The Ticking Euro Bomb

SPIEGEL‘s cover story on the history of the common currency

Politicians have maneuvered their countries into an unparalleled situation in the euro crisis. And they already know what most voters don’t yet suspect. In the end, only two possibilities will remain to save the beleagured common currency: an expensive transfer union or a smaller monetary union. Either solution will be extremely costly

The Greek crisis has revealed why the euro is the world’s most dangerous currency. The euro was built on a foundation of debt and trickery, where economic principles were sacrificed to romantic political visions. The history of the common currency is the story of a good idea that turned into a tragedy of epic proportions. By SPIEGEL Staff.

How a Good Idea Became a Tragedy

Before Germany’s Horst Reichenbach had even stepped off the plane in Athens, the Greeks knew who was coming. He had already been given various unflattering nicknames in the Greek media, including “Third Reichenbach” and “Horst Wessel” — a reference to the Nazi activist of that name who was posthumously elevated to martyr status. The members of his 30-strong team, meanwhile, had been compared to Nazi regional leaders.

The taxi drivers at the airport were on strike, while hundreds stood in front of the parliament building, chanting their slogans. One protestor was wearing a T-shirt that read: “I don’t need sex. The government fucks me every day.” Within the first few hours, Horst Reichenbach realized that he had landed in a disaster area.

Reichenbach is the head of the task force the European Commission sent to Athens to provide what Brussels officials call “technical assistance” in the implementation of necessary reforms. For the Greek media, the task force is the advance guard of an invasion force, the bureaucrats that have arrived to transform beautiful Greece into a German colony.

Reichenbach describes his tasks as follows: restructure the tax system, streamline the administration, accelerate privatization, strengthen legal certainty, open up access to protected professions, restructure the energy and healthcare sector and remove structures that are hostile to investment. The effort, says Reichenbach, requires “thinking in terms of years instead of months.” He was the vice-president of the European Bank for Reconstruction and Development and had planned to retire at the end of December. But then he received a call from European Commission President José Manuel Barroso, who then dispatched Reichenbach on this mission impossible.

He is a middleman between two Europes, the north and the south. The euro was intended as a currency that would help Europe grow together, but the first major euro crisis is in fact pitting the north and the south, the deutschmark economy and the lira economy, against each other. To make matters worse, there are also two different speeds in Europe, with one part of Europe moving at the high-paced speed of financial markets and banks, while the other drags along at the speed of governments and parliaments. And then there is also the Europe of two versions of the truth. One is at home in Brussels, Berlin and Paris, in the centers of power, while the other resides in the living rooms and on the streets of European cities.

As admirable as it is for Reichenbach and his 30 nation-builders to be bringing order to Athens, no amount of reorganizing can simply do away with €350 billion ($473 billion) in government debt. How to cope with this debt without ruining the European project is the most pressing question of recent weeks. After 20 years of bad decisions, spineless reforms and postponed actions, it isn’t the citizens but the markets that have forced united Europe into an endgame over the euro. How can this currency have a future? Is there a risk that Greece is only the first domino in a row that could end with Germany? Is the euro zone a faulty design?

A team of SPIEGEL reporters went to Brussels, Luxembourg, Athens, Berlin and elsewhere to find answers to these questions. They have reconstructed the rise and fall of a currency that can only survive if the mistakes that were made over two decades are corrected in the next few months.

Act I: The Birth of the Euro (1991 to 2001)

Why the mistakes that would later threaten the euro were already made in the foundation phase. How Greece and other countries cheated their way into the monetary union. Why the common currency is a trillion-euro bet made by politicians against the markets — and one that they would ultimately lose.

The bold, visionary project of creating a common currency for different countries and populations cannot be understood without reminding ourselves that the Berlin Wall came down in the late 1980s, the world still felt that World War II was a relatively recent event, and that Europe was still discussing whether Germany could pose a threat again.

Jacques Delors was the president of the European Commission for 10 years, and he was the lead author of the Maastricht Treaty, which defined the basic features of the euro. Now Delors is forced to listen to the daily criticism of how illusory his vision of a common currency was. But if he had had his way completely, he says, Europe would have been far better equipped, would have a more uniform constitution, and would be centrally governed by a Commission whose work would not be constantly undermined in the European Council, which comprises the heads of state and government.

