President Barack Obama’s reelection prospects may have improved slightly because the US economy is showing an uptick but the Greek debt crisis could still land a painful punch across the Atlantic in the late summer, hurting both Obama and American jobs.
Tuesday morning, European finance ministers reached a complex deal to provide a 130 billion euro bailout for Greece to prevent a government debt default at the end of March. Banks very reluctantly agreed to take a 53.5 per cent haircut on their Greek bonds but few among them expect the country to put its overall debt on a sustainable path. The austerity measures required are too severe and many banks expect disruptive social unrest.
The austerity deal underpinning the bailout has already forced a drop of at least one quarter in the Greek average wage and caused thousands of small business closures while the cost of living continues to rise. For instance, the national insurance system is on the edge of chaos because many pharmacies do not trust the government-funded health authority to refund their sales of medicines. Wholesalers are refusing to supply the pharmacies without advance cash payments and they in turn are demanding cash from customers.
As this kind of sharp pain spreads across people’s lives, Athens may find it impossible to control protests and riots without using violence. It would have to slow down the bite of austerity measures causing bailout funds to stop because of a monitoring mechanism that ties disbursement to tough austerity conditions set by the European finance ministers.
That would be a bankers’ nightmare, forcing them to take a haircut of over 60 per cent later this year to prevent a Greek collapse. Some top Greek officials and politicians are already muttering about becoming a failed state in the heart of Europe.
The International Monetary Fund is trying to put together a one trillion euro fallback package for Greece and other heavily indebted countries like Spain, Portugal and Italy. But getting non-Europeans like China, Brazil and India to pay into an international bailout of rich Europe is an uphill task. After the Tuesday meeting, some analysts said the IMF doubts Greece’s ability to get out of the mess. Chinese analysts have said that Beijing will prefer to buy influence in European governments and high-tech companies rather than lend with no strings attached through the IMF.
In a wise and bold move, the European Central Bank is providing almost unlimited loans to banks at just one per cent interest to keep liquidity flowing through the system. The new bailout will add to this relief but there is a serious moral hazard. The more the ECB intervenes, the more likely weak European banks will continue business as usual without going through their own painful internal restructuring.
Optimism has increased that European governments led by Germany are finally moving effectively to build a firewall around Greece and prevent a Europe-wide economic recession by marshaling nearly two trillion euro (including the IMF facility). But the distance between cup and lip is quite huge.
All 17 Eurozone parliaments must ratify Tuesday’s bailout and all 27 must ratify moves through the IMF, to which they will jointly contribute about 200 billion euro. Britain, which is not in the Eurozone, is refusing to join in the IMF-linked rescue and the US is also staying out so far.
The ECB is a Eurozone central bank, so Britain and the US have little or no say in its decisions. It has printed over 500 billion euro for its loan facility to banks. This is against the letter of the ECB’s founding charter but politicians are turning an expedient blind eye.
Under bailout terms, Athens must reduce its government debt to 120.5 per cent of Gross Domestic Product by 2020 but the internal structure of Greece’s economy is so dilapidated and its social welfare costs so high that even eight years are seen as too short a time. Some bank analysts think the debt may rise as a proportion of GDP in mid-2013 because of sharp shrinkage in the Greek economy provoked by austerity.
In any case, that time horizon may be too far. Things could turn south if widespread workers’ riots take off in Greece, Italy, Spain, France, Portugal, Ireland and other weaker European countries in the warmer months of late spring and summer. That unrest will impact on the US economy because Europe is still a very influential trading partner and investment destination. That would be just in time to spread a chill over the Presidential race’s final stretch.
Of course, what happens to Obama will depend on domestic American issues and the politics of the right, center and left rifts there. But the possible impacts of European disarray should not be underestimated.