Euro – a Greek tragedy
Dubai, as I said when the specter of default loomed large, was symptomatic of a bigger global problem of a sovereign debt crisis. Greece is symptomatic of the problem that the Eurozone (and, by default the Euro) currently faces. Success of Eurozone depended on strict internal discipline by the members. Problem was the different stages of economic growth in different countries. Fact is, many of those nations who aspired to be a member of the much avowed group of countries, did not really care for the discipline expected out of them. The problem was exacerbated by the fact that there was a uniform monetary policy across members as was the uniform deficit target. Sure France and Germany sent out wrong message by violating the deficit targets without inviting sanctions, thanks to the clout they enjoyed. The smaller economies thought that they would continue to enjoy the benefits of being a member without being disciplined. The credit fuelled growth enjoyed by them without the adequate checks and balances meant that, when the global environment turned around for the worst, they paid a heavy price for their lack of discipline. And they did not have ammunition to fight given the centralized policies.
Make no mistake, the PIGS (Portugal, Ireland, Greece and Spain) economies are in real danger of sovereign default and the only way that can be averted is by forcing all of them to drastically reduce the deficit, meaning to say that the government should cease to play the role of propping up the economy. In the current environment, this would lead most of these economies into another bout of recession. And this will pull the others alongwith. Also, as the risk perception increases, it can lead to an increase in risk premium in the interest rates, which can also slowdown the recovery process.
Essentially what this means is that Euro will continue to be weak. And, by default, the US dollar will strengthen, more so given the likely flight to safety. Since its December low, the dollar has already gained more than 10% vis-à-vis Euro and as a result, the trade weighted dollar index is also moving up. My feeling is that, the dollar will generally remain strong, although it will continue to be volatile, given that the US economy itself is on a weak wicket. However, sustained weakness of the dollar is not on the cards now.
Comments
One wonders if the common currency is only effective in good days and creates trouble during recessions. As per Keynesian prescription deficit financing becomes a necessity during bad times which makes it difficult for member nations to borrow and spend to come out of recession. Different countries have different fiscal level of comfort and they would be entitled to enjoy this if they had free will on monetary side. The issue of morality apart (and Greek Government was certainly involved in hiding the truth), Greece and some other countries will still end up countering excess deficit in next few years unless they return to neo-classical theme of laissez-faire and invite social and political unrest for considerable time. The other point, off course, is that would they be able to attract the means to finance their needs if they do not resort to the necessary evil.
Posted by: Dev Ashish | February 25, 2010 11:28 AM