Delors always wanted to go further than the political elite he was dealing with. At the time — unlike today, he says — that elite was consistently filled with dedicated Europeans, people like then-French President Francois Mitterand, then-German Chancellor Helmut Kohl, then-Dutch Prime Minister Ruud Lubbers and then-Portuguese Prime Minister Aníbal Cavaco Silva. But they too were not bold enough to integrate their countries to a degree that could count as true European coordination.

The Maastricht Treaty, which marked the establishment of the European Union when it was signed in 1992, made it all possible. It placed Europe on “three columns,” the first of which was an economic column, complete with an “Economic and Monetary Union.” The treaty provided the necessary legal framework, so that a common financial policy would have been conceivable, as would a coordinated fiscal and interest-rate policy. But the political will to fill out the Maastricht framework was missing.

The “United States of Europe” remained little more than a soundbite. And yet the introduction of the euro created a fait accompli that could no longer be rolled back. This European Big Bang, if you will, was to be followed by a process of evolution, during the course of which all the details were to be resolved.

Perhaps most importantly, the common currency was also a political symbol. Delors says that he always perceived Greece as being very far away, different and foreign. The country’s acceptance into the euro zone happened much too early, he adds. But at the time, in the 1990s, politicians stood up in front of microphones and said that Europe was inconceivable without Athens, the “cradle of democracy.” And Portugal, with its Carnation Revolution, also surely deserved to be part of the club. And the Irish, oppressed for so long by the British, had to be helped too. And who would have wanted to show Italy the door, merely because of its high unit labor costs and inflation rates?

And so, when the euro zone became a reality, elephants like Germany and France came together with mice like Portugal, Ireland and Luxembourg. Stable, prosperous countries of the north shared their common currency with shaky, underdeveloped countries of the south, mature industrialized nations joined forces with what were hardly more than developing countries. Strict Protestants mixed with sensual Catholics.

The promises of the euro were recorded in the Maastricht Treaty. It was to be a currency that would make Europe strong in a competitive globalized world; that would bring the European economies closer together; that would oblige countries to limit their debts and deficits; that would guarantee that no country would be liable for the debts of another; and that would promote political unity.

And the details? Well, they would be ironed out later.

The Greeks Jump at the Opportunity

In Greece, the euro fueled hopes of a better future. In October 1993, socialist Andreas Papandreou was reelected as prime minister. Then-Finance Minister Yiannos Papantoniou recalls today that the cabinet of Papandreou’s new administration quickly became convinced that Greece’s accession to the monetary union was the only chance to solve the country’s financial problems.

Greece was already well over its head in debt at the time. The country’s liabilities exceeded its real economic strength, with the national debt amounting to 114 percent of the gross domestic product. Athens was battling more than 14 percent inflation and the economy was shrinking.

Any economist could have recognized that the Greek economy was not competitive, and that the country, without outside impulses, seemed incapable of fundamentally changing its situation. The euro and its regime were to forcibly bring about necessary reforms, and in particular make it easier to obtain credit. Gaining accession to the euro zone became Finance Minister Papantoniou’s mission.

He used every opportunity to remind people of Greece’s claim. When the EU finance ministers met in Brussels in April 1997 to discuss what the new money would look like, Papantoniou proposed that the coins be embossed with both Latin and Greek letters. Then-German Finance Minister Theo Waigel curtly rejected the idea.

Greece was not in a position to make demands, he said. And then, turning to Papantoniou, he added: “You are not part of this, and you will not be part of this.”

When the two finance ministers spoke later on, Papantoniou proposed a bet to Waigel, namely that Greece would get the euro. Indeed, it would only take a few years for Papantoniou to win his bet.

Waigel, who recently described Greece’s acceptance into the euro zone as a “mortal sin” in the German newspaper Süddeutsche Zeitung, eventually became a fan of Greece, says Papantoniou. “It was Waigel who brought us into the euro,” he says. “It is absolutely untrue that he was opposed to our accession to the euro.”

The former Greek finance minister dismisses the charge that his country used falsified figures to cheat its way into the euro zone. “We didn’t do anything differently from all the other countries,” he says.

The Trickery of Euro Candidates

In his book “Herausforderung Euro” (“The Euro Challenge”), Hans Tietmeyer, the then-president of Germany’s central bank, the Bundesbank, confirms that “questionable cosmetic surgery” was performed in some countries to make data on inflation rates, government debt and price trends conform to the euro zone’s requirements.

