Eurotrash: The Greek Bailout, the European Project, and the World’s Reserve Currency

Attentive and loyal readers of this blog will recall that I wrote, almost exactly a year ago, about China’s proposal to replace the dollar as the world’s reserve currency with the special drawing right (SDR), a unit of account used by the IMF, which is based on a weighted basket of currencies that includes the dollar, the euro, the yen, and the pound. I wrote then that this proposal had virtually no chance of being adopted, one reason being that the Europeans would be loath to abandon their new currency, which already accounted for a growing share of world reserves, in favor of a faceless accounting unit.

The events of the past few days have confirmed this view and have, if anything, reinforced the position of the dollar as the reserve currency of choice. In agreeing to a €750 billion (more than $900 billion) package to save the Greeks from the consequences of their impecunious ways and to signal that the Spaniards and Portuguese would be similarly protected should the need arise, the stronger members of the eurozone sought above all to protect the Euro, which was always about politics, not economics. German Chancellor Angela Merkel on Monday night proclaimed, in a message certainly meant for the German people,  that “for us in the federal government the most important thing is the stability of the currency.” This was not, it turned out, about rescuing the shiftless Southern Europeans but about preserving the union. It marked a possibly irrevocable turning point towards abolition of national sovereignty in the EU in favor of something we might start to call the United States of Europe. One can easily foresee a time, not far off, when France has about as much sovereignty within Europe as Vermont has within  the United States, which is to say almost none.

Henceforth, the EU will stand ready to make cash transfers to member countries whose fiscal imbalances threaten collapse and/or default on sovereign debt. France and Germany were quick to stress that it is not the EU per se but its member governments, who will make the transfers, but this seems little more than a fig leaf to hide the huge erosion of sovereignty this measure implies. It seems a foregone conclusion that what exists in practice will soon be enshrined in law or binding treaty,  and that the sovereignty of EU member states in fiscal matters will be gone for good.  As always, there will be winners and losers.

The winners certainly include investors who were long in Greek 10 year government bonds, which less than a week or two ago were trading at a 9.65 percentage point risk premium to German government debt.  In today’s European trading, the spread dropped to 4.37 percentage points with the receding probability of a Greek default. As the Euro fell to new lows, other winners may include eurozone exporters whose products will become cheaper in international markets.

The other – and arguably, the biggest – winners are those who believe passionately in the European project. The bailout all but eliminated the chance that Greece would be forced to abandon the Euro, which would have threatened the survival of the currency itself, while also halting progress towards deeper European integration, which now seems an unstoppable juggernaut. The European Commission today issued a report calling for more unified fiscal and economic policies throughout the EU, while Dominique Strauss-Kahn, the Frenchman who heads the IMF and is a likely challenger to Nicolas Sarkozy in France’s next presidential election, suggested introduction of a new European system of cross-border budgetary coordination to avert the risk of a repeat of the Greek crisis.

The losers? Britain, and citizens of other EU countries who stubbornly persist in their quaint belief in national sovereignty.  At some point it will become next to impossible for a country to remain inside the EU without signing on to the euro as well. It will become similarly hard for countries like Britain and Ireland to cling to their “Anglo-Saxon” views on business regulation and taxation (yes, I know the Irish are Celts, not Anglo-Saxons). The new Conservative-Liberal Democrat coalition government in Britain could easily founder on the European question, just as the last Conservative government did. The EU is happy to let countries like Switzerland, Iceland, and Norway enjoy free access to their markets, but it is not clear that it would be so accommodating towards Britain, a much larger country which could soon have to make a stark choice between joining the euro and the whole EU project or being booted out entirely.

As for the United States, it’s hard to tell whether we really have a dog in this fight. In the near term the dollar’s status as the world’s reserve currency  appears even more firmly entrenched.  Over the longer term, if I thought I knew what would happen I would be trying to figure out how to profit from it.