Europe buys another breather

Another European bailout package, another relief rally. Not only European share markets, but stock markets around the world, blew off the champagne corks amid relief that the much-feared crisis had, once again, been averted.

But then morning came, and someone looked out the window to see the neighbours, the bond markets. They hadn't joined the celebrations. In fact, they had gone about their business, and were now going through the party expenses and preparing the bill.

That bond markets did not rally as the stock markets did may be a worrisome omen of the latest European rescue plan, agreed last week. That plan is bolder than any before. However, the devil will be in the detail. Over the coming days, as the details emerge, yet another plan may slowly unravel.

Interestingly, the Europeans took a page out of the Jamaican playbook when they based the Greek rescue plan upon a debt swap. This will require holders of Greek government debt to take a 50 per cent cut in the value of their holdings. Since Greek bonds were last week trading on open markets at less than that, it can be expected that bondholders will leap in to take advantage of the deal.

Compliance rate

But there's no guarantee. One thing Jamaica's debt swap had going for it, was that the debt in question was held by local banks. It was easy enough to gather them around the table, and use a combination of pressure and patriotic appeals to get them to buy in. The result was an extraordinarily successful compliance rate.

In Greece's case, though, bondholders are largely foreign. If they are fed up with Greece's dodgy bookkeeping, they may decide to hold out for better, convinced that the Germans will sooner or later have no choice but to step in. Should that happen, we will find ourselves on the road to yet another crisis.

A fundamental problem in the rescue package is that it does not deal with the mad uncle in Europe's attic. European politicians are constantly dancing around the apparent tension built into a monetary union that lacks a fiscal equivalent. In the absence of an effort to remedy this, what the constant improvisations do is create, de facto, an increasingly united state.

Except that instead of being founded on some kind of political union, it results from increasing control of the paymaster: Germany. When Jamaica's debt mushroomed out of control, it was, in large part, because of contingent liabilities. The central government had a fairly good grasp on its finances. However, public-sector bodies were running up lines of credit, secure in the knowledge the Government would pay the bills.

Public-sector payrolls

Think of countries like Greece or Italy as Europe's contingent liabilities. But unlike Air Jamaica, it's not so easy to dump them. One can expect the conflicts to only worsen. Germans are fed up with underwriting what they see as the profligate ways of the southern Europeans, who pad public-sector payrolls with redundant workers and offer pension benefits that have not been funded. The new plan envisions European growth bouncing back fairly comfortably in the next few years. The region is expected thereby to gradually grow its way out of debt. But this, too, may be a tad optimistic. It would be a brave punter who put all his money on a bet that the economies of the West will see strong growth, without first dealing with their structural problems.

Meanwhile, there are reports that the Chinese may put some money into the rescue plan. Jamaicans complain of the International Monetary Fund (IMF) being able to call the shots, but I would rather have the IMF call my tune, than know the Chinese may be able to do it some day.

All in all, it's probably a bit early to say the worst is past in the next leg of the financial crisis.

John Rapley is a research associate at the International Growth Centre, London School of Economics and Political Science. Email feedback to columns@gleanerjm.com and rapley.john@gmail.com.