Greek tragedy means euro trouble

"We are cooperating with those who have more serious problems”, said Joaquin Almunia, European Union economic and monetary affairs commissioner. “We are all in the same boat”. Truer words were never spoken.

Sovereign debt is not a Greek problem, (though it is the Greek problem); it is not a European Monetary Union (EMU) problem. The explosion of deficit spending and debt is a European Union problem.

Membership in the European Union, what used to be called the Common Market, is supposed to include adopting the united currency, the euro. New EU members, like Poland and Hungary, are expected to meet the economic convergence criteria for euro qualification set out in the Maastricht Treaty within a few years of joining the EU. Their governments are instructed to discipline their budgets and stabilize their finances under the strict 3% and 60% deficit and debt to GDP limits of the Stability and Growth Pact.

“It is quite clear that economic policies are not just a matter of national concern but European concern”, stated Jose Manuel Barroso, European Commission President. The European Commission, headquartered in Brussels, acts as the executive to the 27 nations of the European Union. The smaller 16 member set that uses the euro forms the EMU.

The Greek deficit is a threat not only to the credibility of the EMU, the euro and the continued existence of the Stability and Growth Pact of the Maastricht Treaty. Greece represents the failure of the convergence criteria for accession to the euro. It is a threat to the adoption of the euro by the remaining eleven non EMU members of the European Union.

After this deficit experience, will the central European Union countries of the EMU led by Germany and France ever accept the new members into the euro without the qualifications of the Pact? But how will the governments of Hungary, Romania Bulgaria, Poland and the others promote the economic hardships necessary to meet the Pact criteria to their voters when current EMU members have transgressed the limits at will and without penalty? Why adopt the euro at all, particularly when an independent currency provides monetary and interest rate flexibility without having to give up the trade and economic benefits of the Union's common market?

Every EMU member is expected to breach the 3% deficit limit in 2010. Under the extraordinary conditions of the financial crisis and the recession that one year breach in itself would probably not sink the Stability Pact. Given time the aspiring euro countries would be willing to submit themselves to some fiscal and monetary criteria, perhaps weaker and more flexible, in order to join the euro. The European Commission could if necessary apply strong pressure through the subsidies, and trade, labor and other concessions that have been granted to the non-EMU nations.

But if in 2013 Spain, Italy, Ireland and Greece, for example, are still beyond the 3% limit, the willingness and ability of governments to undertake the discipline needed to meet the convergence criteria and the Stability Pact are likely to be minimal. The euro promise is likely to seem far-fetched and fanciful to those Eastern European electorates.

There is no easy escape for the Europeans. If the markets force Greek bond rates to a point where they begin to damage other EMU sovereign debt, then the entire government-funded continental recovery stands at risk. But if the rescue of Greece is too swift or lenient, the aspiring euro countries will hardly be encouraged to respect the Stability Pact when their turn to join the euro arrives.

European corporate bond rates have already responded to the uncertainty and doubt engendered by Greece. Corporate bond buyers have begun withholding purchases. They know that companies must clear their bond sales and a few days of waiting may provide the purchasers with better rates on bonds whose creditworthiness is essentially unchanged from last week.

The premium for Greek government debt over German Bunds, the strongest European debt and used as a standard for risk, narrowed to 3.73% on Friday after having been at a record 4.05% on Thursday.

Despite recent denials by European Union officials and earlier German and French government disavowals that they were contemplating a Greek rescue, the Athens stock market finished Friday trading 3.2% higher.

European officials at all levels, in national chanceries, in the EMU and the European Commission have been discussing in private budgetary support for the Athens government. When a plan is announced officials will go out of their way to deny that it is a bailout of Greece. They will note its strict criteria and the Greek promises to reform and the government's determination to bring its underground economy into the light. They will highlight the unprecedented nature of the financial crisis and its effect on national economies. All of these things may be true; the promises may even come true. But after this very public debacle how will any prospective euro member take the Stability and Growth Pact seriously?

Joseph Trevisani is the Chief Market Analyst for FX Solutions,LLC

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