Italy’s government debt of 115 percent of GDP was dramatically higher than the 60 percent debt limit agreed to in the Maastricht Treaty. Belgium was also massively in violation of treaty provisions.

At the time, then-Bundesbank President Tietmeyer noted with concern that, in 1998, the Europeans, inspired by the sheer magnitude of their project, had eliminated the final test of whether enough countries even satisfied the requirements for the euro, from their roadmap for switching to the new currency. They were determined that the euro would be introduced on Jan. 1, 2002.

In a German government meeting that was supposed to make a decision on the currency, Tietmeyer raised his objections against certain euro candidates — to no avail. In fact, the outcome of the meeting had already been determined in advance, and it had even been stated in writing.

Then-German Chancellor Helmut Kohl, a thoroughly committed European who belonged to the school of thought that there should never again be a war in Europe, wanted the historic decision. As Tietmeyer recalls, the chancellor said solemnly: “May we look back at the euro in 50 years’ time as positively as we do today with the deutsche mark.”

Numbers and data were constantly being thrown around at the time, in the late 1990s. The gathering of data was left up to each EU country, and Europeans trusted one another. But there was one question that hadn’t been clarified: When the figures came together in Luxembourg, what would happen if Eurostat, the organization tasked with assembling the data, discovered mistakes or violations of the rules? What authority or body would implement sanctions, and at what level?

Schröder and Eichel Inherit the Euro

Germany was still preoccupied with other issues. After 16 years under Kohl, a coalition of the center-left Social Democratic Party (SPD) and the Green Party won the German national election in 1998. In Germany, it felt like the beginning of a new era, but there was little enthusiasm for the European project. For the new Chancellor Gerhard Schröder, the euro was no longer a question of war and peace. Schröder flippantly referred to the new currency as a “sickly premature baby.”

But the euro was also a consistently political currency, says Eichel. Spain, Portugal and Greece were all former military dictatorships that had only found their way back to democracy in the mid-1970s. The strong connection to Europe, says Eichel, was also seen as a means of strengthening democracy.

Greece’s democracy received the validation it desired in 2000, when the European Commission and the European Central Bank concluded that the country had made great strides in the previous two years. The ECB warned against Greece’s high debt levels, and yet the Commission recommended that Athens be admitted to the common currency. “Greece has completed a successful convergence process after a long and difficult path,” then-Finance Minister Eichel told the German parliament, the Bundestag.

Then-Greek Finance Minister Papantoniou had reached his goal, winning his bet with Theo Waigel. Greece became a member of the euro zone.

But that meant that the European treaties weren’t worth the paper they were printed on. Greece’s public debt wasn’t at 60 percent of GDP, the required maximum, but at over 100 percent. And even back then, there were already doubts about the numbers that Athens was officially reporting.

The Critics of the Euro

There were opposing voices in society, particularly in Germany, where the deutsche mark was not just a means of payment but also a psychologically important symbol of Germany’s postwar reconstruction and economic miracle. The 1990s were a decade of squabbles over the euro.

In 1992, for example, 62 German professors issued a joint warning against introducing the euro. They feared that the monetary union, the way it was structured, would “expose Western Europe to strong economic fluctuations, which, in the foreseeable future, could lead to a political acid test.”

In the end, the political will prevailed over the economic objections. In April 1998, the two houses of the German parliament, the Bundestag and the Bundesrat, which represents the interests of Germany’s 16 states, cleared the way for the last step toward monetary union.

After that, whenever a government official spoke out against the euro, it would set off an enormous commotion throughout Europe. Hans Reckers, the president of the central bank in the German state of Hesse, learned that when he dared to voice his concerns publicly.

Reckers was a member of the Bundesbank executive board at the time. In April 2000, near the end of a speech to a handful of financial journalists in the conference room of the state central bank, he cleared his throat and said: “In my view, Greece is by no means ready for the monetary union. Its accession must be postponed by at least a year.”

It took about 20 minutes for the first news agency reports to be sent, and another five minutes for prices to begin plunging on the Athens stock exchange, prompting Greece’s central bank to buy up drachma to prevent it from declining in value. Eichel, the finance minister, called then-Bundesbank President Ernst Welteke, and Welteke called Reckers, who was promptly muzzled. But today Reckers claims that all 15 of the bankers on the Bundesbank executive board felt that the Greece accession was a mistake.

