It ought to be Rule No. 1 for any effort to fix a financial crisis: Don’t do it during an election. Politicians pandering to voters are likely to make a bad situation worse.
Which unfortunately is exactly what’s happening in the current Greek debt crisis.
The German government of Angela Merkel faces a tough May 9 state election in North Rhine-Westphalia, Germany’s most populous state, that could force coalition partner the Free Democrats to campaign against the plan for a $60 billion Greek rescue co-financed by the IMF (International Monetary Union) and the members of the European Union. Germany would pick up the biggest share of the tab in any such rescue plan.
Opinion polls show that 86% of Germans oppose the bailout plan. And with support for the Free Democrats at just 6% to 8% in recent polls, the party faces an almost irresistible temptation to bash the plan. Especially because the opposition Social Democrats have ratcheted up their criticism of the plan.
That has left Merkel’s government, a coalition between her Christian Democratic Union and the Free Democrats, doing some tough talking that threatens to make the bailout plan into a recipe for disaster in Greece. Merkel said just today, April 26, that she won’t release any funds until Greece shows that it has a credible plan to cut its budget deficit not just in 2010 but in 2011 and 2012.
The Greek government has already introduced increases in the national value added tax, cut public sector jobs, wages, and benefits, and pushed to cut private sector wages as well in an effort to reduce a 2009 deficit projected at 12.9% of GDP to below 9% in 2010.
Merkel is now asking for detailed plans that would cut the deficit by another three to four percentage points of GDP in each of 2010 and 2011.
There are three things that can happen here. None of them good.
- The parties squabble and Greece misses its May 19 deadline for re-financing $11.3 billion in Greek bonds that come due then. That would force some kind of debt moratorium that could destroy any hope that Greece can access international financial markets to finance its deficit. Bankers working on the deal say that something needs to be in place by May 6 to meet the actual May 19 re-financing deadline.
- Germany gets its way, the Greek government delivers the kind of detailed austerity program that Merkel is insisting on, and then collapses. Greek Prime Minister George Papandreou has been trying to avoid spelling out the worst parts of the solution to avoid making his own political crisis worse. The austerity measures identified so far are deeply unpopular in Greece and opposition parties have joined to try to kill the plan. The collapse of the Papandreou government might mean that Merkel got what she wanted on paper but that the effort killed the only Greek government that could possibly deliver those promises. The IMF and the European Union would then be faced with a new government determined to negotiate better terms. I think this leads to either a collapse of the bailout plan or a political crisis in Athens or maybe both. Bet the financial markets would really like that: A crisis with no one in charge or with the power to make a deal that’s not likely to last longer than it takes the ink on the document to dry anyway.
- The Papandreou government manages to give Merkel enough of what she wants so that the bailout plan goes through—and the government somehow clings to power. I think this only puts off the day of reckoning. The only way that Greece can escape a future where a round of budget cuts slows the economy, lowering taxes and increasing the deficit, which requires another round of budget cuts, which slows growth even more is if the Greek and European economies grow fast enough to increase Greek GDP. Greek growth isn’t likely under the kinds of cuts proposed by Merkel. European growth is projected at just 1%to 2% in the period that counts. And with the current imbalances in the European Union—Germany grows its economy by exporting but its frugal consumers don’t spend very much—it’s pretty clear that 1% to 2% growth in the European Union as a whole isn’t enough to let Greece dig out of its hole.
Greek interest rates, already 6.07 percentage points higher for Greek 10-year bonds than for equivalent German maturities, are headed higher, and the euro is headed lower against the U.S. dollar. The only questions are how fast and how short the temporary bounce from the final delivery of any bailout funds might be.