Last Thursday’s bailout of Greece by the principal actors in the sovereign debt crisis –France, Germany, and the European Central Bank – has buoyed the spirits of European credit and stock markets. But the agreement does little more than paper over Europe’s sovereign debt crisis. It neither resolves Greece’s inability to pay its debts nor ensures the preservation of the eurozone.
Eurozone leaders agreed at their Brussels summit to provide Greece with additional emergency funds of some 109 billion euros ($157 billion) through 2014. The rescue package also cuts interest rates on loans to Greece as well as to Ireland and Portugal to around 3.5 percent. Private creditors will also chip in by swapping or rolling over short-term Greek debt for 15- and 30-year maturities issued by the European Financial Stability Facility (EFSF). In addition, the EFSF will be authorized to buy bonds on secondary markets, recapitalize banks that will be forced to write down the value of Greek bonds they hold, and preemptively lend to countries undergoing market pressure before they face a financial crisis.
The agreement required concessions from all sides. European Central Bank President Jean-Claude Trichet acceded to the demand of German Chancellor Angela Merkel that private bondholders share in the cost of the rescue plan. The Germans, along with the Dutch and the Finns, agreed to make large payments to EFSF and French Prime Minister Nicolas Sarkozy abandoned his proposal to defray the cost of bailout funds by taxing banks.
Relieved that the can had been kicked down the road, stock markets in Europe and the US rose on the news; yields on Italian and Spanish 10-year bonds also dropped sharply. But market jitters are bound to return for three reasons. First, the rescue deal did not go far enough. Second, Greece remains in a parlous economic condition. And third, intra-European political tensions continue to impede the creation of a common fiscal policy.
Given the prolonged and dysfunctional tug-of-war between the European Central Bank and Germany over the terms of a bailout, the deal to come to the aid of Greece and the other peripheral economies is more impressive than one would have imagined. The authorities granted to the EFSF are extensive, but they do not constitute the “the beginnings of a European monetary fund,” as Prime Minister Sarkozy rhapsodized. For one thing, European leaders failed to increase the EFSF’s lending capacity. To ensure that markets do not raise interest rates on the debt of other Eurozone countries, as has recently occurred in Spain and Italy, the debt of all members of the eurozone will need to be guaranteed. More important, European governments continue to resist the creation of Eurobonds, the issuance of which, economist Joseph Stiglitz and former EU commissioner Mario Monti have argued, would restore the market’s confidence in the eurozone’s ability to deal with troubled economies.
Although the debt agreement buys Greece some time to get its financial house in order, the prospect of default has not diminished. Greece’s aggregate debt, currently at least 150 percent of GDP, will not be appreciably lower as a result of the rescue package. The Institute of International Finance estimates that the bailout will only reduce the present value of debt by 21 percent. Because of the exchange or rollover of private debt, credit rating agencies such as Moody’s and Standard & Poor’s are likely to find Greece in default. Fitch Ratings has preliminarily called Greece in “restricted default.” Even if the default judgment is lifted after the swap is completed, Greek debt would still be classified as junk.
Moreover, the availability of emergency funds is a palliative. The restoration of Greek economic health is contingent on continued fiscal austerity and the privatization of state-owned assets. But successive fiscal adjustments, which are inevitable, will impede economic growth. They will also provoke more protests among an already demoralized citizenry. Privatization of government-owned enterprises will aggravate matters. It will put more people out of work and intensify the perception that the country’s jewels are being sold off at liquidation prices. Without the privatization of government-owned entities, however, it is hard to see how Greece will be able to generate economic growth. But it will be a slow process under the best of circumstances, encumbered by legal wrangles and domestic politics.
The most encouraging aspect of the Brussels summit is the transfer of funds from prosperous countries to their struggling neighbors and the incremental movement of the eurozone toward a fiscal union that this implies. But publics in Germany, the Netherlands, Finland, and elsewhere show no signs of embracing a federal structure such as that which exists in the US. Unlike the US, Europe lacks a common culture. For all the progress toward a closer union, different national cultures and histories still inhibit federalism. The rise of right-wing and anti-euro parties is indicative of a competing trend in favor of national sovereignty versus pan-Europeanism.
It is entirely possible, of course, that the threat to the edifice of monetary union posed by the spread of the financial contagion from the periphery to the center may prompt European publics to reconsider the value of pooled sovereignty. For this to occur, however, European taxpayers will need to see a return on their investment, which means that troubled countries such as Greece will have to get their fiscal house in order sooner than later. No less important, European heads of government will have to exercise leadership and convince national publics that their long-term interest stands to benefit from closer integration. Neither is imminent.
Hugh De Santis is a strategic analyst and international consultant. He is a former career officer in the Department of State and chair of the Department of National Security Strategy at the National War College.