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Why Greece has the same problem as Tasmania: Kohler

โ€œPrime Minister, Lara Giddings is on line two. Sheโ€™s babbling something about wanting to leave the Aussiezone.โ€ โ€œHi Lara, itโ€™s Julia. Whatโ€™s up?โ€ โ€œListen, Julia, weโ€™ve been thinkingโ€ฆ the only way we can kick start the Tasmanian economy and have at least one Labor Party with a pulse in this country, is to devalue our […]

โ€œPrime Minister, Lara Giddings is on line two. Sheโ€™s babbling something about wanting to leave the Aussiezone.โ€

โ€œHi Lara, itโ€™s Julia. Whatโ€™s up?โ€

โ€œListen, Julia, weโ€™ve been thinkingโ€ฆ the only way we can kick start the Tasmanian economy and have at least one Labor Party with a pulse in this country, is to devalue our currency. We need to leave the Aussiezone. Itโ€™ll work, Iโ€™m sure of it!โ€

โ€œJesus Lara, youโ€™re such an idiot.โ€

โ€œSeriously Julia, unemployment here is 8.3% and rising. Iโ€™m borrowing $6 million a week and Iโ€™ve got no hope of getting the budget back above zero. The banks are shouting at me. Iโ€™ve had to sack 250 nurses for Christโ€™s sake! Theyโ€™ll vote in the anti-austerity Greens!โ€

โ€œCalm down Lara, youโ€™re getting hysterical. Look, economics is all Greek to me, but Iโ€™ve been reading Karen Maley and I know that if you bring back the Tasmanian peso and devalue it, thatโ€™ll wipe out everyoneโ€™s savings and make everything they buy from the mainland โ€“ which is everything โ€“ really expensive.โ€

โ€œAt least the poor buggers will have a job cutting down trees and making toys, and weโ€™d have lots of tourism. And I could flog cheap power across Bass Strait and get the budget back into surplus. Honestly Julia Iโ€™m at my wits end. Please let us do it. Either that or get Colin Barnett to give me a bailout.โ€

โ€œOh God, I canโ€™t talk to that appalling man, and anyway heโ€™d have to ask Gina Rinehartโ€™s permission and look what sheโ€™s just done to her kids. Think what sheโ€™d do to you! Look, Iโ€™ll talk to Wayne about it. He knows about these things. Maybe he can cook up an acronym for you, as cover for a handout. Iโ€™ll get back to you.โ€

โ€œThanks Julia, youโ€™re a pal.โ€ Hangs up. โ€œWayne!โ€

The fact that the pro-austerity, pro-euro parties are now on top in the polls in Greece buoyed markets last night, but the options for Europe remain limited and difficult โ€“ especially if Greece stays in.

The immediate, core problem in Europe is the banking system, which has been rendered under-capitalised and dysfunctional as a result of cross-border euro lending since 1993, as well as real estate bubbles in Spain and Ireland. As a result of that, the money transmission mechanism across Europe is broken.

Longer term, of course, the problem is the same as Tasmaniaโ€™s: the lack of competitiveness of smaller states within the monetary union. But the first step for Europeโ€™s leaders is to fix the banking system and get the banks lending again.

Step one: they need to be recapitalised from the centre. The equity markets wonโ€™t do it, not for a long time at least. The European Central Bank is advocating completing the European Banking Resolution Fund, possible using money from the European Stability Mechanism. If the banks can be recapitalised, as Americaโ€™s were in 2008-09, then lending can start flowing again.

Getting deposits to stay put is more difficult. Some are advocating a deposit insurance scheme to prevent bank runs, but itโ€™s not clear how that would work against losses caused by currency devaluations following an exit from the eurozone. That sort of scheme would amount to massive fiscal risk transfers between European nations, which Germany is dead against.

The ECB could do another long term refinancing operation, but the banksโ€™ problem is not liquidity, itโ€™s solvency. In fact the banks are awash with cash from the last LTRO โ€“ itโ€™s just been deposited back with the ECB.

In the meantime, until the banks can be recapitalised, there probably needs to be a new lender of first resort created. Some are suggesting that the ESM be granted a banking licence, others reckon it should be done by the creation of eurobonds.

Meanwhile, the EU needs to do more to boost growth in periphery. So far the European Investment Bankโ€™s capital has been boosted by 10 billion euros, which is expected to result in 15 billion euros per year in new infrastructure projects to boost employment, but that merely injects about the same amount across Europe as the Spanish fiscal consolidation alone withdraws.

Whatever, Germany is against it, on the basis that it would represent monetary financing of fiscal deficits.

To produce a sustained recovery in global markets the overriding need in Europe is not to persuade Greece to stay in, but to persuade Germany to allow the pace of fiscal adjustment to slow down, and perhaps even reverse for a while.

Greece, Spain, Portugal and Italy need to be given longer to return their budget deficits to 3% of GDP, by both the EU and the bond market. That comes back to Germany, since the bond markets wonโ€™t support those countries on their own.

What Germany is ignoring is that banks and sovereigns are being forced to deleverage simultaneously. That is is producing a vicious downward spiral as fiscal multipliers fall to one-to-one (a dollar of budget reduction is a dollar off GDP) and debt reduction by both the governments and the banks becomes a moving target because the economy is shrinking.

Somehow the periphery countries need growth, and they wonโ€™t get through austerity. Just ask Lara Giddings.

Follow @AlanKohler on Twitter.

This article first appeared on Business Spectator.