Has Germany been prudent or short-sighted?

 

It was billed as the eurozone leaders' package to prop up their currency union.

In practice many would see it as the German plan because:

  1. it was Germany that pushed hardest for banks and private sector lenders to the Greek government to take a 50% cut in what they're repaid;
  2. it was Germany that placed a strict limit on the expansion of the resources of the bailout fund by vetoing the deployment of the unlimited resources of the European Central Bank;
  3. and the imposition of strict new budgetary disciplines on governments perceived to be borrowing too much is a manifestation of Germanic fiscal rectitude.

Also what may gall some is that German banks even got off relatively lightly from the measures to strengthen European banks - since they're being forced to raise a relatively paltry 5bn euro in new capital.

It all means that reputationally Germany has the most to lose if the rescue flops, even if all of Europe would pay a steep economic price from such a failure.

So will it work? Well investors appear to think so, given the big bounces in share prices (especially those of banks) and the falls in prices of assets - such as German, UK and US government bonds - that are regarded as safe havens in a storm.

That said, huge uncertainties remain.

For example, technical preparations to increase the firepower of the European Financial Stability Facility, the bailout fund, are so ferociously difficult that it will be weeks before we know whether it really will have a trillion euros or more at its disposal.

Also it's unclear whether a 50% reduction in what Greece pays back to the banks represents a sufficient reduction in its debt burden to stem the vicious contraction of its economy.

What doesn't augur well is that even with this painful cut for banks, Greece's public-sector debt will still be a hefty 120% of GDP in 2020, or roughly twice the ratio deemed to be economically healthy and sustainable.

The point of course is that private sector lenders to Greece account for only a relatively small proportion of what the country owes. And the refusal of public sector lenders, such as the European Central Bank, to write down what they've lent means that the overall quantum of Greece's debts will remain back-achingly hefty.

And then there's the much more fundamental risk that the weakness in big European economies such as those of Spain and Italy turns into a severe recession - which could put a dent in their respective forecasts for tax revenues and blow up their respective plans to strengthen their public sector finances.

In which case, the German-imposed ceiling on the financial succour that the bailout fund can provide to the likes of Italy and Spain may turn out to have been short-sighted rather than prudent - and mean that eurozone leaders are back in firefighting mode sooner than they would like.

 
Robert Peston, economics editor Article written by Robert Peston Robert Peston Economics editor

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