Why Euro’s woes should scare us all

Last Thursday, Herman van Rompuy, the European Union’s new president, corralled Angela Merkel, the German chancellor, and Nicolas Sarkozy, the French president, into his office in Brussels to hammer out a statement that would pledge support for the tottering Greek economy.

Also present were George Papandreou, the Greek prime minister, Jean-Claude Trichet, president of the European Central Bank and Europe’s top money man, and an interpreter, who dived in when Sarkozy’s ability to express himself in his patchy English failed him.

This was EU realpolitik at its most obvious, the old Franco-German axis in full cry. The concern was understandable: as the two most powerful economies that use the euro, they could not afford to see the currency laid low by its weakest member, Greece.

Sarkozy was being typically assertive. He pushed hard for specific measures to bail out Greece, becoming “theatrical” at times, according to EU sources, as he pleaded with Merkel to accept the need for solidarity. She stood firm, knowing that more than 70% of her countrymen opposed coming to Greece’s aid.

When the meeting went into its second hour, officials started worrying that the other European leaders, including Gordon Brown, who were gathered in the nearby Solvay Library, one of Brussels’s architectural gems, for a routine summit, would get “jumpy”.

Eventually, after Jose Manuel Barroso, the European commission president, joined the meeting, a deal was struck. There would be an announcement but with no specifics. It would buy time — perhaps enough for the crisis to blow over — but if not, the eurozone’s finance ministers would be meeting on Monday to flesh it out. Even then, the announcement did not go well. Van Rompuy managed to fluff his lines and had to be gently encouraged by Barroso to repeat himself.

When he got the words out, Van Rompuy committed the 16 members of the eurozone to “determined and co-ordinated action if needed to safeguard financial stability”.

It fell far short of the rescue plan for the Greek economy the markets were looking for. The euro lost value against the dollar and the pound. The stock exchanges of Europe fell.

Papandreou was not happy either. On Friday, he criticised the EU for being “timid”, attacking the institutions which he said were “multiple doctors with differing prescriptions over the patient that is Greece”.

An analyst from Société Générale, one of Europe’s most august banks, continued the medical metaphor, saying that the rescue was a “sticking plaster” and that it merely put off “the ultimate denouement: the break-up of the eurozone”.

Others fear that the crisis could have even graver consequences. If Greece’s ills are not cured it could infect other countries — much as the banking crisis spread from institution to institution 15 months ago.

Those most in the spotlight are Portugal, Italy, Ireland and Spain, which with Greece make up the dealer’s acronym Piigs. Britain, which has a comparable budget deficit, when compared with GDP, to Greece, has also entered the frame.

If they were to suffer the same problems raising money as Greece has, then the already fragile recovery of the European, and indeed global, economy could be put in jeopardy.

This is why the seemingly distant issue of Greece’s economic wellbeing is being taken so seriously far beyond southern Europe.

THE mood in Athens last week was as gloomy as the weather. Heavy rain and strong winds put a dampener on plans by many Greeks to take advantage of a three-day weekend that marks the beginning of Orthodox Lent tomorrow.

The fiscal fast faced by most ordinary Greeks is set to last a lot longer than 40 days, as they are becoming only too aware. Even the divorce of Eleni Menegaki, one of the country’s most famous television personalities, has been relegated to the inside pages as the media have indulged in blanket coverage of the financial crisis.

On taking office last October, Papandreou inherited an economic nightmare. In August, the former Greek government had said it was on course for a budget deficit of 3.7% of gross domestic product. A month later, just ahead of the election, the figure was revised up to 6%.

By January, the figure was revised up again to 12.7% of GDP amid allegations that the previous numbers had been deliberately falsified.

It was the suddenness of the deterioration, and the suspicion it aroused about all Greece’s economic statistics, that spooked the markets and provoked a crisis for the euro.

When countries have their own currencies, these act as the safety valve when budget deficits soar. A fall in the currency — of the kind that has happened to sterling — helps economies grow out of recession and makes it cheaper for foreigners to buy the country’s government bonds and other assets.

