Germany, France Won't Let Greece Default

This morning, the bond markets decided to make Greece pay even more for money it borrows than it ever has since adopting the euro. The rate has passed 9.15%, which is 6.14% higher than Germany's, which forms the base rate for European sovereign debt since it is the biggest and best run economy in the EU. That spread is the largest seen in 12 years. Financiers, economists and investors are taking a cautious approach. They shouldn't. Germany and France will never allow Greece to default because the matter isn't an economic or financial issue. It is entirely political.

There is a parallel here between the EU of today and America's investment banks back in 2007-2008. First, Bear Stearns went, then speculators attacked Lehman Brothers, and then others. Only when the US government made it clear that no one else was going under did the speculative attack stop. The same holds true in Europe.

For the last several months, the so-called "PIIGS" nations (Portugal, Ireland, Italy, Greece and Spain) have been in precarious financial positions. Ireland has already bitten the bullet, causing a great deal of pain. Greece is under speculative attack. Next to feel the force of the global market will be Portugal because it is smaller than Italy or Spain and therefore, more likely to be breakable. Should Portugal go, Italy and Spain are not safe from speculators.

It is for that very reason that Greece will be propped up regardless of economic costs. Once a run on European sovereign debt starts, it will only stop when the eurozone is broken. Because French and German foreign policy, and indeed, to some degree, their national identities are tied up in the euro, they will protect it beyond what economists and financiers may believe are reasonable measures.

Last week, Greece announced that it did want to call on the EU and IMF stand-by rescue packages after all. Greece needs 8.5 billion euros by May 19, when its next bond payment is due. A bail-out of Greece is hugely unpopular in Germany, and there is a state election on May 9 in North Rhine Westphalia. One can expect a great deal of posturing and arguing, but the deal will get done and be announced no later than May 10. Germany may wait until the votes are cast, but the Merkel government can't wait much longer. It will, after all, take a few days to actually shift the money to where it needs to be.

This won't mean Greece is out of the woods. Truthfully, the IMF and EU offers only keep Greece afloat until the end of this year. Eventually, Greece will have to take the Irish course and get a grip on its finances. However, as the world economy recovers, Greece will see tax receipts rise a bit, and that will make the rest of the austerity program a bit easier to draft.

As for the speculators who are thinking about betting on a Greek default, this journal agrees with Greek Finance Minister George Papaconstantinou, "All I can say is that they will lose their shirts." Politics trumps economics here.

© Copyright 2010 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Ubuntu Linux.

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