Komal S.

Sri-Kumar
Chief Global Strategist

February 16, 2010

Greek Bailout: This is A Trojan Horse!

One of mythology’s most vivid lessons in unintended
consequences is the story of the Trojan Horse – the
sneak attack that enabled Greek soldiers to secretly
enter and destroy the ancient city of Troy. I fear the
Eurozone powers may be reenacting this story in their
efforts to rescue Greece from a debt crisis, only this
time, they themselves are building the Trojan Horse
that will soon haunt them. Advice: beware the bailout
of Greece, it brings unintended consequences that
could weaken the entire Eurozone.
By way of background, it is worth recalling that
Greece was not among the founding members of
the Eurozone in 1999, instead gaining admittance
in 2001 after convincing founding Eurozone members
that Greece had the necessary fiscal discipline to join
the monetary union. The move to the euro immediately
of the fiscal deficit. The estimated deficit figure for
the year was raised all the way from 3.7% to 12.7%
of GDP! When investors learned of the higher figure,
more than four times the Eurozone’s limit, they
punished not just Greek debt, but the debt of Portugal
and Spain as well. Spreads on Greek bonds vs. the
German Bund, and the cost of obtaining insurance
against a Greek sovereign default, both increased
significantly, demonstrating a clear lack of confidence
in Greece’s ability to manage its way out of the crisis.
The result: a widening debt crisis that has set in
motion what is now widely characterized as the most
serious crisis of the Eurozone in its brief history.
Greece: Public Spending (% of GDP)
52%

benefitted Greece – concerns about its currency, the 50%

drachma, evaporated, and investor doubts about Greek
monetary policy quickly disappeared. The drachma 48%

was replaced by the euro, and monetary policy for the 46%
Percent

entire Eurozone was administered out of Frankfurt,

not Athens. Soon, Greek businesses and consumers 44%

had access to a stable currency and lower interest 42%

rates, and growth accelerated. It was exactly the kind
of economic stability the Eurozone had promised, 40%

and with the staging of the 2004 Olympics in Athens, 38%

Greece appeared to be a commercial for Eurozone 2003 2004 2005 2006 2007 2008 2009

success. Sources: Eurostat

The temporary prosperity, however, hid a dirty

economic secret: a continuing lack of fiscal discipline
in Athens, where government spending was surging,
causing government debt to grow much faster than
the underlying Greek economy. The current debt crisis
came to light only when the new Papandreou
government disclosed in late 2009 that the previous
government had doctored and under-reported the size
The Greek Crisis Exposes the Eurozone’s
Structural Weakness
The crisis in Athens is clear evidence of a deep
structural flaw in the conception of the Eurozone:
it was created as a monetary union in the absence
of a political union, and without a capacity for fiscal
transfers between nations. The 16-member countries
operate their fiscal houses independently, with no
coordination, or even close monitoring, by a central
authority. Fiscal policy is, at best, a hodge-podge.
To borrow from another well-known myth, this is the
Achilles Heel of the Eurozone: not just a lack of
coordination in fiscal planning and policy, but the
growth in public spending belong in this category.
Still, as hopes for Greece being bailed out rose, CDS
spreads, which measure the cost of insuring against
the risk of default, fell in the case of Greek, Portuguese
and Spanish debt over the past few days.
Five-Year Credit Default Swaps (USD)
450

inability to use coordinated monetary and fiscal policy 400

to respond to an economic downturn. The region has 350

16 separate fiscal policies, each subject to the political 300

B asis Points
whims of the authorities and taxpayers in 16 countries. 250

This sharply reduces the ability of the European Central 200

Bank to respond swiftly and effectively to problems as 150

they arise. In contrast, this is one of the acknowledged 100

strengths of the U.S. system: the ability of the U.S. Fed 50

and the U.S. Treasury to coordinate monetary and 0

fiscal policy, both in good times and bad. Fed

10

10

10
09

09

10

10

10
09

09

09

20

20

20
0

0
20

20

20
/2

/2

/2

/2

/2
5/

2/

9/
5/

2/

9/
Chairman Ben Bernanke accomplishes some of this

/1

/8

12

19

26
1/

2/

2/
/1

/2

/2
12

12

1/

1/

1/
12

12

12
coordination in the simplest of meetings: frequent Source: Bloomberg Greece Portugal Spain

private luncheons with Treasury Secretary Geithner.

