Perilous
Times
Euro crisis spreads and puts the world economy at risk
When G20 finance ministers meet in Paris next weekend, the stakes
will be enormous for both Europe and the world
o Heather Stewart
o The Observer, Sunday 9 October 2011
Face to face: German chancellor Angela Merkel and Greek prime
minister George Papandreou at a press conference during their
talks over Greek debt last month. Photograph: Sean Gallup/Getty
Images
When finance ministers from the G20 major economies meet next
weekend, they could be excused for having a sickening feeling of
deja vu. This time it's Paris, not London, but, just as in May
2009 when Gordon Brown brought the power-brokers of the world
economy together in Docklands, they are trying to prevent a
financial crisis spiralling out of control and dragging the global
economy into recession. This time, though, there is far less
political agreement or goodwill.
Instead of the US, where the collapse of Lehman Brothers sent
consumers and investors into panic mode, this time the focus is
firmly on the eurozone, and time is running out. Greece is on the
brink of going bust if it doesn't receive a fresh injection of
cash, and bond vigilantes are focusing their fire on the much
bigger Italian and Spanish economies, which had their debt
downgraded by Moody's on Friday. Meanwhile, many economists think
the eurozone as a whole may already have sunk into recession.
An intertwined global financial system means that's not just a
problem for Europe. The Bric economies – Brazil, Russia, India and
China – have warned that fixing the eurozone debt crisis must be
an urgent priority, while the US has seen shares in its banks
plummet because of their exposures to potentially toxic Greek
debt. The G20 heads of state meet in Cannes on 3-4 November. By
then the eurozone countries have to have a credible plan.
But for non-eurozone members of the G20, including China, the US
and the UK, this week's gathering is likely to be just as
frustrating as their sojourn in Washington, when they repeatedly
urged their eurozone counterparts to get a grip on the spiralling
crisis, and were greeted with disdain or outright hostility.
For eurozone finance ministers, there are complex, interlocking
challenges. First, they must decide whether, and for how long, to
keep bankrolling the Greeks. Greece received its first bailout
last spring, and a second rescue deal was agreed in July, against
the background of panic on world markets. Without the much-delayed
release of the latest €8bn (£6.8bn) tranche of that first loan,
Greece could run out of money within weeks but, so far, despite a
dizzying series of austerity programmes, Athens has failed to
convince its creditors to hand over the cash.
Graphic eurozone To see the full size graphic click here
Meanwhile, parliaments across the 17-member zone have been hastily
voting through the pact agreed in July, which involved increasing
the powers of the eurozone bailout fund, the European financial
stability facility (EFSF), enabling it to buy the debts of
distressed economies when they come under pressure from investors,
and to lend money to member countries that need to bail out their
banking sectors.
But the July agreement could still fall: the Slovakian parliament,
where there is widespread opposition to beefing up the EFSF, is
due to vote this week. Even if the deal is signed by all member
states, there is still intense pressure to come up with a much
more powerful response to the crisis and show that eurozone
countries are determined to contain it.
The EFSF is much too small to bail out Italy or Spain if that
became necessary, or to fill the gaping hole in the balance sheets
of Europe's banks that would open up if the debts of Greece had to
be written down by 50% or more, which many observers believe to be
inevitable.
The International Monetary Fund (IMF), which has part-funded both
Greek rescue loans, said last week that it would cost at least
€100bn to shore up Europe's banks. IMF head Christine Lagarde is
meeting France's Nicolas Sarkozy today to drive that message home.
The travails of Franco-Belgian lender Dexia, which has called for
help (for a second time) from both governments, because of its
exposure to eurozone debt, underlined the urgency.
Markets were cheered when German chancellor Angela Merkel
announced she was ready to countenance recapitalising the German
banking sector. But insiders say France is pushing a competing
plan, under which the EFSF would administer a Europe-wide bailout,
perhaps along the lines of America's "Tarp", in which the
government took mandatory stakes in all the major US banks to
temper the stigma of going cap in hand to the authorities. If each
country is left to rescue its own banks, France fears the fragile
state of big lenders such as Société Générale could imperil its
AAA credit rating.
Among the movers and shakers at the IMF's annual meetings in
Washington, there was talk of "leveraging up" the EFSF, to turn
its €440bn-worth of firepower into something closer to €2tn. But
financial experts say it's hard to make the numbers add up. Unlike
other multilateral lenders such as the World Bank, the EFSF does
not have a guaranteed call on the resources of its sponsor
governments, or "preferred creditor" status that would ensure it
would get paid even if one of its backers went bust.
That means any bonds it issued to fund its activities would carry
a risk of default, and could miss out on an AAA rating and
potentially attract a hefty rate of interest. Yet it's not clear
whether giving the EFSF a direct call on the resources of Germany
would be constitutional, let alone acceptable to the country's
taxpayers.
Until the question of the size and role of the EFSF is resolved,
the European Central Bank is the only institution that can help.
It reluctantly agreed to buy Italian and Spanish debt to bring
their borrowing costs down to more manageable levels as bond
markets attacked over the summer. But even that relatively modest
intervention cost it the resignation of two German members, Axel
Weber and Jürgen Stark, and its outgoing president, Jean-Claude
Trichet, has been extremely protective of its independence.
Incoming ECB boss Mario Draghi, an Italian whose appointment was
controversial in Germany, is unlikely to want to be seen to play a
role in bailing out his crisis-hit homeland, making the politics
of the situation even more difficult.
The past two years have seen a recurring pattern of bold
announcements, followed within weeks, sometimes days, by a sense
of vertigo when the political challenges re-emerge. But with every
passing day, the markets' expectations about the eurozone's
ability to fix the crisis rise by another notch, and the price of
failure increases. Few in Brussels or Berlin are in any doubt that
over the next fortnight the very future of the euro is at stake.