The rescue package adopted last week by the members of the eurozone could temporarily help Greece refinance itself in acceptable conditions in the coming months. However, the package has not changed the fundamental situation:

- The other eurozone countries are in a too fragile state to be able to provide any real sustainable assistance to Greece, particularly taking into account their massively unfunded pension liabilities;

- Lending to Greece might enable the country to face up to its short-term liquidity problems but will not resolve its solvency problem. Greece has entered a vicious circle in which its public debt to gross domestic product ratio has exceeded 100%, and in which interest paid on the debt is higher than the rate of nominal GDP growth (in other words, the numerator of the ratio is increasing faster than the denominator);

- Debt is not Greece’s only problem. It has a fundamental problem of competitiveness due to the sharp increase in labour costs (adjusted for productivity gains) in the past few years. Its lack of competitiveness is reflected in the very high current account deficit, making it strongly dependent on foreign capital. Once foreign investor confidence has been shaken, this dependence makes a country extremely vulnerable;

- Greece cannot devalue its currency, which means that restoring its competitiveness will only be possible through a downward adjustment in wages (unless productivity suddenly soars), a much more painful and politically-challenging solution. It could be that the increasing awareness within the country is such that it may be possible to impose the necessary measures (similar to what seems to be the case in Ireland). Nothing could be less sure, however, especially since the very low level of inflation in the eurozone means that Greek wages will just have to fall, rather than simply increase less than wages in other countries;

- The problems of debt, budget deficits and lack of competitiveness (and therefore external debt) are all linked. The accounting identity whereby "private sector financial balance + public sector financial balance - current account balance = 0" means that a reduction in the debt of the Greek private and public sectors will not be possible unless the country records a current account surplus (the current account balance is recording a deficit of around 9 % of GDP). The only scenario in which Greece could quickly experience a surplus in its external trade balance would be if its imports collapsed following a very severe economic recession and a deflationary environment;

- Greece is not the only country to be experiencing a lack of competitiveness. Broadly speaking, Southern Europe is no longer competitive compared to Northern Europe (which seems to explain the recent criticisms of Germany’s trade surpluses). The Southern European countries will not be able to restore their competitiveness by devaluing their currency given that they are in the euro⁽¹⁾. This situation will generate increasing pressure on the monetary union and single currency. It is worth noting that many economists had brought up this risk when the single currency was introduced, but at the time, any criticism of the euro was seen as ‘anti-European’. History shows, however, that it is dangerous to ignore economic laws (and common sense).

For the financial markets, two conclusions can be drawn from the preceding:

- The European Central Bank is expected to maintain a very expansionary monetary policy, especially since the budget austerity measures in an increasing number of European countries will restrict the eurozone’s growth potential even further;

- The convergence of bond yields in the eurozone towards the level of the most solid country (and therefore the lowest level), which characterised the period from 1995 to 2008, is over. If the eurozone countries rally around Southern Europe, the financial problems of the latter will spread to Northern Europe and bond yields will converge to an average level that will be higher than that currently prevalent in Germany or the Netherlands. If they decide not to rally, bond yields will diverge and the yield differential between the Northern and Southern European countries will widen.

⁽¹⁾ an alternative would involve a sharp depreciation in the value of the euro compared to other currencies, which would help to restore the competitiveness of the Southern European countries, if not in comparison to Germany, at least compared to the rest of the world. Rather than worrying about the euro’s weakness (which is actually relative as, since launch, the currency has been valued at between 0.85 and 1.60 USD. At the current level of 1.34 USD, the euro is still overvalued), the European authorities should thus encourage a lower euro. The problem is, however, that in the current environment, none of the main industralised countries has any interest in having a strong currency. The Obama administration’s recently-announced National Export Initiative, whose stated goal is to double U.S. exports by 2015, is thus hardly compatible with a strong dollar.