How things change! On 1 January 2002,
much of western Europe rejoiced at the sight of euro
banknotes and coins in 11 countries and three
principalities. At last, Europe’s unification drive
had created a common currency which could
conceivably end of the monopoly of the US dollar.
Today, with some European countries toppling like
ninepins and others swaying drunkenly at the post,
many are wondering if it was a case of premature
The euro is a story where meticulous planning and
careful design of a common currency has been
systematically debased by political grandstanding
and poor governance of many member countries. Let me
When countries relinquish their right to manage
their own currencies, they lose a critical policy
variable and therefore need to be very disciplined
in their fiscal policy — particularly controlling
deficits and public debt. The Maastricht Treaty of
February 1992 underscored this through the
‘stability and growth pact’ (SGP). Adopted in 1997,
the SGP had six conditions that all euro countries
had to follow, of which two were non-negotiable,
• No euro nation could have an annual budget deficit
higher than 3 per cent of its GDP — which was the
sum all public budgets, including municipalities and
regions and off-balance sheet items.
• Each euro country needed to have its public debt
at less than 60 per cent of GDP, or close enough and
approaching that ratio.
It is one thing to sign off on these conditions. It
is quite another to define what actions would come
to bear if these were breached. That was the problem
— and remains so till today.
The questions were simple enough: What would happen
if a country deviated from the two core conditions?
How soon would they be punished? How severe and
credible would it be? Who would punish? Would the
enforcer get the political freedom to inflict the
punishment? Or would the political importance of a
unified currency preclude any credible punishment?
The euro’s tragedy is that no country has been ever
punished for deviating. Right from the beginning.
Here are some facts. Consider the 3 per cent fiscal
deficit ceiling. In the last 10 years, Greece has
breached it every year; Italy on seven occasions;
France and Portugal, six times; and Germany, four
Now consider the 60 per cent public debt ceiling.
Greece has broken it every year with much to spare;
so too Italy, also by significant margins; France
breached it seven times; parsimonious Germany, eight
times; and Portugal, five times. In 2011, it is
estimated that Italy will breach it again at 4 per
cent of GDP, with suspect numbers; France at 5.8 per
cent; Spain at 6.5 per cent; and Greece at 9.6 per
No country has been punished. Not even with a gentle
reminder. In such circumstances, why should be
surprising to see major collapses? The first Greek
crisis led to a May 2010 bailout that cost €110
billion. Then, Ireland tanked in November 2010
leading to a €85 billion bailout. This was followed
by a €78 billion bailout for Portugal in May 2011.
Then, on 21 July 2011, there was the second Greek
rescue of €109 billion.
The second Greek bailout is farcical. Private
bondholders are expected to show support by rolling
over or swapping their sovereign Greek debts for new
bonds that mature in 30 years, thus taking a haircut
of an extra €37 billion. Moreover, the European
Commission has committed to support Greece until it
becomes financially healthy — an act of political
grandstanding that can haunt European taxpayers for
The private sector ‘haircut’ was forced by Angela
Merkel to reduce Germany’s tax-transfer burden and
so assuage her irate taxpayers, who had just about
had enough of supporting ‘the feckless Greeks’.
Since the haircut is a decapitation, amounting to 21
per cent of the value of Greek bonds, it is unlikely
that private bondholders will agree to such harakiri.
If that occurs, we will see the first default on
euro zone bonds since the creation of the euro. No
wonder this bailout was resisted by Jean-Claude
Trichet, the President of the European Central Bank.
Investors don’t believe in the euro zone. Italy is
trembling, with the spread on 10-year government
bonds having risen to 311 basis points (bps) over
the German bund. Spanish bond spreads are 333 bps
higher; and Greek bonds are junk — at a spread of
11.76 per cent above the bund.
Europe’s leaders can do one of three things. Option
1: Pray that things pass with the Almighty’s help.
Option 2: Realise that it won’t and prepare for yet
another bailout. Option 3: Say to Greece, “Remain in
the European Union. But return to the drachma.” You
know what will happen. So, why you shouldn’t you be
bearish on the euro?
Published: Business World, August 2011