The Alchemists: Three Central Bankers and a World on Fire (28 page)

This is the voyage that the world’s leading finance ministers and central bankers made in the dead of winter in 2010. Canada wasn’t the first nation to choose a less than convenient location for an international summit, though the meeting place of the Group of Seven finance ministers that February is among the more extreme examples.

The choice could have been made for a variety of reasons: to isolate officials from any potential distractions, including any noisy protestors; to celebrate the area’s native Inuit culture; to try to persuade the Europeans that they should lift their recent ban on the importation of commercially hunted seal products; to remind attendees of Canada’s deep connections to the Arctic—and hence its rights to the region’s oil reserves. Whatever the relative weights of these factors in the Canadians’ thinking, the results of these talks at the top of the world would have far-reaching consequences across the planet.

With the temperature an unseasonably warm 0° Fahrenheit, the attendees were treated to demonstrations of igloo making and other examples of native culture. The British press had fun with a photograph of Mervyn King wearing a giant fur-lined coat and riding a dogsled. “For God’s sake, just don’t get photographed clubbing a baby seal,” said one central banker’s communications adviser on the banker’s way out the door. Or, for that matter, get caught eating any: All the officials except the Canadians skipped the final meal, at which raw seal meat was served. The Americans tried to fly home early Saturday, but were waylaid in Boston for the night; ironically, after they had experienced relatively pleasant weather in the Arctic, their plane couldn’t land because Washington was being buffeted by a snowstorm.

Wearing sweaters and sport coats rather than their usual dark suits, the finance ministers and central bankers assembled in a circular conference room at the Frobisher Inn (“the largest full-service business hotel in the Eastern Arctic”) under a domed ceiling of exposed wooden beams evocative of an igloo. Trichet made an impassioned plea to his European colleagues, one that suggested he might be changing his mind about giving Greece “special treatment”: The Greek situation wasn’t sustainable, he said. The government’s borrowing costs were rising even in the face of its deficit reduction plans. Major banks in France and Germany and Spain owned hundreds of billions of euros of Greek debt, so a worsening of conditions in Greece could endanger the entire continent’s banking system. And in financial markets, it was already becoming clear that whenever investors became worried about Greece, they also began shedding the debt of other European countries that seemed to have precarious finances, particularly Portugal and Ireland but also Spain and Italy.

Making one of his characteristic appeals to grand principle, Trichet argued that the threat wasn’t just to Greece, but to the European project as a whole. It must be taken seriously. European leaders left the Arctic with a greater understanding of what was at stake. As Trichet departed Iqaluit, the gathered reporters asked how he was feeling about Europe’s outlook. “
Confident
,” he replied.

And a second thing happened at the summit: In the isolation of the Canadian wilderness, the leaders of the world economy collectively agreed that their great challenge had shifted. The economy seemed to be healing; it was time for them to turn their attention away from boosting growth. No more stimulus. The Greek problem was seen as evidence that it was time for all the nations of the world to begin reducing budget deficits. No more ultra-easy-money policies. Even Ben Bernanke, more wary of tightening monetary policy than most of his counterparts, would explain in a presentation a few days later how the Fed planned to exit from easy money. “
We have spent considerable effort
in developing the tools we will need to remove policy accommodation, and we are fully confident that at the appropriate time we will be able to do so effectively,” he assured the House Committee on Financial Services.

Iqaluit was the moment the world’s central bankers and other financial leaders began a great pivot toward tighter money and austerity.
“The global economic situation has, of course, improved
and is improving,” said Canadian finance minister Jim Flaherty, the host of the gathering, summing up the conclusions reached in a press conference on February 6, 2010. “We need to . . . begin to look ahead to exit strategies and move to a more sustainable fiscal track.” In other words: We’re out of the woods.

It would turn out to be a wildly premature—and costly—pronouncement.

Three weeks later, Jürgen Stark, a member of the ECB’s Executive Board and the central bank’s chief economist, traveled to Athens. He was officially there as an observer of talks between the Greek government and Olli Rehn, the European commissioner for economic and monetary affairs and the euro. But there was more to his trip than that. Eurozone officials, persuaded by Trichet’s efforts in Iqaluit, were ready to offer some financial backstop to the Greek government in case it lost access to bond markets.

