Ezrati's Economic Outlook: Europe’s Tunnel Vision

Europe’s heads of state have done a lot of summiting and deal making of late. Greece has voted more austerity. But on balance the results have disappointed again. The only genuine help for Europe’s sovereign debt troubles has come from the European Central Bank (ECB), which at last has begun to provide markets much needed liquidity. Otherwise, Europe’s leaders, though they have managed some action, seem incapable of thinking broadly enough even to begin grappling with the continent’s underlying problems.

For all the deep problems facing Europe—questions of default, of membership, of its basic political-economic model, even of the biases built into the euro—the continent’s summiteers have kept a remarkably narrow focus. They have considered just two things, in fact: (1) how to enforce haircuts on the holders of Greek debt and (2) how to enforce fiscal austerity. Though such matters are important and help for Greece hinges on their resolution, they are nonetheless a relatively small part of Europe’s problems. Until Angela Merkel, Nicholas Sarkozy and other European leaders expand their focus to deal with the fundamentals, markets and investors will show no confidence beyond that evoked by the ECB. Yet, rather than broadening the scope of their concerns, Europe’s leaders have failed even to reach agreement on the narrow goals with which they seem so wonderfully preoccupied.

On the matter of Greek bond values, they have talked private bondholders into swapping their existing holdings for only half their value in new, longer-term bonds. Since private entities hold just under 60% of outstanding Greek public debt, this haircut would cut the overall burden of outstanding Greek government bonds by almost 30%, bringing it down to about 115% of the country’s gross domestic product. But they have accomplished a little more. Though the ECB has agreed to suffer a haircut, the exact extent and nature of the deal remain ambiguous. Substantial dispute remains over whether the International Monetary Fund (IMF) should take a loss. There is also disagreement on the size of the coupon attached to the new debt. The Germans and the IMF want a low figure below 3.5% to ease Greece’s financing burden. Private holders want a coupon closer to 4%.