The Euro debt crisis, a self-inflicted wound, by Baard Erik Haugen

During the current European debt crisis, Germany and France have often been seen as victims of the irresponsible fiscal policies of southern European governments. But reviewing recent history, one can argue that Germany and France have only themselves to blame.

When the Euro project started in the early 1990s, a strict framework was developed to maintain the financial stability of the currency. The Maastricht treaty of 1992 outlined some important criteria. First of all, countries joining the Eurozone could not have a national debt exceeding 60% of GDP. Secondly, the nations could not have a deficit of more than 3% of GDP. The purpose of these rules was to ensure fiscal uniformity and ultimately prevent the situation the European monetary union is facing today.

Although the proper framework was in place, it was not put to proper use. Both Greece and Italy had public debt of more than 100% of GDP. Even though they did not fulfill the Maastricht criteria, they were still allowed to join the Eurozone. Admitting Greece and Italy was the first mistake made by France and Germany, the financially strong countries of the Union.

The second mistake was made in the early 2000s. In the early days of the Euro, Greece and Italy had trouble keeping their deficits within 3% of GDP. This was a breach of the Maastricht treaty and should have resulted in sanctions. However, around 2002 Germany and France also had large deficits. With the two major Eurozone-nations also breaking the rules, there was no political will to impose penalties or sanctions. Although the Eurozone as a whole experienced growth during the boom years of 2003-2007, the seeds for a future disaster were now planted.

Fast forward to 2011 and Greece was facing bankruptcy. In this turmoil, a lot of anger was directed at Greece. Their hesitance to accept the European rescue package has been seen as stubborn and their unwillingness to give up Greece’s infamous welfare benefits is perceived as arrogance. 

Seeing this from Greece’s perspective, they have little to gain by accepting the so-called rescue package. The rescue package proposed by the Eurozone was not primarily designed to save Greece, but rather it’s creditors. Coincidentally, some of the large creditors are German and French banks.  By some reports, up to 80% of the funds in the bailout package would find their way to the creditors, leaving Greece with a mere 20% of the funds.

In my opinion, Greece should go bankrupt. The perceived losers in a default, Germany and France, did little to stop this crisis from developing until it was too late. By enforcing the rules of the Maastricht treaty properly, this situation would not have evolved, simply because Greece would never have adopted the euro. Germany and France are not victims of anything but their own ignorance.

The German and French banks will indeed suffer massive losses if Greece defaults. But like the German and French governments, neither the banks can claim to be victims. In the summer months of 2011, the interest on Greek bonds soared as the country issues new debt. Interest reflects the risk and the banks should have been well aware of the risks involved. If the authorities in the Eurozone bail out Greece, or rather it’s creditors, the banks will have earned an interest rate reflecting significant default risk without actually being in danger of losing their money.

For Greece the benefit of a default and return to the Drachma would be regaining control over their monetary policies.  With the Drachma they could devaluate their currency, something that would benefit their exporters. Often, this is a zero sum game because the exporters benefit while the rest of the country suffer from decreasing standards of living. A cheap Drachma would benefit the tourism industry, one of the country’s biggest employers, and would therefore benefit the population. Also, reducing the standard of living through devaluing the currency might be more edible politically than budget cuts. 

Finally, the Eurozone would be better of if Greece defaulted and went back to the Drachma. The Greek economy has never really showed the stability and fiscal discipline that should be required of a Eurozone country.  A default will definitely not be painless, not to Greece nor its creditors. But in my opinion the alternative is worse. By keeping Greece in the Eurozone, Europe runs the risk of simply prolonging the agony and bringing a potential problem with them into the future.

Baard Erik Haugen