Europe in Focus

The key talking point today is whether the EU/IMF backstop for Greece will be formally tapped this weekend. The summit in Madrid appears to be underway and the general news environment is poor. The Greek Prime Minister still is denying that funds are needed, claiming the facility is a safety net and incredulously suggests that the IMF involvement was not his idea. Recall that Papandreou previously suggested that if the Europe did not pony up, Greece could go to the IMF. Germany, in effect, for its own reasons, called Papandreou’s bluff. It will be used to demand more concessions from Greece.

Many European officials still seem to be in denial. Rather than prepare the public for an eventual use of those funds, Germany’s Finance Minister, for example, is saying that Greece is on the right path and there is no need for emergency funds. The ECB’s Notwotny is saying that backstop can only be activated if Greece losses market access. Does not the cost of market access matter? Simply put, investors are unlikely to get closure any time soon on this issue. Europe’s facility, even if implemented, is short-sighted in two important ways. First, the sums discussed a little more coverage for one year for Greece. Then what? Second, what is Europe doing to preempt the contagion risk?

European officials could have helped stabilize investor sentiment if they would have used the Greek crisis to recognize the sovereign risk and come up with a scaleable blueprint and facility. Meanwhile interest in a Greek dollar-denominated issue is reportedly poor and the anticipated size has been cut dramatically and the whole issue might be pulled.

Meanwhile the broader news environment surrounding Greece remains a weight on the euro. Comments by ECB’s Trichet about the difficulties Greek banks are facing in terms of liquidity undermined whatever upticks the euro had enjoyed in the European morning.

A Wall Street Journal article, citing a Brookings Institute report, highlights the bribery, patronage and corruption behind Greece’s debt. The study estimates that there nefarious activities cost Greece 8% of GDP or around 20 bln euros. While no doubt these types of activities are not helpful, the real underlying problem is the lack of competitiveness. This means that a stronger anti-corruption regime would be beneficial; it is not a sufficient solution.

Meanwhile, a large US investment is warning that the euro zone may degenerate into fiscal profligacy and it could lead to an eventual withdrawal by Germany.

This strikes one as a bit of hyperbolic and too economic determinist. Monetary union was first proposed not by economists, many who argue it is not a optimal currency zone, but by politicians. It was an economic solution to a political problem. The political problem in bald terms was under what conditions could Germany be reunified. There were two conditions. Share the uber-mark with Europe. Share the Bundesbank’s anti-inflation credibility (and low rates) with Europe. This would tie the united Germany, who had flirted with its own Ostpolitik, into Europe. Germany is the first among equals in the monetary union. While painting scenarios of a German exit may be colorful, it seems far-fetched and politically unrealistic.