Last Friday, as leaders in Europe squared off over a high-stakes bailout for Greece, Robert Mundell, the Canadian-born economist widely regarded as the father of the euro, was in Bulgaria attending the world chess championship. It’s been more than 40 years since Mundell laid out his vision for a common European currency, work that earned him a Nobel prize in 1999. And after making the ceremonial first move of the match—akin to tossing out the first pitch in baseball—Bulgarian reporters asked the 77-year-old Columbia University professor to sum up the Greek drama in chess terms. Was Greece in check, or checkmate? In other words, does the country have any hope left, or is it game over? “I would rather describe the current situation as zugzwang,” Mundell reportedly replied, using the German term to describe the moment when a player is forced to make a move even when it’s going to be harmful. This financial game cannot finish with a checkmate, he assured. There won’t be a losing side.
If only it were that certain. The European debt crisis has shaken the region to the very core, pitting rich nations against poor, savers against squanderers and speculators against moribund economies. Last weekend, when the 16 European countries that have adopted the euro, along with the International Monetary Fund, finally agreed to a massive $146-billion bailout package for Greece, it was a desperate last ditch effort to stop the contagion from spreading to several other struggling nations, including Portugal and Spain. In exchange for the life preserver, Greece has been ordered to slash its bloated public service and hike taxes.
But this is about much more than just bailing out incompetent politicians and overpaid public servants in Athens. The way the Greek drama played out has made one thing blindingly clear: the last two decades of prosperity merely papered over the deep political, economic and cultural fault lines that still criss-cross Europe. Far from a seamless political and economic union built on the notion of a common currency, Europe remains a region marred by deep mistrust and resentment between countries.
Now, more than at any time since its creation, observers are openly talking about the end of the euro, and the way that could rip apart the fragile ties that bind the larger 27-member European Union. Looming ominously in the background is the continent’s dark history of conflict and strife. “A failure of the monetary union would call the whole European project into question,” Peter Bofinger, an economist and member of the government-appointed German Council of Economic Experts, wrote in the newsmagazine Der Spiegel last week. “European integration has made it possible to transform a continent that was devastated by wars into a place of peace and prosperity for over half a century. It’s not just money that is at stake today. It’s also a question of political stability in Europe.”
And, by extention, it’s a question of whether the fragile global economic recovery can continue. Europe is the world’s largest trading bloc, and it’s Canada’s second-largest economic partner after the U.S. If Europe tumbles into a financial crisis, it will undoubtedly make its way here.
This is the first real test for European integration. And it’s shown that Europe is not just broke, it’s dangerously broken.
When Greek Prime Minister George Papandreou went on TV to say his country had gone, Greek sailor’s cap in hand, to the IMF and its European partners for a bailout, he could well have been recording a tourism spot. He stood under sunny skies, with a row of riverside Mediterranean villas behind him. But the cheery landscape couldn’t have contrasted more with the dark warning he had for the nation. “We are at a historic crossroad to save the country,” he said. “The only red line my government has is not to allow the country to become bankrupt.” Unfortunately for the world, Papendreou’s urgent call for reform comes years too late.
Greece’s economy, which was a bloated, dysfunctional mess when it was allowed to adopt the euro in 2000, has only gotten worse. By some estimates, 20 to 30 per cent of people are employed by the government, many of whom automatically qualified for two-month bonuses in addition to their annual salaries. Workers in “hazardous” jobs, including both miners and musicians, get early retirement (50 for women and 55 for men). Meanwhile tax evasion and the black market is rife, robbing Athens of roughly $30 billion a year.
The global recession has exposed Greece’s wasteful ways in brutal fashion, as well as those of countries elsewhere in Europe. In order to fund their stimulus plans when the global recession hit, countries borrowed heavily. Last year, countries in the European Union rang up deficits equal to 6.8 per cent of total GDP, up from just 0.8 per cent two years earlier. Those deficits are forecast to rise further this year.
