Another EU summit passes by and still Greece has yet to get any joy from its fellow euro-zone members.  All Greece has been offered is a combination of loans from euro-zone members combined with loans from the IMF at market interest rates.  That is not what friends are for – they are supposed to lend you money cheaply when you are in a pickle.

Greece quite correctly points out that it is effectively adopting an IMF-style austerity program but without access to long-term loans at usual IMF-style interest rates of roughly 3.25%.  Instead Greece is having to pay more than 6% to borrow long-term money from government bond investors. Understandably Greece is not happy about this state of affairs.  Unfortunately the normal “3-pronged IMF cure” of a cheap loan, big devaluation and budget cuts will not work for Greece because Greece is locked into the Euro and cannot stimulate its economy to grow by devaluing its currency since the Drachma no longer exists.

The rest of the euro-zone cannot allow Greece to leave the Euro and revert to the Drachma (which would promptly collapse against the Euro).  This is because every euro-zone bank which owns Greek debt would suffer large losses on their Greek bonds.  The rest of Europe’s peripheral bond markets would also crater as investors headed for the safety of German bunds, so banks would also suffer losses on their other euro-zone debt assets which would precipitate another banking crisis in Europe. Bank runs would also take place in the weaker countries as savers moved deposits to banks located in core euro-zone countries. 

The ECB has also been forced to relax its collateral criteria so as to allow Greek government bonds to be eligible even if Greece has its credit rating downgraded in the future.  In the good old days the ECB would only lend against bonds rated A- or better but during the credit crunch the ECB decided to accept bonds rated as low as BBB-.  The ECB had planned to tighten the criteria back up at the end of 2010 but yesterday ECB President Jean-Claude Trichet confirmed that the ECB would carry on accepting BBB- bonds “beyond the end of 2010″.  It is notable that this commitment is deliberately open-ended.

The broader question is starting to arise :  Just what is the point of the Euro?

It serves Germany because the countries she exports to can no longer devalue their currencies to gain a competitive advantage.  However, as the current Greek crisis is now illustrating, when a euro-member country gets into trouble there are no benefits to euro-membership.  The markets charge you a hefty premium to borrow money and you can’t even get a cheap loan from your euro-mates to tide you over.  And you can’t devalue your currency to gain some relief either.  And you get lectured by your biggest sister that you wouldn’t be in such a mess if you had played by the rules all along.  Not much help when you are stuck.  Not much help either are the Growth & Stability Pact rules that say you get fined just when you are least able to pay (although no-one has yet been forced to pay).

The biggest draw of the Euro to aspiring members was the hope that everyone would be able to borrow at close to the interest rates that Germany borrows at.  This hope has now come seriously unstuck and needs patching back together again.  What is the point of joining a club which offers no benefits to members?