A mistake, some said, that could be absorbed because Greece is such a small country.

A dramatic mistake, others said, warning against underestimating the power of the financial markets.

The true problems were not addressed in the wake of the Jan. 1, 2002 introduction of the euro. Despite all the declarations of intent in Maastricht, the 12 new euro countries drove up their debt by more than €600 billion in the five years of preparations for the introduction of the euro. By the end of 2002, they had a combined debt of €4.9 trillion, with Italy’s debt alone amounting to €1.3 trillion.

The Skepticism of the Americans

Across the Atlantic, American economists were busy examining Europe’s plans, which they felt were half-baked and “oversized,” in the words of financial economist Kenneth Rogoff, a Harvard professor and adviser to US presidents and governments around the world. His office is in the Littauer Building on the edge of Harvard’s manicured campus in Cambridge, Massachusetts.

When the euro became a real currency, Rogoff had just taken the position of chief economist at the International Monetary Fund (IMF), and he was teaching at Princeton when the euro began to take shape in the 1990s. He agreed with his fellow US economists’ view that the euro was conceived “on too grand a scale.”

Rogoff observed that a trans-Atlantic rift was developing between two groups of economists. The Americans and the Western Europeans, who usually more or less agreed on key macroeconomic issues, were suddenly arguing to the point of insult. The Europeans accused their overseas colleagues of failing to recognize the historic processes, the grand vision and Europe’s great leap forward. The Americans, dry and pragmatic, accused their European counterparts of downplaying the risks. Once again, they felt that Old Europe was being overly romantic and blind to reality.

Rogoff did find some good ideas in the work of the EU and the architects of the euro. The Maastricht debt criterion, for example, remains a brilliant and valid idea to this day, says Rogoff. He is still convinced that setting an upper limit for the ratio of government debt to GDP at 60 percent proved to be a great success.

“It was something new at the time,” says Rogoff. “It was a great insight.”

The only problem, as soon became apparent, was that the Europeans had a tendency to betray their own ideals.

How the Euro Zone Ignored Its Own Rules

After they joined the euro zone, the countries of southern Europe suddenly discovered they could borrow money at German-style rates, and any hope of sorting out their dodgy finances vanished. But it was France and Germany who set the worst example, when they broke the euro-zone rules they had forced on others.

Act II: Life With the Euro (2001 to 2008)

How the euro heated up the borrowing-fueled economies of member states. Where Greece got its billions from. How the growth miracle failed to materialize. How the Germans betrayed the rules of the EU and benefited from the euro zone.

The Europeans’ new determination and palpable desire to make the historic project a success was rewarded. Banks, pension funds and major investors from around the world began to show an interest in this new Europe.

Portuguese and Irish government bonds, coupled with French economic strength and German reliability, suddenly looked like low-risk, reasonable, future-oriented investments. It was at this time that the financial industry developed its new magic tricks.

Sewage treatment plant operators in southern Germany, city governments in Spain, villages in Portugal and provincial banks in Ireland got involved with Wall Street bankers and London fund managers who promised profits by converting debt into tradable securities. And while central governments tried to cap their national budgets to comply with the Maastricht requirements, municipalities piled on debt that was not documented or recorded anywhere at the European level.

Low-interest loans were available everywhere, and it was all too easy to postpone their repayment to a distant future and refinance or even expand government spending.

A loophole developed in the Maastricht Treaty. Harvard economist Kenneth Rogoff says that the rule about the maximum debt-to-GDP ratio should have been amended, and that it was wrong to establish the 60 percent limit on a purely quantitative basis without asking where the loans were actually coming from.

According to Rogoff, it would have been necessary to limit the proportion of foreign liabilities in each country’s national debt. In the long run, and especially during an economic crisis, this kind of debt leads to an undesirable dependency on the vagaries of the markets.

In fact, governments borrowed excessively from foreign lenders, especially the major European banks. They accumulated what economists refer to as external debt. Deutsche Bank bought Greek bonds, Société Générale invested in Spanish bonds and pension funds from the United States and Japan bought European government bonds. The yields were not particularly high, but neither were the risks of default, or so it seemed. However, it was during this period that the monetary relationships were formed that turned Greece into a money bomb that would threaten the entire euro zone years later.

