Financial debt - The euro Crisis is not all Greek

 

 

Ian Bremmer

President of the Eurasia Group

As eurozone leaders face growing uncertainty in financial markets about the public finances of Greece and other member countries, their statements, while being somewhat vague, clearly underscore a much larger story – one that will force firms and investors to question their assumptions about Europe’s overall economic, financial and political environment.

Let us first dispense with a powerful emerging myth. Greece’s troubles have encouraged some to wonder aloud if the eurozone can survive its growing internal imbalances. But such doubts ignore the political and cultural factors that buttress a deep European commitment to the mission of preserving the monetary union in the face of the numerous challenges that it is faced with.

The euro was created partly in order to bolster internal market efficiency and prevent currency volatility. But it is also the product of a deep-rooted European conviction that transnational institutions and economic interdependence have helped establish and sustain peace across the continent for the past six decades. In a world of weak multilateral institutions – including a G20 beset by substantial differences of opinion on basic questions – it is more important than ever that eurozone governments bolster their collective clout in an uncertain, unprecedented, and competitive global environment.

For member states, the eurozone is simply too important to fail. It means that solutions to the many problems they now face will require adjustment to the way each of them taxes its citizens and spends. Yet, from one government to the next, the result will be massively uneven. That has been a recurring problem during Europe’s multi-decade drive for internal currency stability. This divergence on fiscal policy has many causes, and no single shock will alter it.

Understanding the increased importance of fiscal policy is complicated by confusion over how various eurozone governments actually make policy decisions – a process that relies on an ever-changing, complex mix of opaque institutional factors and domestic political dynamics that vary considerably from one country to another. In an era in which transparency and disclosure are the prevailing norm in most aspects of European governance, the politics of fiscal policy still, rather unfortunately, look like conference diplomacy, circa 1815. This is Europe’s new reality, not merely a momentary lapse in good order. Companies and investors that are exposed to risk in Europe must simply assume much more volatility in interest rates within the eurozone and increasingly uneven growth and inflation prospects. The convergence of sovereign debt yields implied and required by the establishment of the common currency need not return.

The absence of a stable framework will force investors to re-think their asset allocation decisions and risk pricing in a significant way. As the bond market begins, finally, to price in greater relative risk in eurozone sovereigns, the intellectual underpinnings of the idea of a global division between emerging-market and developed-market bonds will be fundamentally tested. These shifts will be gradual, persistent, and less predictable than what investors had come to expect during the deceptive calm of the euro’s first decade, when the currency union’s establishment, together with EU enlargement and liberalisation, appeared to create a stable and benign environment.

Finally, remarkable and lasting policy shifts will not be limited only to countries that are staring immediate financial trouble in the face. German fiscal policy could soon look very different from the zero-deficit bias that prevailed in that country under the grand coalition that governed it from 2005 until 2009. During that particular period, the deficit-reduction camps within both the Social Democrats and the Christian Democrats made common cause to fend off pressures from other factions within their respective parties for a change in policy.

That structure does not exist anymore. Today, those that are on the right want tax cuts and those on the left, now in the process of reconstituting itself, may begin to push for higher spending. No one quite believes that Germany might be at real risk of default, but investors can afford to overlook this sort of policy shift only at their own risk. After all, a significant change in policy direction within the eurozone’s biggest economy could have a much larger effect on the currency union than the developments that are currently unfolding in Greece. Given the continuing internal conflict over taxes and spending, maybe Germany, and not Greece, will become the eurozone’s first country to see a government fall.