But even those startling figures don’t tell the full story. The real danger lurks in the disastrous finances of a group of countries known unflatteringly as the PIIGS—Portugal, Italy, Ireland, Greece and Spain. Those countries face deficits this year that are twice as large as the rest of Europe. Making matters worse, Greece’s previous government had until last October concealed the true state of its finances. Overnight the country’s deficit more than quadrupled. Meanwhile, the country now faces a debt load equivalent to 124.9 per cent of GDP. Add in all the other promises it’s made for pensions and health care benefits, and Greece’s total obligations are nearly nine times larger than its economy.
Not surprisingly, the news roiled debt markets. Soon investors began to question whether Greece would be able to repay its staggering debt load, including hundreds of millions it owes to other European banks. In turn, that has driven up borrowing costs for Greece sharply. Yet despite the risk of Greece defaulting on its debt, Germans were adamantly opposed to any bailout. “It’s been repeated so many times it’s a cliché, but why should German BMW workers be bailing out public sector workers in Athens?” says Jeffrey Kopstein, director of European, Russian and Eurasian Studies at the University of Toronto.
Indeed, the whole debacle has raised the ire of ordinary Germans, not to mention Chancellor Angela Merkel. For months she resisted a bailout for Greece, going so far as to suggest it was a mistake for the country to have been allowed into the eurozone in the first place. One key reason for her opposition is an upcoming regional election her party faces this coming weekend in North Rhine-Westphalia. But her views echoed those of many Germans. The country’s media has been the most vociferous of Greece’s critics. The conservative-leaning daily Frankfurter Allgemeine recently published an editorial cartoon advocating kicking Greece out of the European Union and returning it to the Turks, under whom the country endured 400 years of Ottoman occupation.
Amid the acrimony, old and dangerous animosities have boiled to the surface. A German magazine called Focus ran a cover photo of the famous Venus statue, the middle finger thrust in the air, with a story that accused Greece of being a “traitor” to the euro for its excesses. A Greek paper responded by running a doctored photo of the statue that stands above Berlin’s Victory Column with a swastika in her hand. Greek Deputy Prime Minister Theodoros Pangalos even accused Germany of holding out on billions of dollars of war reparations.
Such conflicts send worrying signals to European observers. It’s always been understood that countries in the eurozone would come to the rescue of their brethren in troubled times. “This is the first real test of whether these countries will come to the collective economic defence of one of their own,” says Kopstein. “It raises the central question of the European Union: how much solidarity is really there?”
But when Standard & Poors, the debt rating agency, slashed Greek bonds to junk status in late April, even the Germans couldn’t put off taking action any longer. The three-year, $146-billion bailout package will see eurozone countries cough up the bulk of the money. In return, Greece has promised to hike taxes on alcohol and tobacco by 10 per cent as well as additional taxes on luxury goods. It must slash the size of its public sector, while putting an end to early retirement. In all, it’s a remarkably ambitious attack on spending that aims to cut Greece’s deficit-to-GDP ratio all the way back to three per cent, the eurozone’s stated cap.
Despite the sheer scale of the rescue plan, some experts have already said it won’t be enough. “The announcements will not mark the end of the Greek debt crisis, nor will they constitute a much-needed turning point that can be sustained for many months,” Mohamed El-Erian, chief executive of Pimco, the world’s second biggest bond fund, wrote in a report earlier this week. At the same time, Greeks have continued to riot en masse against the austerity measures. Everyone from teachers and librarians to the country’s air force have shut down the Greek economy in recent weeks, raising questions about whether Papandreou can live up to his promised cuts.
There are hopeful signs the message is getting through. Last week, in the heart of Exarchia, the rundown bohemian district of Athens, many residents continued to harbour deep resentment for “the rich,” “the banks” and the IMF. Yet some, like Nikos, a 29-year-old graphic designer who still lives at home with his mother, recognize they, too, have played a role in bringing profligate Greece to the brink of insolvency. Everyone is to blame, he told Maclean’s. “We can’t just blame the 300 [MPs in parliament]. There are 11 million of us in Greece. It’s a whole bordello here.” Adds Angeliki, a bartender: “Everybody thinks about how to steal money. They’ve been doing it for the last 60 years. Now we’re broke.”
