Not only was DSK no longer able to persuade German chancellor Merkel that the problems needed just “a little more time, a little more money”. Instead, he was replaced at key meetings by an IMF technocrat, who focused on financial rather than political issues.
This is helpful to an extent, as it means the Eurozone is no longer relying on smoke and mirrors to obscure the real issue. This is whether Greece, Portugal and Ireland’s problems are due to lack of solvency or liquidity:
• Solvency is whether one is able to pay one’s total debts
• Liquidity is whether one can pay today’s bills
As the chart from the Financial Times shows, Greece’s 10 year bond is now trading at a 15% spread to its German equivalent. Portugal and Ireland are trading at a 10% spread. Thus ratings agency Moody’s has downgraded them all to ‘junk‘ status. Whilst spreads for Italy and Spain (the other members of the at-risk PIIGS group) are rising ominously.
The next head of the European Central Bank, Mario Draghi, has also warned very clearly about the risks of the current position:
“The solvency of the sovereign states is no longer something acquired, but something earned with high and sustainable growth, which is only possible if budgets are in order. Today’s cost of credit reflects that new reality.”
But, as readers will have spotted immediately, this desired “high and sustainable growth” cannot be achieved without German support:
• High growth requires capital to be available for loans
• But the only source of this capital is Germany
• Germany doesn’t believe in ‘bailing out’ its Southern partners
• The PIIGS are therefore being forced to adopt austerity measures
• This will reduce their growth rates, not increase them
We therefore remain in exactly the same position as when the Eurozone crisis first began in May 2010. At least 3 of the PIIGS are clearly insolvent, and will never be able to pay their debts. Only prompt action now will resolve their problems, and protect Italy and Spain.
But as the blog argued back in December, this would mean the Eurozone would have to become a fiscal union (like the USA), as well as a currency union. One cannot exist without the other.
Germans and wealthy North Europeans would have to agree to pay their partners’ debts. This seems unlikely in today’s political climate.
Yet the alternative is not the status quo, as too many politicians still hope.
It is that the Eurozone could eventually break up, and in the process severely damage both the European Union and the wider global economy.