The Greeks were able to borrow at interest rates that were only slightly higher than those that the German government paid on its bonds. “The euro was a paradise of sorts,” says then-Greek Finance Minister Yiannos Papantoniou.

Once they had joined the euro zone, Europe’s southern countries gave up trying to sort out their finances, says Papantoniou. With a steady flow of easy money coming from the northern European countries, the Greek public sector began borrowing as if there were no tomorrow. This was only possible because the country, in becoming part of the euro zone, was also effectively borrowing Germany’s credibility and credit rating.

The Greeks Establish a Debt Agency

Prior to the euro, Greece had shown little interest in the international bond market. The country was simply too small and economically too underdeveloped to play much of a role. But in 1999, the Socialist government in Athens established a “Public Debt Management Agency,” naming Christoforos Sardelis as its director. Sardelis, an economist, had taught in Stockholm during Greece’s military dictatorship. Now he headed a staff of two or three dozen employees.

For the first time, the Greeks tried to convince foreign investors to buy larger volumes of debt with longer maturities. The message was: Buy an attractive security from the European Union.

He worked all of Europe, speaking with every fund, Sardelis recalls. Today, he is 61 and a member of the board of directors of Ethniki, Greece’s largest private insurance company. “Our task was to obtain money in the best possible way,” he recalls.

Greece was soon selling packages of bonds worth upwards of €5 billion at government auctions, says Sardelis. Starting in 2001, there was “enormous demand from all over Europe,” as well as from Japan and Singapore, he says. Things were going so well that Sardelis was even able to lure experts away from Deutsche Bank. Greece was in vogue. In reality, the Greeks were auctioning off their own future, without even noticing. They saw joining the euro as their goal, even though it was only a beginning.

In the spring of 2003, rates on Greek bonds were only 0.09 percentage points above comparable German bonds. In plain terms, this meant that the markets at the time felt that Greece, with its economy based on olives, yogurt, shipbuilding and tourism, was just as creditworthy as highly industrialized Germany, the world’s top exporter at the time. Why? Because both countries now had the same currency. And because the markets — as Andreas Schmitz, the head of the Association of German Banks, explained in a recent interview with the German weekly newspaper Die Zeit — never believed in the so-called “no-bailout” clause of the Maastricht Treaty, a clause that was designed to prevent euro-zone countries from being liable for the debts of other members.

According to Schmitz, the markets were confident that “in an emergency, the strong countries would support the weak ones,” a view based on European politicians’ lax treatment of their own rules early in the game. Those who bought Greek bonds on a large scale at the time were betting that Europe’s statesmen would break their rules if a crisis came along.

Sardelis claims that he had recognized the looming problems and warned against them. Today, he describes a mood characterized by the ever-increasing “illusion that the monetary union could solve our problems.” But instead of pushing for serious reforms of Greek government finances, the Greeks simply “relapsed into old mentalities.” Instead of saving being promoted, obtaining “as much money as possible” was encouraged.

Germany Undermines the Treaty

In 2002, the German government had other things on its mind than examining Greece’s public finances. It was having troubles of its own, with the European Commission threatening to send a warning to Berlin. Germany was expected to borrow more than had been forecast, thereby exceeding the allowed 3 percent of GDP limit for its budget deficit. The result was not, however, an example of German fiscal discipline and exemplary adherence to European rules, but a two-year battle by the Schröder administration against the slap on the wrist from Brussels.

Few within the European Commission openly criticized the loosening of the Maastricht rules. And the Germans, together with the French — both facing the threat of an excessive debt procedure — were too busy undermining the Maastricht Treaty. The two countries, determined not to submit to sanctions, managed to secure a majority in the EU’s Council of Economic and Finance Ministers to cancel the European Commission’s sanction procedure. It was a serious breach of the rules whose consequences would only become apparent later.

The German-French initiative effectively did away with the Stability and Growth Pact, which the Germans had forced their partners to sign. The consequences were fatal. If the two biggest economies in the euro zone weren’t abiding by the rules, why should anyone else?

The lapse was concealed behind political jargon. The violation of the pact was covered up with false affirmations of the pact. Its provisions were not formally abolished, but they were informally softened to such an extent that, in the future, they could be twisted at any time to benefit a government in financial trouble. The process also led to a not insignificant side effect: Executive power in Europe, supposedly held by the European Commission, which is informally known as the “guardian of the treaties,” was de facto transferred to the European Council, which consists of the European heads of state and government.

