A referendum threatens disaster.
Apparently a spasm of democracy, no matter how potentially catastrophic it may or may not be, has broken out in Greece. In apparent defiance of a deal worked out last week among members of the European Union (EU) and the International Monetary Fund (IMF), Greek Prime Minister George Papandreou has called for a referendum, allowing the Greek people to decide whether or not they want the deal. Thus, the Oct. 27th pact, comprised of a second bailout of $178 billion along with a commitment by bondholders to accept a 50 percent writedown in Greek debt, remains very much in limbo--along with Mr. Papandreou's future. Six members of the Prime Minister's socialist Pasok party have called for his resignation, and party defections leave him in control of only 151 seats in the 300-seat parliament.
“If it continues with Papandreou and the referendum, we will end up with a default and the default will push us into the drachma,” former Greek Finance Minister Stefanos Manos said in an interview with Dublin-based broadcaster RTE today. "The referendum call puts in jeopardy the payment of the next installment of bailout funds by the International Monetary Fund and the European Union," he added.
Before a referendum can be held, the government itself must decide whether the details of the bailout package meet their approval. The process surrounding a vote of confidence is scheduled to begin today and conclude by the end of the week. While it unfolds, Mr. Papandreou is traveling to Cannes to meet with 20 European leaders to discuss the crisis. And despite the political opposition surrounding a referendum, Papandreou remains defiant. "For the new agreement, we must go to a referendum for Greeks to decide,” Papandreou told Pasok lawmakers Monday. “Democracy is alive and well and Greeks are being called to rise to a national duty beyond the regular electoral processes.”
Where do the Greeks themselves stand? A Kapa Research SA poll of 1009 people taken on the same day the bailout package was finalized, revealed that 44 percent saw the deal as "negative." Another 15 percent said it was "probably" negative. Furthermore, 76 percent said Mr. Papandreou should seek an "enhanced majority of 180 votes" in parliament for the package, and a majority agreed with the idea of a referendum. As for the referendum itself, 46 percent said they’d vote against the plan, which cuts Greece's debt ratio to 120 percent of gross domestic product by 2020 from about 170 percent for next year. Yet in an apparent disconnect, more than 70 percent said they wanted Greece to remain in the EU.
Alexander Stubb, the Finnish minister of European affairs and foreign trade, put it in starker terms. "The situation is so tight that basically it would be a vote over their euro membership," he warned. "Greece has committed to a new program which includes structural reforms. All of a sudden, if they vote against those reforms, then Greece is the one who violated the agreement."
Germans were very angry. “You can’t help thinking that they should be grateful as Europe is trying to help,” said Konstanze Pilge, a 26-year-old student. “Now it looks like they are going to mess things up.” Wolfgang Gerke, a banking professor and president of the Bavarian Financial Centre think tank, was even more irate. “It just goes to show once again what a huge mistake it was not to throw Greece out of the eurozone at the start,” he fumed. Rainer Bruederle, a leader in German chancellor Angela Merkel's coalition was equally upset. "One can only do one thing: make the preparations for the eventuality that there is a state insolvency in Greece and if it doesn't fulfil the agreements, then the point will have been reached where the money is turned off," he explained. “The prime minister had [agreed] to a rescue package that benefited his country. Other countries are making considerable sacrifices for decades of mismanagement and poor leadership in Greece--wrong decisions were made and the country maneuvered itself into this crisis,” he added.
While Mr. Bruederle is correct in one sense, he is being utterly disingenuous in another. There is little question that Greece has been a fiscally irresponsible nation, especially in comparison to Germany. But it was precisely the willful determination to ignore such differences in culture, history--and fiscal acumen--that allowed for the formation of the European Union in the first place. Furthermore, the unstated (and unseemly) reality is that if Greece's troubles could be isolated from the rest of the EU, they would have left them to their own devices a long time ago. Greece's economy is quite small with a GDP of about $300 billion, and $470 billion in public debt. Such debt is large relative to the Greek economy’s size, but it represents less than one percent of global debt.
The real trouble centers around the idea of contagion. The possibility of a Greek default elevates the possibility that other, far larger European countries, most notably Spain and Italy, also wrangling with massive amounts of debt, may also be unable to pay back their loans. When investors question the ability of any borrower to make restitution, interest rates on those loans invariably rise. Thus it is hardly surprising that yesterday, Italy and France’s 10-year borrowing costs climbed "to the highest levels relative to benchmark German bunds since before the creation of the euro in 1999," according to Bloomberg Businessweek.
