Merkel and a hard place

As he tried to talk up the Australian economy last week, the Reserve Bank's Glenn Stevens, somewhat tongue in cheek, said: "I have begun to wonder whether we in Australia worry more about the Greek economy than the Greeks do.''

While Stevens made his point for the audience in Australia, his comment is clearly wide of the mark. Over the weekend, the leaders and policy makers throughout Europe, and Greece in particular, have continued their agonising discussions and deliberations over the approach needed to ensure Greece gets its next instalment of assistance.

Remember, these are not policy discussions that will provide a once-and-for-all fix to the disintegrating Greek economy, they are about Greece having in place a policy agenda that will see it get the next tranche of financial assistance in September so that it avoids sovereign default.

At one level, there was not a lot to come from the weekend news, with separate meetings between Greek Prime Minister Antonis Samaras, French President Francois Hollande and German Chancellor Angela Merkel. It remains the case that bailout funding from the troika – the International Monetary Fund, the European Central Bank and European Commission – is irrefutably dependent of the Greek government sticking to the magnitude and trajectory of the timetable to repair its fiscal position.

Merkel is increasing her already rock solid resolve and stepping up her rhetoric that is unequivocally focused on the eurozone remaining intact. Over the weekend, Merkel said people advocating that Greece leave the eurozone or should have lesser fiscal assistance than currently planned should "weigh their words very carefully” as they threaten to undermine progress and confidence in these times of crisis.

These comment from Merkel were a direct response and challenge to the head of the Bundesbank, Jens Weidman, who said that the various central bank rescue packages "can become addictive like a drug.” Weidman's concerns went further when he said "in democracies, it is parliaments and not central banks that should decide on such a comprehensive pooling of risks”.

Ahead of the weekend meetings, Samaras highlighted Greece's difficulties and hinted at a wish for some relaxation of the terms and conditions that are attached to the bailout money being paid. In particular, Samaras wants more time to implement the reforms. At the moment, when the unemployment rate is around 25 per cent, when GDP is falling with the same sort of momentum of the worst economies in the 1930s Great Depression, such a request would seem reasonable, yet it glosses over the magnitude of the problem.

For the rescue packages to work, it is essential that there be little or no deviation from the toughness of the terms and conditions being imposed by the troika. Greece's public finances are a wreck. The debt and deficit positions are simply unsustainable, which it must be recalled is how this whole crisis started. To qualify for the next €33.5 billion of assistance, the Greek government needs to present a fiscal package that the troika approves. It cannot afford to go soft on reforms or else the disaster of default will hit the economy and Europe as a whole even harder than with the austerity measures.

In simple terms, a weakening of the fiscal package means no funds from the troika.

In addition to government spending cuts, which in this tranche alone are expected to be around 5 per cent of GDP, Samaras needs to hold the line on a range of reforms, including privatisation, labour market changes and long run microeconomic policies aimed at lifting productivity.

It will be a nervous few weeks ahead to see whether either side – Greece or the troika – changes its approach.

The market reaction to the recent run of news in Europe is that the euro has strengthened in recent weeks. It is around $US1.2515 this morning, up around 3.5 per cent from a level under $US1.21 a month ago. As with all things with currency markets, there are two sides to any exchange rate. There is a question whether the stronger euro reflects eurozone specific news and confidence that it will muddle through or, rather, is the market driving the US dollar lower due to expectations of addition quantitative easing from the Federal Reserve and a assessment that the US economy is also on the brink of something nasty happening.

Whatever these currency markets show, the news from Europe remains disconcerting. There are no quick fixes. The slow fixes will inflict social pain and they may not even work. Even optimistic projections suggest Greece will have double-digit unemployment for another decade or so and will not return to the pre-crisis level of GDP much before 2020.

In these circumstances, it is easy to see why Samaras wants some leeway of the bail conditions. It is also easy to see why the troika does not want to given any leeway. The problems in Greece do not have a solution.