch to Spain and Portugal. It all reminds me of 1992 again. If the markets then test Italy, the Euro itself will be looking death in the face.

 

The original rules that set-up EMU, tried to enforce convergence between member states before allowing entry to the Euro-Zone and then had a Stability Pact to make sure the states kept within deficit limits of 3%. In practice, the entry requirements were fudged and the stability pact has not been enforced (why fine a country which is already running a large deficit?).

 

It now points to two directions, either the Euro-Zone collapses, or it pulls through but means that economic union needs to be much tighter to take control of fiscal policy.

 

Either way, we are much better off out of it.

 

Squiffy.