As Auditors Arrive in Greece Germany Faces a Downgrade

Today auditors from the European Central Bank, the International Monetary Fund, and the European Commission arrive in Greece to assess whether the Greek government is keeping to the conditions necessary for continued assistance. If sufficient progress has not been made Greece will not receive the last payment of the bailout, worth $38 billion. The Greek Prime Minister, Antonis Samaras, said today that Greece can expect a deeper recession than previously predicted. According to Samaras Greece, like Spain, will not see growth until 2014.  

The situation in Spain continues to rattle investors, with the bond markets looking like they have lost confidence in the country completely, indicating that investors think a sovereign bailout increasingly likely.

The news for the typically economically sounder countries in Europe is also far from reassuring. Moody's has put Germany, the Netherlands, and Luxembourg on negative watch. France and Austria both lost their AAA rating earlier this year, and it looks like Germany will follow suit unless a Greek euro exit can be contained and support for countries such as Spain and Italy can be organized.

It looks increasingly likely that September will be the month in which the lifespan of the euro will be more easily estimated. A European Commission spokesman has said that it is unlikely that the troika (ECB, IMF, and European Commission) will be able to report on their audit until September. That month, on the twelfth, the German Constitutional Court will rule on the constitutionality of the European Stability Mechanism. While it is likely that the court will rule in favor of the agreement the conditions attached will almost certainly make the conditions of future bailouts of Spain and Italy much harsher than bailout conditions for Greece.

If the German Constitutional Court rules in favor of harsh conditions for future bailouts and Germany and other stronger European countries lose their ratings it is hard to see how Greece remains in the eurozone past the end of the year. 

The likely situation is that Germany suffers a loss in growth while trying to support Italy and Spain through some sort of sovereign bailout after Greece leaves the eurozone. Were this to happen we would almost certainly see closer fiscal union and the issuing of Eurobonds.

As usual in Europe the political reality of the situation could change quickly. Germans may express their dissatisfaction with bailing out irresponsible countries through political action and dissatisfaction with 'austerity' in the Mediterranean could see left-wing parties like the Greek Syriza enjoying more support. Such a situation would make future bailouts impossible to negotiate and would cause the euro to collapse sooner than expected.