Euro or Drachma – that is the question

The past few days have seen the Greek prime minister George Papandreou excel in his brinkmanship when faced with the severe dissent of his electorate. When the third bailout plan was still on the table after marathon talks at Brussels on 27 October, Papandreou dropped a clanger by asking for a referendum before signing. This was the straw that broke the camel's back. The markets collapsed, knowing quite well that the Greek will never accept the bailout conditions and will certainly pave the way for an exit from euro.

This would have been the third deal to save the Greek solvency problem. In brief, it proposes the banks to suffer a 50% haircut of loans, the increase of the EFSF rescue fund to €1 trillion and a serious move to recapitalise banks. Many doubted the effectiveness of the rescue plan. Economists labelled it as patchy and without validity. It was devoid of the necessary details and confusing, while it looks more like a ploy to calm the markets... which it failed to do in the medium term.

All this comes from a drop in market sentiment, and of course mirrors the imbalances in countries' budgets. Deficits have been plaguing the economies of the eurozone since the onset of the global recession in 2008. Euro-sceptics have expressed their fears for the leitmotif of the single currency. Certainly, the British are not crying for the resurrection of the currency brandishing a large 'E' with two slashes in the middle on a blue background surrounded with gold stars.

The euro currency has now betrayed the effects of a 'hangover' suffered by some of its profligate members who lived beyond their means and funded by cheap credit. Perhaps it is worth recalling Charles Dickens' David Copperfield, who solemnly predicted that "annual income twenty pounds, annual expenditure nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery".

And misery is what has been the harbinger coming out of latest news on beleaguered workers in Greece, Portugal and Ireland. These face job losses and unprecedented austerity measures. Naturally, such bad news has percolated in the foreign currency scene, with the euro weakened to a six-month low against the yen after Moody's Investors Service reduced Ireland, Spain and now Italy's sovereign debt rating, adding to concern the European debt crisis is deepening. Irish bonds dropped following the downgrade, which came after European finance ministers failed to present a solution to the contagion that's threatening to spread to the Pasta and Pizza country (Italy under Berlusconi) and the other Club Med members.

It is no exaggeration to state that Ireland's downgrade will make it "more difficult" for St Patrick's islanders to return to a surplus anytime soon. Moody asserted that while Ireland has shown a strong commitment to fiscal consolidation and has, to date, delivered on the terms of its bailout, there are fears that latent implementation risks remain significant.

History tells us how the euro currency was launched more than a decade ago amid much fanfare and hope. It is now represented by the cumulative values of  17 disparate economies. Yes, the experiment was a bold one but unfortunately, little  every effort is made by the bureaucrats in Brussels to hold a tight rein on the euro countries to toe the line and follow the Maastricht criteria.

Paradoxically, the first ones to break the mould were France and Germany a few years back and yet no punitive measures were taken. Perhaps their banks have the most to lose if the euro collapses. So who else will come to the euro's rescue? Certainly not the British, who shied away from filling the pot of contributions in favour of Greece. Yes, many blame Greece for its profligacy, alleged corruption with its bloated civil service and low productivity. But the mystery thickens when one ponders how, up to 2007, Greece was sailing along merrily and without any major problems although its bonds funded by French and German banks have contributed to the myth that Athenians can continue to mortgage its €360 billion debt till the cows come home. Even mighty Zeus cannot wipe the slate clean for them.

The latest rescue plan for Greece reached on 27 October by Europe's policy-makers is likely to cost twice as much as previously expected if it is agreed upon. The framework for a new Greek deal emerged from two hectic days of EU finance ministers' meeting in Brussels, with the stakes raised because of alarm over the fate of Italy and Spain. Jean-Claude Trichet, former president of the ECB, led the campaign against acceding to a Greek default, and this was a pragmatic move considering the upheaval in the European banking sector (particularly French and German) if the Greek debt problem is not tackled.

Concurrently, it has been a frantic move to set up a European Financial Stability Fund as a buffer against future financial troubles. The EFSF is a special purpose vehicle agreed by the 27 EU member States, aimed at preserving financial stability in Europe by providing financial assistance to eurozone states in economic difficulty. It is a novel economic tool, as it can issue bonds or other debt instruments on the market to raise the funds needed to provide loans to eurozone countries in financial troubles. Malta's modest contribution to the EFSF shows solidarity with the beleaguered countries. Through the EFSF, Malta is to deposit a share capital of €58.4 million in approximately five tranches of €12 million, each over five years to the EU fund and agreed to guarantee up to €700 million. It was also generally accepted that private creditors would need to take part and bear losses while the eurozone bailout fund has to rise from its current €440 billion to over €1 trillion. It is only in this way that the euro can escape from its debt trap. The aim - an EU official said - was to relieve Greece's debt burden - currently at €360 billion, or 170% of gross domestic product - to about 120%, or €255 billion, in the hope of boosting recovery prospects.

That represents another €85 billion in loans on top of the planned second bailout of up to €120 billion.

The initial bailout agreed three months ago was worth €110 billion. Senior EU officials admitted that the cost of bailing out Greece and slashing its debt levels would add tens of billions to the loans granted by the eurozone countries. On the other hand, the Italian Prime Minister Silvio Berlusconi urged parliament in Rome to adopt sweeping budget cuts quickly, as Italy and Spain moved to stem financial market contagion from Greece's debt crisis spreading. Italy aims to cut around €65 billion via austerity measures.

Sadly, the euro's recent troubles have seen the currency's value reach the lowest level against the dollar and the Swiss franc, since the notion that its citizens have been spending beyond their means has given investors the jitters.

Luckily, with the trio of bad performers all measured up proper, swift attention is being given for the bad apples not to spread the rot to the whole barrel. In fact, we have seen generous bailouts to Greece (now in the third tranche) while both Ireland and Portugal have merited their bailout monies.

Evil tongues wag that the risk of contagion may spread to larger economies such as Spain and Italy. Italy is the euro region's biggest bond market, with €1.8 trillion of outstanding debt last year. But why worry when the Teutonic Knights in Berlin boast of a similar burden? In fact, the Germans carry a debt of €1.1 trillion. Obviously, it is Italy's economy that is worrying since it has started to contract, whereas the German economic engine is firing on all cylinders. The latter is growing close to 4% annually. So, 'Fairy Godmother' Angela Merkel is protecting its children, while heavily scolding the Greeks for playing truant and evading taxes, thus living dangerously.

But the solution can only be a lasting one if the major creditor country outside Europe comes in from the cold to rescue the euro.

Enter China. Rumours circulate in the bond market that the Chinese central bank is preparing to buy significant quantities of the distressed European government debt market. As can be expected, such good news have caused a flight to quality.

Back to Brussels, the new Greek deal is expected to be shaky and non-systemic, while it tries to accomplish two goals. The first is to save Greece by cutting its debt to sustainable levels, and secondly, to erect a shield against sovereign debt contagion. But the Germans, backed by the Dutch, after seeing the Greeks's fragile political set-up are having second thoughts on the political future of Pasok's government.

The prime minister is being pushed out of a future coalition and unless a stable government is in place the bailout monies will not be released. Typically, the Dutch finance minister Jan Kees de Jager uttered nervously that they "can't afford haste to become the enemy of the good... Money alone won't solve the problem".

To conclude, if money alone cannot solve the problem then it is inevitable for the Greeks to exit the euro and default on their sovereign debt while embracing the not so popular Drachma. It will be a tough journey which everyone hopes will not be the Greek economy's final swan song.

The writer is a partner in PKFMALTA, an audit and business advisory firm.

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