Why Greece Loves the Euro

January 28, 2010 - There is no shortage of pessimism about Europe’s economic prospects in Davos. The subdued attitude of European executives at the World Economic Forum matches the glum forecast released by the International Monetary Fund this week, which predicts that the euro area will grow by just 1.0 percent this year, compared with 2.7 percent for the U.S., an average of 6.0 percent for emerging market economies and a dizzying 10.0 percent for China. But despite the outlook, Europe’s political leaders remain upbeat about the euro.

Greek Prime Minister George Papandreou arrived here Thursday amid heavy market speculation that the country’s debt woes could force the government to default and abandon the euro. Yields spreads on Greek government bonds have nearly doubled over the past month to about 395 basis points more than comparable German bonds, a record level for any country since the euro was introduced 11 years ago. Various reports circulating this week had Athens looking to the European Union for a bailout or seeking to sell E25 billion in bonds to China.

But Papandreou, who joked about being “in popular demand” at the forum, denied those reports and said Greece would solve its own problems. He promises to slash the deficit to 3 percent of GDP by 2012 from an estimated 12.7 percent last year by doing everything from slashing pensions to posting the signatures of public officials on the Internet to combat fraud in public procurement.

“We Greeks are responsible for putting our house in order,” Papandreou told Congress Hall. “The euro zone will help us in creating the necessary discipline to do so and give us the motivation to do so.”

The fealty to the euro may strike some outsiders as bizarre, given the depth of Greece’s debt woes and recession. Spain is also struggling inside the euro, while the Balkan states continue to peg their currencies to the euro amid severe downturns rather than devalue to stimulate growth. But the political and economic cost of giving up on the euro makes it an unthinkable step for most EU members.

"No one is going to be leaving the euro; more countries are going to be joining," Spanish Prime Minister José Zapatero told the same audience. Jean-Claude Trichet, the president of the European Central Bank, said government debt problems wouldn’t pose a threat to the euro. The task of managing a single currency for a diverse economic bloc was not much different than the Fed’s job. “Greece is not Finland, Spain is not Germany exactly as Missouri is not California,” he said.

The euro area is “a club where, if you’re a member, you’re a member for life,” says Stephen King, chief economist at HSBC. Other euro countries are fed up with Athens for providing faulty statistics that underreported Greece’s deficit in the past, he says, but they will have to help Athens get its budget under control rather than adopt a harsh stance. A Greek default would have massive repercussions throughout Europe, likely worse than the economic turmoil that followed the 1992 European currency crisis and ultimately persuaded European countries to launch the euro, he said.
Those political realities explain why one famous currency speculator believes Greece will solve its deficit woes inside the euro. “I’m actually confident they will make it,” George Soros said here.

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