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BY DR. JIM LEONTIADES
The Cyprus International Institute of Management
Public unrest in Greece has reached boiling point. After three years of austerity the only word from the government is that things will get worse. The fact that the country has been saved from insolvency does not appear to impress the general public.
They say that what doesn’t kill you will make you stronger. You cannot really blame the Greeks who feel that the latest Euro rescue plan is indeed killing them. Anger at the recent OXI day parade in Thessaloniki boiled over, some in the crowd even calling President Papoulias a “traitor”. A most undeserved comment, particularly considering his role in World War II.
If Greece does survive the Euro medicine it may indeed make its economy stronger. Prior to the crisis, the Greek economy had exceeded any rational bounds in its borrowing, its bloated public sector, its tax cheating, its too liberal pensions were obvious excesses which had to be corrected. Euro-zone efforts to improve these matters have been constructive. But focusing on the excesses of an individual country may disguise more fundamental weaknesses in the Euro system itself.
VOLATILE EURO-ZONE INTEREST RATES
A major problem encountered since the formation of the Euro-zone has been the soaring and volatile interest rates. Governments which feel they can manage their debt and its interest rate suddenly see that the interest they are required to pay has risen to the point where they cannot afford to finance their debt. Austerity follows.
Even members without exorbitant national debts, such as France and Belgium have seen their rates rise unexpectedly. The latest meeting of the Euro-zone in October was meant to solve this part of the financial crisis once and for all. Immediately afterwards, the rate on Italian sovereign debt surged to near danger level at 6%. A couple more percentage points would trigger another Euro-zone emergency.
The problem of high interest rates will be compounded by the recent requirement that European banks need to acquire over 100 billion Euros to reinforce their capital structure. Governments and banks will be competing in the market for funds. This will contribute to a further increase in interest rates for everyone, crowding out many small businesses also looking for funds. Just the opposite of what is needed for an economic recovery.
PRINTING MONEY
Prior to joining the Euro-zone, the central banks of the various member countries could act as a bank of last resort. National central banks could in effect “create” money which they could use to buy bonds, including their own sovereign debt. If the bond markets were for any reason nervous or not interested in such bonds, the central bank could act as the purchaser of last resort. In this manner, speculation on possible default was discouraged. Interest rates could be kept manageable. The central bank could in the final analysis print money to make up any shortfall in demand. This central bank function is no longer permitted to national governments of the Euro-zone.
Theoretically, the European Central Bank can also perform this function, to “create” money, using such money to buy the sovereign debt of member countries. Germany has adamantly opposed this. It holds the belief, one might say dogma, that such printing of money inevitably leads to inflation and high interest rates. A number of Nobel prize-winning economists (e.g. Paul Krugman and Joseph Stiglitz, along with others) profoundly disagree. They argue that the creation of money by a central bank can be controlled. It can be used to stimulate the economy while at the same time retaining interest rates and inflation at a low level.
EURO-ZONE AS AN EXPERIMENT
The Euro-zone is in fact an experiment which will test these opposing views. Much depends on the outcome. Many countries which have resorted to printing money have been punished with soaring interest rates and inflation, Brazil and Argentina are only two examples. Other countries have taken this route without incurring the predicted inflation and high rates of interest. The American Federal Reserve bank is the obvious example, having created many billions of dollars to buy its own bonds. What is the result?
The American economy has been downgraded from its triple-A rating by Moody’s but its interest rates are still surprisingly low. American 10-year bonds earn an interest rate close to Germany’s and below that of most Euro-zone countries The yield for German 10-year bonds is 2.23%, while for the USA it is currently 2.26%. French bonds have a significantly higher yield, 3.10%. Spain’s is 5.33%. Italy’s, as noted above, has just risen to 6%. Cypriot bonds currently command 11.5%. The American rate of inflation is significantly higher than that of France and Germany but at 3.9%, it is not at a level considered alarming.
Why are American interest rates so low despite a large national debt? To quote Alan Greenspan: “The US can pay any debt it has because we can always print money. So there is no chance of default”.
Only time will answer which approach is best. Unless the Euro-zone is able to overcome the volatile, high interest rates which presently seem to be a systemic feature of its monetary union, there will be more cries of “OXI”.
