Speculation against the Euro Luiz Carlos Bresser-Pereira

This speculative attack is another evidence of the need to strictly regulate the banks and hedge funds

Financial markets are incorrigible. Speculation now turns against the euro or, more specifically, against Greece, and will later attack Portugal and, subsequently, Spain – the most fragile countries in the eurozone. The price of the¬†credit default swaps¬†(CDS) aimed at protecting creditors against a possible Greek bankruptcy went from a level of 120 in October 2009 to 419 on February 9, 2010. People who buy CDS at such a high price are betting on the country’s bankruptcy, which will convert this high price into a huge profit – a bet with a strong self-fulfilling ingredient. The higher the bets, the more difficult it is for the country to refinance itself, and the higher the possibility of bankruptcy.

However, speculators are not likely to win this time. It is true that the euro has a weak point: the European Union lacks, on the one hand, a federal authority capable of demanding higher fiscal responsibility and higher transparency from its governments, and, on the other, more resources to help them when in need. Yet, although the European Commission doesn’t have those resources, European governments and their ministers of finance do.

The Greek conservative government, defeated in the last election, was irresponsible both at fiscal and exchange rate levels, putting the State and the country in debt. The public deficit rose to 12.7% while the current account deficit reached 14% of GDP. And the government lied about figures. But the new Prime Minister, George Papandreou, is a competent and cautious Keynesian economist who is already adopting a number of fiscal measures. And the European Union will certainly give Greece the necessary support.

The alternative would be for Greece to demand IMF’s support, but Europeans are not likely to agree on that. Greece is a country already well integrated into the eurozone – and IMF’s support for it would represent a support for the eurozone, something that major countries of the region will not accept. This alternative was adopted for the Eastern European countries, but those are countries that have only recently joined the European Union. The huge increase in capital approved by the IMF was justified by the need to rescue those countries, whose deficits – the public deficit and particularly the current account deficit – had irresponsibly increased. In fact, it was approved in order to rescue the major Western banks that had equally irresponsibly lent money to companies in those countries with the IMF’s support, because they would allegedly be “growing with foreign savings”.

The European Union was severely affected by the global financial crisis, because some of its major banks had followed the wave of speculation based on “financial innovations”, and also because its countries’ exports were badly affected by the crisis. The household indebtedness, however, was not as big as in the United States, and only Spain faced a real estate bubble. The eurozone as a whole did not have the kind of public deficits or current account deficits that the United States had. During the crisis, after a brief depreciation against the dollar, the euro appreciated again, indicating a higher equilibrium of the European economy.

For all these reasons, the speculators are likely to end up losing this game. But this speculative attack is another evidence of the need to strictly regulate the banks and hedge funds. The creation of money is an inherent ability of the financial system; it creates credit and finances economic development, but money is a powerful and dangerous public good that democratic societies must have control over.

(This article was first published in Folha de S. Paulo on 15 February 2010)