But they insisted that Greece enact a wide-ranging program of budget cuts, privatizations, and improved tax collection in exchange. Trichet’s belief in confidence-inducing austerity had won the day. The German government, however, wanted to ensure that Rehn and the European Commission would be adequately tough in their negotiations. That’s where Stark came in. The ECB, with its roots in the Bundesbank, could serve as a powerful counterbalance for any temptation to let the Greeks off the hook. Stark, himself German, was to join Rehn in Athens as a sort of enforcer.

When Stark walked into the room for the talks at the Greek finance ministry on the morning of March 1, Papaconstantinou visibly tensed. He initially ignored Stark, speaking only with Rehn. But Stark wasn’t shy about speaking up, and unbeknownst to Papaconstantinou, he and Rehn had eaten breakfast together that morning to plot their strategy. Divide and conquer wouldn’t work in this meeting.

The Greek finance minister presented a plan for his nation to cut its budget deficit by about a third in 2010—from around 13 percent of economic output in 2009 to 8.7 percent. That would imply around 4 percent less economic activity in Greece, which amounts to a very steep recession. (By comparison, the U.S. economy contracted 3.3 percent in 2008.) To avoid a painful contraction, the budget cuts would have to be offset by some other economic change: lower interest rates from the ECB, for example, or trade partnerships that could drive up exports, or the sort of international investments in the country that, Trichet presumed, would result from increased confidence. But the talks that day in Athens weren’t focused on the risk of recession or any steps that might relieve the pain. They were focused on the how and when of austerity.

The good news for Papaconstantinou was that both of the men on the other side of the table liked what they heard. Stark and Rehn left persuaded by the finance minister that his nation had an aggressive plan for reforming its finances, as well as the political will to carry it out. The Greeks described plans to increase the nation’s value-added tax and step up tax collection, to freeze public pensions, and to eliminate the “fourteenth month’s salary” for government employees. Greek workers, in addition to monthly paychecks, received so-called thirteenth- and fourteenth-month’s checks to cover their holiday spending and summer vacations. Cutting one of them would be effectively slashing pay for those workers by 7 percent.

“The effort is not easy, however the reduction of deficit and debt is necessary and will contribute significantly to the improvement of the economy,” Rehn told reporters. “The commission will continue to support the Greek authorities and the Greek people so that the economy will regain its viable course.” Stark, meanwhile, reported back to his colleagues in Frankfurt that Papaconstantinou was serious about budget cutting.

Even as the urbane Papaconstantinou, with his dapper suits, rimless eyeglasses, and PhD from the London School of Economics, negotiated with European authorities, there were early signs of the strain that austerity would put on Greek politics. Three days after meeting with Stark and Rehn, about two hundred members of a union group affiliated with the Greek Communist Party stormed the finance ministry, draping a banner from its roof calling on workers to rise up against the proposed budget cuts.

And the streets of Athens weren’t the only place where there was discontent. As discussion of a Greek bailout heated up, anger swelled in Germany as well. If Greeks hated the idea of losing their fourteenth paycheck or seeing their pensions cut, Germans hated nearly as much the idea of coming to the financial rescue of a country with such free-spending ways. In the pages of the
Bild,
a lowbrow, high-circulation tabloid, populist outrage at Greece turned alarmist and xenophobic. Its front-page headlines in the winter of 2010 included, “
Is Greece making the German banks bankrupt
?” and “Greeks quarrel and strike, instead of saving”—even “Sell your islands, you rotten Greeks, and the Acropolis too.”

Nonetheless, by March 2010, the pieces for a eurozone rescue of Greece were finally coming together. The morning of March 25, Trichet stepped before the European Parliament in Brussels to deliver his regular testimony about the state of the monetary union. “
Sehr geehrter Herr Präsident
,”
he began in German, before moving to a few lines in French, then, for the bulk of his testimony, English. Near the end of the twenty-two-hundred-word presentation, he inserted a single sentence that sounded so obscure that many in attendance didn’t realize its significance: “
It is the intention of the ECB’s Governing Council
to keep the minimum credit threshold in the collateral framework at investment grade level (BBB−) beyond the end of 2010.”

