The Euro and the Deficit Crisis

The fiscal stress on the euro-zone continues. Last week the EU non-solved the Greek problem:

Eurozone finance ministers on Tuesday (24 February) approved a list of reforms submitted by Athens and cleared the path for national parliaments to endorse a four-month extension of the Greek bailout, which otherwise would have run out on 28 February. “We call on the Greek authorities to further develop and broaden the list of reform measures, based on the current arrangement, in close coordination with the institutions,” the Eurogroup of finance ministers said in a press statement.

Don’t expect that to happen. Prime minister Tsipras wants Greece to secede from the euro zone so he can pursue his Chavista socialist agenda on his own. He cannot do that without a national currency, but so long as a large majority of Greeks want to keep the euro he cannot outright declare currency independence. He needs to build momentum and create the right kind of political circumstances. This extension of status quo gives him four more months to do so.

The question is what those circumstances will look like. The EU Observer article provides a hint:

[The] IMF, while saying it can support the conclusion that the reforms plan is “sufficiently comprehensive”, criticised the plan for lacking details particularly in key areas. “We note in particular that there are neither clear commitments to design and implement the envisaged comprehensive pension and VAT policy reforms, nor unequivocal undertakings to continue already-agreed policies for opening up closed sectors, for administrative reforms, for privatisation, and for labour market reforms,” IMF chief Christine Lagarde wrote in a letter to Eurogroup chief Jeroen Dijsselbloem.

These are reforms that the new socialist government in Athens would not want to carry out. It is a good guess that they will be punting on the reforms to provoke the IMF into making an ultimatum. At that point Tsipras can tell the Greek people that he will not subject them to any more IMF-imposed austerity, and the only way he can protect them is to re-introduce the drakhma.

Will this happen in four months? It remains to be seen. But there is no way that Tsipras is going to tow the line dictated by the IMF, the ECB and the EU. His very rise to political stardom is driven by unrelenting opposition to such fiscal subordination.

In other words, the Greek crisis is far from over and will continue to be a sore spot on the euro-zone map. If it were the only one, the euro zone and the entire EU political project might still have a future. That is not the case, however:

The European Commission on Wednesday (25 February) gave France another two years to bring its budget within EU rules – the third extension in a row – saying that sanctions represent a “failure”. France has until 2017, having already missed a 2015 deadline, to reduce its budget from the projected 4.1 percent of GDP this year to below 3 percent. “Sanctions are always a failure,” said economic affairs commissioner Pierre Moscovici adding that “if we can convince and encourage, it is better”.

This is a non-solution similar to the Greek one, though for somewhat different reasons. In the Greek case the EU does not want to provoke an imminent Greek currency secession; in France they do not want to give anti-EU politicians more gasoline to pour on the European crisis fire.

What the European leadership does not seem to realize, or at least will not admit, is that the euro will lose either way. By pushing Greece too hard the EU Commission will give Tsipras his excuse to reintroduce the drakhma; by treating France with silk gloves the Commission hollows out the enforcement backbone of the currency union. Known as the Stability and Growth Pact – the balanced-budget requirement built into the EU constitution – it was supposed to hold sanctions as a sword over member states to minimize budget deficits. Now the EU Commission has effectively neutered the Pact and created an ad-hoc environment where austerity is forced upon some countries but not others.

With no sanctions there are no incentives for the states to comply. On the contrary: compliance means austerity, which comes with a big political price tag for the member states; non-compliance, on the other hand, comes with no price tag whatsoever.

To be blunt, the silk-glove treatment of France has put the final nail in the coffin of the Stability and Growth Pact. Aside from its consequences for the inherent strength of the euro, this silk glove stands in sharp contrast to the iron fist that the Commission presented Greece with already in 2010. The EU Observer again:

Valdis Dombrovskis, a commission vice-president dealing with euro issues, admitted that France is the “most complicated” case discussed on Wednesday. Paris is in theory in line for a fine for persistent breaching of the euro rules. However the politics of outright punishing a founding member of the EU, a large member state, and a country where the economically populist far-right is riding high in the polls, has always made it unlikely that the commission would go down this route.

This is of course a major mistake. The only mitigating circumstance is that France is not yet in a situation where it requires loans from the EU-ECB-IMF troika to pay its bills. But if the socialist government generally continues with its current entitlement-friendly, tax-to-the-max policies it will not see its budget problems go away.

Down the road there is at least a theoretical possibility that France could be sucked into the bailout hole. More likely, though, is that Marine Le Pen will be elected president in 2017 and pull France out of the euro. That will, so to speak, solve the problem for both parties.

I have said this before and I will maintain it ad nauseam: so long as Europe’s political leaders persist in their fervent defense of the welfare state, they will continue to drive their continent deeper and deeper into the macroeconomic quagmire called industrial poverty.