The Greek crisis is not over, even if markets are now paying more attention to Beijing or Washington than to Athens. As soon as euro area countries disbursed the first tranche of their €86 billion ($97 billion) bailout to Greece, Prime Minister Alexis Tsipras resigned and called for snap elections, raising fresh political uncertainties. One does not have to be overly skeptical about the prospect of structural reform under a Syriza government to anticipate another funding crisis and risk of Grexit in the next three years.
What went wrong? There were two original sins: one related to the design of the monetary union, one to Greece. Starting with the latter, euro area political leaders' original sin was to turn a blind eye to the Greek economy and public finances when they let the country join the euro in 2001. Technocrats knew Greece's public finance data was not reliable and that its economy was inefficient and plagued with corruption and rent-seeking. Decision makers ignored the skeptics, though, believing an economy worth 2.3 percent of the euro area could not generate a systemic risk. The Germans thought the deficit restraints in the Stability Pact, which they imposed on their partners at the start of monetary union, would prevent free-riding fiscal profligacy.
These assumptions proved wrong. Greece stealthily implemented a free-riding budget strategy, with public spending rising from 43 percent of gross domestic product the year before joining the euro to 54 percent in 2009. The budget deficit that year, originally reported as less than 4 percent of GDP, was revised to more than 15 percent once the truth emerged. And yet the state attorney decided earlier this year to prosecute the chief statistician who told the truth, not his former colleagues who had cooked the books. The Stability Pact, meanwhile, proved ineffective, not least because France and Germany flouted its rules in 2004. Although the euro area revised its fiscal standards during the crisis to make them more credible, it is unclear that the Greek economy has changed, even after four years of structural reforms under the eyes of the troika. And still Greece's euro partners have decided to double down on their bets instead of taking the losses that would have followed a Grexit, probably for fear of even worse consequences.
The other original sin was existential. It derived not from lies but from the nature of the euro project itself. As former IMF managing director Dominique Strauss-Kahn, who as French Finance minister tried to renegotiate the Stability Pact back in 1997, put it in a recent online note, "The euro was conceived as an imperfect monetary union forged on an ambiguous agreement between France and Germany." Germany originally argued that a single currency without political union would be doomed but eventually yielded to French pressure to launch the euro first, believing that strict rules could prevent monetary union from turning into a fiscal transfer union. France invoked Jacques Delors's bicycle principle claiming that the whole European project would topple if not kept moving forward. In reality, Paris was betting on a coalition with Italy and Spain to impose an economic government on Germany and shield the French economy from competition with devaluation ruled out. Unsurprisingly, things haven't worked out. By 2018 euro area countries will have lent close to €270 billion to Greece at low rates and long maturities not far from the transfer union feared by Germany. France was shielded from competitive devaluations, but its labor rigidities made its economy vulnerable to countries that pursued reforms, led first by Germany and more recently by Spain and Italy. No wonder why French growth is sluggish and unemployment has been above 10 percent since 2012. Is this monetary union without a political union doomed? The Greek deal shows that European leaders believe a failure would be so costly that the bicycle should be kept moving at almost any cost. On the positive side, Germany's strategy of exerting maximum pressure on weaker countries to implement structural reforms, and eventually signing big checks, has proved reasonably successful, as the recoveries in Spain and Ireland tend to prove. But because markets and foreign central banks have come to the view that Germany will always support France, the pressure to reform the euro area's second-largest economy has never been significant. This is the main challenge for the future of the euro, as long as the prospect of political union remains remote.