Another element of contagion is credit default swaps (CDS), which are financial instruments that are insurance against non-payment of outstanding debt. For example, financial institution A lends Greece money and pays a premium to financial institution B which, if Greece defaults must pay off institution A on the remaining debt. A concentration of CDSs at a particular institution could put it at greater risk than the institution which originally lent Greece the money. Furthermore, since CDSs are not transparently traded on open exchanges, no one really knows who's holding what.
For anyone wondering what happens to an institution loaded up on CDSs if the "unthinkable" happens--like a decline in American real estate prices for example--three words should suffice: American Insurance Group (AIG). AIG cost the American taxpayer $182 billion, the largest federal bailout in history.
Thus, the pressure to keep Greece afloat is enormous. But is it the correct path? That depends upon which side of the political divide one chooses to place oneself. The combination of national European leaders, led by France's Nicolas Sarkozy and Germany's Angela Merkel, and EU leaders, European Commission President Jose Manuel Barroso and European Council President Herman Van Rompuy, apparently believe the concerns of the EU as a whole outweigh the concerns of individual nations themselves. For them, the better path to eventual prosperity is to loan individual nations funds staving off bankruptcy, under the condition that such nations embrace severe austerity programs, which will theoretically reduce national debt levels to manageable proportions over an extended period.
The problem with this approach is two-fold under the best of circumstances. One, as Greece has already demonstrated, missing debt reduction targets precipitates more bailouts, which precipitate greater austerity, which lowers economic output, which makes missing future debt reduction targets more likely. Why the best of circumstances? Because as Greeks and other Europeans have amply demonstrated, severe austerity measures have been met with riots, strikes and other acts of violence, which are, unfortunately, a likely reaction by people long used to the sense of socialist-induced, self-entitlement nurtured in Europe for decades. Second, while bailing out a nation like Greece is relatively cheap, the trillions of dollars needed for bailing out larger EU nations, such as Italy, which may be forced into default if borrowing costs continue to rise, may be impossible amass, as a more detailed analysis here reveals.
The other approach? A partial or total breakup of the European Union, in which many or all of the EU nations return to their sovereign currencies. The currencies would then be devalued to make investing in the such countries more inviting. Doubtlessly, there would be fiscal pain, likely of depression-level severity, but at some point the markets would right themselves.
The potentially multi-trillion dollar question: which is worse: fiscal austerity and debt reduction targets mandated by the EU, or pain self-imposed by sovereign nations coming to grips with individual bankruptcies and re-capitalization? The most honest answer? No one knows for sure.
Yet perhaps the economic argument is secondary to the real one, not just in Europe, but in the United States as well. What the EU represents is the ascent of the kind of top-down, command-and-control bureaucracy that socialism's champions inevitably produce. Yet what has such centralization of power--and money--produced? Entities that are "too big to fail." Privatized profits, but socialized losses when those losses threaten not only banking systems and/or nations, but an entire continent as well. Crony capitalists protecting their interests with government's help, and millions of people who feel entitled to a lifetime of well-being enabled by government, even as that government largesse bears no relationship to productivity and fuels massive amounts of deficit spending.
All of this undermines the fundamental notion of individual liberty. Liberty which is best served when government functions from the local level outward, not the federal or EU level inward. It's as simple as understanding that it is far easier to get a stop sign installed on a corner in one's neighborhood when one can call a local alderman--instead of a bureaucrat in Washington, D.C.
One may argue with Prime Minister George Papandreou's intention of letting the people themselves decide their own destiny as an abrogation of responsibility on the part of the Greek government. But the idea that other Europeans see such an exercise in direct democracy as tantamount to heresy is quite revealing. Apparently Greeks are supposed to take the bailout, like it or not, and remain tethered to a supra-national bureaucracy in which failure must be eliminated, at virtually any cost (currently including bank recapitalizations and a scaled up European rescue fund), lest it become "contagious."
Yet the possibility of such contagion reveals an uncomfortable truth about such interdependency: the "too big" in too big to fail is getting smaller every day.
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