Such realizations on the part of Greeks are good. Unfortunately, Europe could face much bigger problems before this is done. “The bailout for Greece may be painful but it’s manageable,” says Kopstein. “Where things would get weird is if one of the big economies went, like Spain. If that happens, all bets are off.”
If the news coming out of Europe about financial contagion has a familiar ring to it, that’s because we’ve seen this before. In 2008, as the subprime crisis gripped Wall Street, vultures circled the big banks and insurance companies, speculating on which one would fall next. The bailout of Greece was meant as a vote of confidence to put an end to such speculation. It hasn’t worked. Now many see it as just a question of which country will be hit next. “It’s not a question of the danger of contagion,” the secretary general of the Organisation for Economic Co-operation and Development, Angel Gurria, said recently. “Contagion has already happened. This is like Ebola.” And with stock markets in Canada and the U.S. tumbling on fears about Europe, it’s clear no place is safe.
Around the same time that S&P, the debt rating agency, cut Greek government bonds to junk level, it also took aim at Portugal and Spain—the latter saw its debt rating fall to the same level as Slovenia. Many see Portugal as the next likely country to require some sort of assistance from its partners. But the bigger fear is if Spain falls. That’s because while Greece and Portugal each account for just two per cent of the European economy, Spain makes up one-tenth of Europe’s GDP. “Frankly there would never be enough resources in Germany or France to bail out Spain,” says Philipp Bagus, an associate professor of economics at Madrid’s Universidad Rey Juan Carlos. “It would actually push them to the edge of bankruptcy.” Indeed, David Mackie, chief European economist at JPMorgan, warns the bailout cost for Greece, Portugal and Spain could hit $800 billion. Other estimates have topped $1 trillion.
Spain is by no means certain to get hit. While it has a larger deficit than Greece, Spain’s debt relative to its GDP is half the size. Yet the country faces its own set of acute problems that make it susceptible, not the least of which is raging unemployment. Last month Spain’s unemployment rate hit 20 per cent, while for youth it’s as high as 40 per cent. Some economists fear that as Spain enforces its own austerity measures, that will slow the economy even further—making the relative size of its deficits grow, rather than shrink. But Bagus says Spain has yet to take its debt crisis seriously. “The austerity measures that have been put in place aren’t even worth calling austerity measures,” he says. “If anything, this bailout for Greece sends a message to the Spanish government that it can continue to do nothing.”
Whatever the outcome, Europe is potentially headed for a decade of stagnation. And that has many worried. “If the immediate threat is speculative attacks, the long-term threat is low growth,” says Peter Hall, a political economist at Harvard University’s Center for European Studies. “The European political system is very vulnerable to a resurgence of the radical left and radical right, and if unemployment remains above 10 per cent in these countries for another five years, it will bring them out of the closet.”
This crisis has spawned no shortage of suggestions for how to fix Europe. Does the region need tougher penalties for countries that overspend? Or since Greece has shown how easy it is to hide staggering deficits, should Europe centralize control over spending and budgets? And would countries ever agree to surrender their purse strings to bureaucrats in Brussels? Europe has been able to shunt aside all of these questions during boom times. But no longer. The test now is whether the solidarity between the countries of Europe is deep-rooted enough to see it through the crisis. “A lot of people say the EU is like a bicycle that has to keep going forward to stay upright,” says Kopstein. “Once you stop going forward toward integration, the potential for pulling these things apart is very real.”
As for Mundell, the father of the euro, he’s watching all this closely. Despite all the concerns, he, like most, remains generally optimistic the euro and European Union will bind together to weather the crisis. “It’s the best game that Europe has,” he told Maclean’s from his home in Italy, a 15th-century castle near Siena.
But there’s something else that leads him to believe Europe will pull through, and that’s the catastrophe its leaders know would ensue if they fail to hold it together. “If it broke up it would be very harmful for Europe,” he says. “It would recreate the old problems again of Germany dominating the continent of Europe. As the prime minister of Greece said, there are big, drastic steps that have to be taken, but the alternatives are much worse.”