I never thought our European Monetary Union courses at the LSE would become so relevant so quickly. My fascination with the unfolding events only matches the sheer amazement when Lehman collapsed in the autumn of 2008. Only now it is actually recognizable - because we studied all this with the aid of Paul DeGrauwe's Economics of the Monetary Union. We studied the asymmetric shocks and fiscal decentralization and the implicit bail-out guarantee. In theory, of course. This was all theoretically possible, but come on, how on earth would a Eurozone country actually come to the brink of default? The border between the thinkable and the unthinkable is moving out constantly.
Leaving aside Ireland for now, Greece, Spain, Italy and Portugal were asymmetrically affected by the global financial crisis due to the structural problems in their economies. Even as demand recovers, their exports will not be competitive in the world markets. The only way they can stabilize their bulging public debt is by running primary surpluses. They promise to do exactly that to calm down the markets - but if they keep to their word, they will face an even more severe recession. In fact, markets question the credibility of the Greek consolidation plan given the conditions of the EUR 110-billion loan package. Analysts argue that the restructuring of the Greek debt is inevitable once the balance sheets of the Eurozone banks exposed to Greek debt are strengthened.
The bailout aims to save the banks and the institutional investors, less so Greece. Greece will pay for the ordeal now. Creditors will pay, if they ever do, a few years down the line, when they are stronger to cope with it.
What makes this story (as with any story) interesting is the politics. What are the preferences of the policy-makers, and what will they be forced to do? Will the Eurozone eventually set up a fund to support states when they are hit by asymmetric shocks? Will the Eurozone issue union-wide bonds? Will a separate fund be established to bail out European banks? Will the ECB buy sovereign bonds to help out investors? The answers to all these questions hinge on the internal politics of large member states, and the inter-state negotiations in the Eurozone.
As these talks are underway, and they will surely take a long time, Southern European states will be expected to put their house in order. This will involve public spending cuts and tax hikes across the board, but these states will also have to undertake structural reforms to reduce costs. Reduce labour costs, that is. Make the labour market more flexible. Cut wages and pensions in public and private sectors.
But will they take the bitter medicine? And should they? As the footage of Greek demonstrations was shown on TV, one Greek woman insisted in the background: "We want to live, not survive." In the greater scheme of things, we might condemn those lazy Greeks. They will have to work harder, just like the Germans - and the Eastern Europeans, Indians and Chinese.
But nowadays new ideas are circulating. Not that they have any chances of becoming reality any time soon, but they challenge the way we are used to seeing things. Dani Rodrik's proposal to establish a more flexible system, which allows countries to "opt out", would potentially lead to more segmented financial and product markets. Martin Wolf also hinted at the possibility of inherent flaws in the system by asking why countries with large current account deficits always end up in crisis. In his new book the Enigma of Capital, David Harvey argues that the "surplus capital" should be put to better uses than roaming freely and violently around the world. More on that when I finish the book.
I don't have a conclusion here, so no use trying to come up with a fancy but empty sentence. To be continued.