Inside the euro, however, countries have no option of devaluing, other than leaving the currency entirely. If the markets decide they do not want to hold the country’s debt, the only recourse is a bailout — which the EU leaders offered in rhetorical if not practical terms last week.

For its part of the bargain, the Greek government needs to get its deficit under control, and quickly. Papandreou has introduced an austerity package to counter some of the more egregious problems.

Tax evasion is the norm in Greece. More than half of families declare incomes of below the €12,000-a-year (about £10,400) threshold for taxation and escape paying income tax. Most businesses also pay minimal amounts of tax.

One credible estimate puts tax evasion in Greece at €30 billion annually, equivalent to an eighth of the economy.

Another problem is the bloated public sector, which employs nearly one in three Greeks. Public workers also receive the equivalent of 14 salary payments a year, with bonuses at Christmas, Easter and in the summer. A pay and hiring freeze has been announced.

Despite muted protests on the streets of Athens last week, polls show majority support for the austerity measures the government says will get the budget deficit down to a manageable 3% of GDP in three years.

But there are few precedents for a country getting its public finances back in shape so quickly, particularly starting from such weakness. New figures show the Greek economy shrank by a further 0.8% in the final quarter of last year.

Turning round an entire economic culture, which has tolerated protectionism, nepotism and corruption, will be difficult. “Sometimes in Greece, we feel like we are a mix of the American Wild West and an African country,” said Stavros Alexakis, an Athens-based entrepreneur. “When one clan is in power, it controls everything, puts its own people in the best jobs, refuses checks and balances, and blames the problems on the other clan’s past governing.

“The Wild West only changed when the US federal government intervened to correct imbalances and injustices. Maybe this is what we need from the EU.”

THE fear that they were dealing with a bunch of cowboys was what concerned many leaders in Brussels last week. “Moral hazard” is what governments worried about when it came to bailing out the banks. The theory is that if bad behaviour is “excused” in the form of a bailout, then what is to stop others doing the same in the expectation that their bad behaviour will also be written off?

Bailing out Greece would be an even bigger moral hazard; rewarding a country for falsifying its own figures and living high on the hog when it could not afford it.

This was a problem for Merkel. “Will the Germans have to work not until they are 67, but also until 69, so the Greeks could enjoy their early pensions?” wrote Frankfurter Allgemeine Zeitung, Germany’s leading conservative broadsheet, which is close to Merkel’s Christian Democratic party (CDU), last week. The German pension age has already been raised to 67, while in Greece unions are calling for a strike because of attempt to raise the age from 61 to 63.

Jochen Felsenheimer of the Assenagon fund, one of Germany’s best-known credit analysts, said: “If you save Greece, it will lead to a destabilising of the currency union. The motivation in countries like Portugal or Spain to implement decisive measures against state debts will rapidly sink.” Ireland and Italy have serious budgetary problems. Will the EU be forced to bail them out too?

[It is unclear which direction this crisis will take next. It is unlikely, though, that the French and Germans would be prepared to suffer the upheaval the collapse of the euro would engender. That is safe for now.

However, there are sure to be knock-on political effects. Some in Brussels see the problems of the past few months as a reason to bind the EU’s members closer together. Lord Mandelson, the business secretary, claimed last week that the euro had been a “remarkable success” and that in the long term it would be in Britain’s interests to join.

“The danger is that a lot of people in Brussels see this as an opportunity rather than a threat,” said Mats Persson, director of the think tank Open Europe. “A decade ago, when the euro was founded, they said that we don’t have the tools now, but when a crisis comes along we will be able to take this forward.”

Having the tools in this case would mean extending the EU’s federal ambitions so it has a big enough central budget to be able to rescue its weaker members.

Last week, Van Rompuy indicated a desire for more central control by proposing that the EU be given greater oversight of national budgets and that summits between leaders take place every month rather than just four times a year.

It was long a criticism of eurosceptics that a single currency would not work among such diverse economies without political integration. Now, precisely such failings are being used as an excuse to increase political integration.

Although Brown stood aside from the deliberations, saying Greece was a problem for the eurozone, such developments would be impossible to ignore.

If a Tory government is elected, such creeping federalism could prove an early, and perhaps defining, test of David Cameron’s premiership.