European bailout only postpones day of reckoning
Europeans just did something that they talk about endlessly in the abstract but rarely achieve in practice: They took collective financial action in a crisis.
The Europeans unveiled a big, bold package of rescue measures that caught some Euro-skeptics off guard. "We were looking for Armageddon," the manager of one big hedge fund confided. Didn't happen. Instead, the Europeans assembled a creative bailout policy that's reminiscent, in some ways, of what the Federal Reserve hammered together during the Wall Street panic of 2008.
The problem with the European package is that it postpones problems rather than resolves them. It will delay Eurobond defaults another year or two, and it will add some fiscal discipline that could eventually make the 16 eurozone nations operate more like one economy.
But there's nothing to address the deeper structural imbalances between high-saving northern Europe and the spendthrift "Club Med" countries of southern Europe that used the euro as a credit card. Basically, the north's abundance created a low-interest Eurobond market that underpriced the risk of investments in the south.
The centerpiece of the rescue package agreed to in the wee hours of Monday morning is the $560 billion "special purpose vehicle" to guarantee new loans to Portugal, Italy, Spain and other needy members of the eurozone if they're about to default on their existing debts. (Greece had already gotten its $146 billion bailout a week earlier, but it can presumably sup at this new trough, too, if the earlier package isn't enough.)
What's innovative (and potentially destabilizing) about this rescue plan is that in exchange for bailout loans, the European Commission will be able to demand austerity measures to, say, cut salaries and pensions in debtor countries. This is the sort of "conditionality" that comes with aid from the International Monetary Fund to destitute Third World countries. And in fact, the IMF will be kicking in an additional $321 billion in bailout money, with the usual strings attached.
The good side of the austerity measures is that they are a step in the direction of economic integration, which has been the missing link in the eurozone since the Maastricht Treaty of 1992. The conditionality of the rescue plan opens the possibility for a common European fiscal policy that, over time, would make the common currency sustainable.
But the austerity measures have two big drawbacks, one economic and the other political. The economic problem is that imposing harsh budget cuts and other belt-tightening on the "Club Med" countries, while appealing to German workers, may not make sense when the European recovery is so fragile.
The trickier problem is building political support for the austerity measures that are coming. Looking at Greek rioters chanting about demon bankers and government ministers who threaten their pensions is a reminder that Europeans believe in the welfare state as a matter of social entitlement. A different social contract may need to be written, more in line with economic and demographic realities. But that won't be any easier in Europe than in the United States.
The unfairness of the rescue process is galling, as it was in the United States in 2008. A speculative panic forced central bankers to come up with a scheme that, in effect, socialized the costs of the bad decisions made by private bankers and government officials. Such actions create long-running social discontent, of which the Greek riots may be just the beginning.
It doesn't help the Greek worker who may be out of a job soon, but the `underlying problem here is the global imbalance that produced a savings glut in some parts of the world (China, Germany) that, in turn, fueled low interest rates that understated the riskiness of some investments (subprime mortgages, Greek bonds).
Until those imbalances are checked, we can look forward to new asset bubbles and new panics. The "wolf pack," as the Swedish finance minister described the rapacious market, is just resting, waiting to pounce on the next overvalued sector or part of the world.
I don't envy the Chinese authorities. They're sitting atop what is arguably the last big bubble. Bloomberg News reported Tuesday that China's inflation accelerated in April, its bank lending exceeded forecasts and its property prices jumped by a record amount. As the Chinese watch rioters in the streets of Athens, they get a stark reminder of the cost of getting economic policy wrong -- and of allowing too much free-flowing capital to distort the real risks of economic activity.