Act II: Life With the Euro (2001 to 2008)
How the euro heated up the borrowing-fueled economies of member states. Where Greece got its billions from. How the growth miracle failed to materialize. How the Germans betrayed the rules of the EU and benefited from the euro zone.
The Europeans' new determination and palpable desire to make the historic project a success was rewarded. Banks, pension funds and major investors from around the world began to show an interest in this new Europe.
Portuguese and Irish government bonds, coupled with French economic strength and German reliability, suddenly looked like low-risk, reasonable, future-oriented investments. It was at this time that the financial industry developed its new magic tricks.
Sewage treatment plant operators in southern Germany, city governments in Spain, villages in Portugal and provincial banks in Ireland got involved with Wall Street bankers and London fund managers who promised profits by converting debt into tradable securities. And while central governments tried to cap their national budgets to comply with the Maastricht requirements, municipalities piled on debt that was not documented or recorded anywhere at the European level.
Low-interest loans were available everywhere, and it was all too easy to postpone their repayment to a distant future and refinance or even expand government spending.
A loophole developed in the Maastricht Treaty. Harvard economist Kenneth Rogoff says that the rule about the maximum debt-to-GDP ratio should have been amended, and that it was wrong to establish the 60 percent limit on a purely quantitative basis without asking where the loans were actually coming from.
According to Rogoff, it would have been necessary to limit the proportion of foreign liabilities in each country's national debt. In the long run, and especially during an economic crisis, this kind of debt leads to an undesirable dependency on the vagaries of the markets.
In fact, governments borrowed excessively from foreign lenders, especially the major European banks. They accumulated what economists refer to as external debt. Deutsche Bank bought Greek bonds, Société Générale invested in Spanish bonds and pension funds from the United States and Japan bought European government bonds. The yields were not particularly high, but neither were the risks of default, or so it seemed. However, it was during this period that the monetary relationships were formed that turned Greece into a money bomb that would threaten the entire euro zone years later.
The Greeks were able to borrow at interest rates that were only slightly higher than those that the German government paid on its bonds. "The euro was a paradise of sorts," says then-Greek Finance Minister Yiannos Papantoniou.
Once they had joined the euro zone, Europe's southern countries gave up trying to sort out their finances, says Papantoniou. With a steady flow of easy money coming from the northern European countries, the Greek public sector began borrowing as if there were no tomorrow. This was only possible because the country, in becoming part of the euro zone, was also effectively borrowing Germany's credibility and credit rating.
The Greeks Establish a Debt Agency
Prior to the euro, Greece had shown little interest in the international bond market. The country was simply too small and economically too underdeveloped to play much of a role. But in 1999, the Socialist government in Athens established a "Public Debt Management Agency," naming Christoforos Sardelis as its director. Sardelis, an economist, had taught in Stockholm during Greece's military dictatorship. Now he headed a staff of two or three dozen employees.
For the first time, the Greeks tried to convince foreign investors to buy larger volumes of debt with longer maturities. The message was: Buy an attractive security from the European Union.
He worked all of Europe, speaking with every fund, Sardelis recalls. Today, he is 61 and a member of the board of directors of Ethniki, Greece's largest private insurance company. "Our task was to obtain money in the best possible way," he recalls.
Greece was soon selling packages of bonds worth upwards of 5 billion at government auctions, says Sardelis. Starting in 2001, there was "enormous demand from all over Europe," as well as from Japan and Singapore, he says. Things were going so well that Sardelis was even able to lure experts away from Deutsche Bank. Greece was in vogue. In reality, the Greeks were auctioning off their own future, without even noticing. They saw joining the euro as their goal, even though it was only a beginning.
In the spring of 2003, rates on Greek bonds were only 0.09 percentage points above comparable German bonds. In plain terms, this meant that the markets at the time felt that Greece, with its economy based on olives, yogurt, shipbuilding and tourism, was just as creditworthy as highly industrialized Germany, the world's top exporter at the time. Why? Because both countries now had the same currency. And because the markets -- as Andreas Schmitz, the head of the Association of German Banks, explained in a recent interview with the German weekly newspaper Die Zeit -- never believed in the so-called "no-bailout" clause of the Maastricht Treaty, a clause that was designed to prevent euro-zone countries from being liable for the debts of other members.
According to Schmitz, the markets were confident that "in an emergency, the strong countries would support the weak ones," a view based on European politicians' lax treatment of their own rules early in the game. Those who bought Greek bonds on a large scale at the time were betting that Europe's statesmen would break their rules if a crisis came along.
Sardelis claims that he had recognized the looming problems and warned against them. Today, he describes a mood characterized by the ever-increasing "illusion that the monetary union could solve our problems." But instead of pushing for serious reforms of Greek government finances, the Greeks simply "relapsed into old mentalities." Instead of saving being promoted, obtaining "as much money as possible" was encouraged.
Germany Undermines the Treaty
In 2002, the German government had other things on its mind than examining Greece's public finances. It was having troubles of its own, with the European Commission threatening to send a warning to Berlin. Germany was expected to borrow more than had been forecast, thereby exceeding the allowed 3 percent of GDP limit for its budget deficit. The result was not, however, an example of German fiscal discipline and exemplary adherence to European rules, but a two-year battle by the Schröder administration against the slap on the wrist from Brussels.
Few within the European Commission openly criticized the loosening of the Maastricht rules. And the Germans, together with the French -- both facing the threat of an excessive debt procedure -- were too busy undermining the Maastricht Treaty. The two countries, determined not to submit to sanctions, managed to secure a majority in the EU's Council of Economic and Finance Ministers to cancel the European Commission's sanction procedure. It was a serious breach of the rules whose consequences would only become apparent later.
The German-French initiative effectively did away with the Stability and Growth Pact, which the Germans had forced their partners to sign. The consequences were fatal. If the two biggest economies in the euro zone weren't abiding by the rules, why should anyone else?
The lapse was concealed behind political jargon. The violation of the pact was covered up with false affirmations of the pact. Its provisions were not formally abolished, but they were informally softened to such an extent that, in the future, they could be twisted at any time to benefit a government in financial trouble. The process also led to a not insignificant side effect: Executive power in Europe, supposedly held by the European Commission, which is informally known as the "guardian of the treaties," was de facto transferred to the European Council, which consists of the European heads of state and government.
Instead of bundling and concentrating the efforts of the euro zone in Brussels, as intended, national interests began emerging once again in Berlin, Paris, Madrid and Rome.
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