Well, the markets are down despite Europe on the verge of passing a 160billion euro Greek bailout bill, and Obama proposing a $447 billion USD plan, the markets still fall. Greatly. Germany’s DAX shedding 4.04% is not something to joke about. Did Greece’s problem suddenly pop-up? Not really. As I mentioned previously, people sort of just forgot about Greece because it wasn’t in the news. Anyways, not that the market is falling to reflect Greece’s 94% chance of default (according to CDS prices), what’s in store for Europe?
What about more bailouts?
I’m not going to deny the possibility. It buys some time, but this will never the the final step. Bailouts buy time, they don’t solve problems. Greece has a bad financial record: you’re not going to get rid of the problem with money. A full cleansing of the European system would cost some $3 trillion. Does Europe have the money? No. And let’s say they invent a magical trick that prints money without devaluing the currency: it still doesn’t solve Greece’s problem. They are plagued by financial difficulties such as a lack of a budget that works, unsustainable public sector debt and a terrible taxing system that encourages massive tax evasion. All this will result in is temporary relief to build up to one of the next two solutions…
There’s been wind of fiscal union for quite a while. But it still hasn’t happened. Fiscal union (combined with effective policy implementation) would likely stabilize the EU and preserve union. However, is it possible? Fiscal union basically entails that Germans and French will have to be pulling the weights of their fellow PIGS nations. It’s already hard enough to ask the rich Texan to pay 1% more tax for the sake of helping the public schools of New York City. It’s going to be even harder to convince the German middle class to take tax hikes across the board to help their Greek fellows. This disaster is already out of proportion, and simply trimming away at Greece won’t work. Given that Greece reaches 160% debt to GDP ratio, the government would have to make 50-70% in cuts to steer Greece back on track. Cutting away 70% of a country’s budget is simply not viable, so other EU nations would have to start helping out Greece (not that they haven’t already).
Fiscal union will be painful, though. It will probably occur after the EU has bailed out the PIGS so many times, that they own so much of their debt, that they might as well merge with their largest investments. But if this means Angela Merkel will bring her tight fiscal policy into irresponsible EU nations, this could be great for Europe on the long run….the key being, of course, people refuse to wait until the long run to see effects. This option will take lots of determination and/or a slow sinking of Germany and France into the quagmire of European debt.
Wait, what about those Euro bonds?
Instead of going full-way fiscal integration, Europe can also do it half-way by issuing Euro bonds. Essentially, what the EU would be looking for with Euro bonds is similar to fiscal union: taking the damage for PIGS, and then financially regrouping the nations overtime. This seems to be a popular solution, but it has problems in itself. By not going the whole way into fiscal union, the EU still wouldn’t be able to fully control how other nations handle their cash. There’s no stopping Italy from being irresponsible again under their sex-scandal-ridden, corruption-filled government. Also, the bonds would have a rating that is pulled down by the weakest link. If a Euro bond were to be formed, it will unlikely have a AAA rating, and be able to raise money with as much power as the T-Bond like many pro-Euro bond politicians claim.
Abandon Ship: Leaving Some Nations to Die
Be it the more fiscally well-off nations abandoning the sinking EU ship, or the fiscally sound nations kicking out the fiscally irresponsible nations to save themselves, this option will require a lot of political momentum. Leaders have to decide whether they want to sacrifice their own well-being to help nations on the brink of disaster, or move on to save themselves. Both options require a lot of political pain…which unfortunately politicians never have the guts to take.
This move would most definitely force the fiscally unstable nations to default, and the fiscally well-off nations to survive. This will likely happen closer to French/German elections, when angry voters vote an anti-bailout platform leader into office. Sarkozy and Merkel are showing no signs of doing this, but who knows what politicians will do when they see their opponents winning votes on an “anti-Greece” platform? However, if Germany lets Greece default without any repercussions, they will watch a lot of their banks fall as well. Now all Germany needs is a way to isolate the financial damage and they will have more of a reason to kick the extra weight off their ship….
So What’s Going to Happen?
Currently, no one is going to let PIGS simply die off. They lack the political momentum to do so, and they don’t have a plan to isolate the damage. If a new political party is gaining traction with an anti-PIGS platform, look to see them gain power, and cut them out of the EU. To be honest, the EU would be such a financially beneficial union for all of its member nations if they didn’t have debt-ridden, fiscally irresponsible nations to pull them down. It is certainly a bit too attractive an option to give up for angry voters. This seems like a likely route for now, as negative voter sentiment is already brewing.
If all goes the “good way” and no one successfully builds political momentum voting to abandon PIGS, either a Euro bond or fiscal union will be formed. By the current progression, a Euro bond is more likely because I don’t think Europe is ready to become a “nation” yet. They speak different languages, are ethnically different and each hold widely different beliefs. If Europe does go down this path, they will either have failed with the Euro bonds, or be forced into it after another few bailouts having increased their stakes in PIGS bonds.