Translation: Even as Standard & Poor’s and Moody’s are downgrading their assessments of the creditworthiness of Greece and other European nations, we’ll allow banks to post Greek bonds as collateral at the ECB in exchange for ready access to cash. It was an explicit reversal from Trichet’s stated position of barely two months earlier; the ECB was willing to risk losses in order to keep cash flowing into Greece and prevent a fire sale if European banks suddenly started unloading Greek debt.

It wasn’t Trichet’s only reversal. German chancellor Angela Merkel had by this point changed her mind on involving the IMF in a Greek bailout, having concluded that the fund could offer not only extra financial firepower and experience, but also credibility-enforcing “conditionality,” or demands for reform. Quite a few domestic critics, as well as French president Nicolas Sarkozy, thought her new position was an embarrassment—and that IMF involvement would give the United States, the fund’s largest shareholder, power over Europe.

“She is betraying the very concept of Europe,” editorialized the
Frankfurter Rundschau
. “In calling on the IMF, Merkel calls on none other than the United States, which dominates the IMF with its blocking minority of 17 percent. What a wretched state of affairs. What a disgrace for the European Commission and the European Central Bank.”

But Merkel had a crucial ally. As late as March 4, Trichet had said that while “
the IMF’s technical assistance is very important
,” he did “not believe that it would be appropriate to introduce the IMF as a supplier of help” financially. But as the political wind shifted, so did Trichet. In a typical Trichet touch, the Frenchman barely acknowledged that there’d been any change in his view at all. “
I never said myself
, and neither have my colleagues, that the IMF did not have very good expertise,” he said on April 8, after endorsing the agreement that brought the IMF in to help support Greece.

The agreement that Trichet and the leaders of the sixteen nations then in the eurozone hashed out in Brussels that Thursday—the announcement came at just before midnight—was a classic product of the Rube Goldberg contraption that is the European decision-making process. Hours were consumed not only by meaty issues like IMF involvement, but also by the question of whether the joint announcement would refer to a “European economic government” being created to handle any Greek rescue, or a “European economic governance.” The French very much wanted the former, while a number of countries more worried about ceding national sovereignty wanted the latter. The finished product ran to only a page and a half and was exceptionally vague, essentially amounting to a promise that the governments of Europe wouldn’t let Greece go bankrupt. “Euro area member states reaffirm their willingness to take determined and coordinated action, if needed, to safeguard financial stability in the euro area as a whole,” the statement said—as if this mere assurance would be enough to keep private markets lending money to the troubled nation. Trichet promised in a press conference that “
the mechanism decided today
will not normally need to be activated.”

There were no numbers in the communiqué that might give a sense of the financial resources the eurozone governments were willing to deploy to help Greece. The amounts that sources were whispering to reporters were in the paltry €20 billion range, about a third of it coming from the IMF. Any such disbursements would require the assent of all sixteen of the nations then using the common currency; even a Slovenia or a Malta or a Cyprus could, in theory, block collective action.

It was the first time European leaders had acknowledged the reality that with the yoke of a single currency, they would need to stand behind each other. But it was also a lost opportunity. This was a time when Greece’s crisis was a relatively inexpensive one for Europe to solve; the nation’s economic output was only about 2 percent that of the eurozone as a whole. But instead of simply writing a check and guaranteeing Greek finances, the message sent from Brussels in the spring of 2010 was that while the nations of the eurozone would stand behind their weaker members, they would do so reluctantly, only when they had absolutely no other choice, with huge procedural obstacles, and on a scale inadequate to the size of the problem.

It didn’t take long for financial markets to reach exactly that conclusion. The cost for the Greek government to borrow money for a decade, 6.46 percent a couple of days before the summit, fell only to 6.28 percent the following day, hardly the move to be expected if markets were convinced that Europe stood behind Greece unconditionally. More worrisome, as the weather warmed up that spring, there was contagion in the air.