The president of the European Central Bank, Jean-
Claude Trichet, has no such lunch partner, and no
such opportunity for policy coordination with any of
the 16 Finance Ministers. Instead, he has 16 very
different governments to deal with. To confuse
matters, he now knows one of those governments
hasn’t even been telling him the truth about its fiscal
state.
If Europe rushes to the aid of Greece, it will be bailing
out and backing a country that has yet to demonstrate
the political will to enact tough austerity measures.
Every indication is that Greece will relapse and need
additional help. Should resources be used now to
bolster a country that seems likely to fail again,
probably in just a few months?

Greece: Fiscal Deficit (% of GDP) Furthermore, a rescue of Greece sends the wrong
14 message to other Eurozone governments facing tough
12
fiscal choices. Why would Portugal or Spain take the
painful steps necessary to put their fiscal houses in
10 order if Greece was not required to do the same? Why
8
not just wait for the next bailout from Berlin?
Percent

6 And lastly, why should the taxpayers of Germany, who

4 have an incipient fiscal problem themselves, be forced
to bail out Greek politicians and civil servants who
2
failed to make tough choices? Such a one-sided
0 sacrifice fosters the exact opposite of regional unity:
2001 2002 2003 2004 2005 2006 2007 2008 2009 indeed, it is likely to breed resentment in Germany and
Sources: Eurostat & TCW Global Strategy
ultimately weaken the Euro zone’s unity. Not
surprisingly, the tough negotiating stance taken last
week by German Chancellor Angela Merkel – she is
A Bailout for Greece is Bad for Europe reported to have made specific demands even on how
much the Greek value added tax should increase by in
A principal reason for the growing uncertainty order to qualify for external assistance! – has
surrounding the situation is that in the Eurozone overwhelming support with the German electorate
charter, there is no mechanism to bail out a member even as it threatens further Greek protest marches.
unless the difficulties are due to natural causes, or
stem from forces “beyond that member’s control.”
It is hard to argue that falsified data, and relentless
The Greek Bailout, in this sense, is indeed a kind of
Trojan Horse – if it is allowed into the Eurozone, it
brings with it problems currently limited to Greece,
and spreads the pain throughout the 16-nation union.
It is planned contagion.
I would suggest that the long-term interests of the
Eurozone are better served by denying Greece a
bailout, even if it means that Greece withdraws from
the Eurozone and, in the process, weakens the euro
significantly, say, from the recent $1.35 – 1.36 level to
$1.20. A weaker euro would actually be quite popular
in export-oriented Germany, and be generally
welcomed in the entire Eurozone as enhancing the
competitiveness of the region. Also, inflation is
currently well below the ECB’s preferred level of around
2% allowing room for any inflationary consequences of
a euro depreciation to be manageable.
would have a beneficial impact on the medium-term
course of Eurozone inflation and of the euro itself.
Leaders of the Eurozone should view the Greek debt
crisis as an opportunity to correct for weaknesses
inherent in the system’s structure. Since absence of
organized, fiscal transfers is a major factor in the
escalation of the current crisis, authorities need to
devise steps for providing fiscal assistance when
necessary and justified. The Eurozone needs to move
toward becoming an economic union supported by
consistent regional fiscal policies which are monitored
more closely than they have been in the past. Such a
coordinated policy would begin with a Stabilization
Fund, and might even provide the rescue Athens
currently needs. But saving Greece should not be the
main goal. Building a stronger Eurozone is more
important than saving Greece.

Second, absence of a Greek bailout would lower the

risk of moral hazard inherent in Portugal and / or
Spain following in the same path if Greece does receive Komal S. Sri-Kumar
a bailout. Despite the temporary weakening of the Komal S. Sri-Kumar
Chief Global Strategist
euro that might result from, say, Greece’s departure
from the Eurozone, the emphasis on fiscal health

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