The euro's troubles

http://www.economist.com/opinion/displaystory.cfm?story_id=15452803

SINCE the launch of Europe’s single currency, there have been theoretical worries about profligacy. The main fear was that free-spending countries (ie, Italy) might borrow excessively and pass either higher interest costs or the bill for a bail-out on to their sober, frugal brethren (ie, Germany). Eleven years after the euro’s birth, as Greece skids towards disaster, those vague fears have become an urgent question of policy.

The first attempt to deal with profligacy, the comically misnamed stability and growth pact, was never going to work. Neither the threat of fines on miscreants unable to afford them nor the euro area’s ban on bail-outs was credible. Yet in the past few months Greek bond yields have widened spectacularly against German ones, as lenders have rightly begun to ask what plans there are for euro-area countries in trouble—and, in the silence that followed, to fear a sovereign default.

What should be done? The aversion of most euro-area countries to a bail-out is understandable, even laudable—nothing would encourage reckless spending like the knowledge that other countries were ready to step in. Greece is especially undeserving (see article). Although some of its problems have been brought on by global recession and by speculators, almost all the blame lies at home. Blatant Greek fiddling with the national accounts to disguise government borrowing has shot to pieces the country’s credibility, both in the markets and with other euro-area members. Deep structural weaknesses in the Greek economy have been left to fester. For a decade or more Greece has lived far beyond its means. Savage austerity is now inevitable. Yet, although the newish Socialist government of George Papandreou has promised to reduce borrowing below 3% of GDP by 2012, that may prove too unpopular to carry through (see article).

A messy Greek default would harm almost everybody. As markets and governments know only too well, behind Greece stand others: Portugal, Ireland, Spain and even Italy, the world’s third-biggest sovereign debtor. Hence the selfish case for other euro-area countries to help. There is plenty of money around. The EU can advance structural-fund aid that is due to be paid in future years. The European Investment Bank can lend more. There may even be scope for a direct EU loan (but not one from the European Central Bank, which under the Maastricht treaty should not bail out euro-area governments).

Look to Washington

The harder question is how to ensure that any help does not undermine reform—that it comes with conditions that promote sound policies, including deep budget cuts and structural reforms. What Greece needs is an outside agency to urge the government on and stiffen its resolve to face down protests if necessary. The answer is to turn to the IMF.

Many in Greece (and the rest of Europe) see calling in the IMF as a humiliation, for the euro as much as for Greece. They also fear stringent IMF conditionality. Yet stringency is just what is needed. In principle the European Commission could monitor performance and impose conditions (or a new European Monetary Fund might do so). But because Greece is a full member of the EU and the euro, any European lender would find it hard to convince markets that it could hang tough against political pressure and social protests. In contrast, the IMF is independent, can afford to be unpopular and has experience of bailing out indebted governments that nobody in Brussels (or Frankfurt) shares. It is, moreover, already dealing with other EU countries such as Hungary, Latvia and Romania.

It is true that the fund’s role in a single-currency zone would be to help avert a sovereign-debt crisis, not to offer classical balance-of-payments support. But its expertise in drawing up austerity measures and reform programmes would be just as valuable. It may be embarrassing for a euro member to need the fund’s assistance, just as it was for Britain in 1976. But the Greeks should be ready to turn to the IMF before they lumber themselves with an even worse fate.