Instead of bundling and concentrating the efforts of the euro zone in Brussels, as intended, national interests began emerging once again in Berlin, Paris, Madrid and Rome.

The Greek Deception Is Discovered
Greece’s new conservative government, elected in 2004, disclosed that its socialist predecessors had been reporting manipulated figures to Eurostat since 2000, including the numbers used to join the euro zone.

But instead of criticizing Greece, European Commission President José Manuel Barroso, a Portuguese citizen, praised the new government for its openness and congratulated it for taking such “courageous steps” to make up for the mistakes of the past. Now it was Greece’s job to put its house in order by 2006, Barroso added.

But the new administration in Athens soon proved to be just as creative with its accounting as its predecessor. Defense expenditures were posted retroactively to the time of order, not payment, cleverly removing them from the current balance sheet. The bureaucracy refused to make projections about budget trends and used a purely fictitious deficit of less than 3 percent in its budget planning.

Sardelis, the director of the “debt agency,” was replaced. His predecessor, like Sardelis before him, took advantage of the low rates on his country’s government bonds. In 2005, Greek bonds were yielding rates only 0.16 percentage points higher than German bonds. The market was buying and the Greeks were selling. Government debt increased by 14.7 percent in 2006.

A blame game began in Brussels, where officials argued over who exactly had given incorrect or insufficient information to whom. The EU currency commissioner pointed his finger at the director general of Eurostat, who shifted the blame to the EU commissioners, who in turn criticized the European Central Bank. National governments and finance ministers joined the fray and, instead of the spirit of optimism that had prevailed around the turn of the millennium, dark skies were suddenly on the horizon for this new Europe.

To make matters worse, hopes of strong economic growth in the euro zone were dashed. Germany, in particular, was ailing, growth was minimal in Europe and unemployment figures were disconcerting. Europe became a constant topic of discussion at the International Monetary Fund (IMF) in Washington.

The IMF Warns Europe

Europe was under observation at IMF headquarters. The euro countries, after having built themselves brave new economic worlds since the late 1990s, mostly on borrowed money, were already in a deepening debt hole, which was still almost unnoticed and certainly vastly underestimated. They were like a mouse that is overjoyed to have spotted a piece of cheese in a trap, without noticing that by eating the cheese it will set off the trap.

At the time, then-IMF chief economist Rogoff’s answer to the question of whether the euro zone could break apart again was simple: “Of course.” Rogoff said that, in 10 years’ time, some countries might not even be using the euro anymore. When he said these things, his colleagues, particularly the Europeans, always looked at him “as if I had a screw loose,” he recalls.

The IMF noted a “paralysis in Europe,” says Rogoff. The political union that had been promised for years as a real framework for the technical monetary union did not materialize. But the European party continued — and as long as the music was playing, everyone wanted to dance. Everyone except the Germans, that is, who were busy introducing painful and unpopular reforms — known as Agenda 2010 and Hartz IV — to their labor market and welfare systems.

“What the Germans accomplished at the time is very impressive,” says Rogoff. “They recognized a debt problem and the systemic weaknesses, and then they rationally went about eliminating those weaknesses.” But instead of developing economic productivity, reforming their social systems and controlling costs, countries like Greece, Portugal and Italy borrowed more and more money, dragging out the maturities as long as possible so as to postpone the necessary decisions into the future.

But the critics targeted Germany instead of these countries. The Germans, they said, were pushing their European partners up against a wall. German exports to countries in the euro zone were growing by an average of 7 percent a year, while 73 percent of Germany’s trade surplus came from these countries.

The Agenda 2010 reforms applied pressure on wages and helped reduce unit labor costs, so that Germany acquired even greater competitive advantages over countries like Italy and Greece. While unit labor costs were declining in Germany, they were going up in most euro-zone countries, especially Greece.

Greece’s Structural Problems

The Greeks were consuming on credit, using cheap loans. They bought German machinery and cars, which helped increase Germany’s gross national product, while neglecting to introduce reforms at home. No elected official was willing to trim the country’s enormous bureaucracy, hardly anyone was interested in debt repayment, trade deficits or unit labor costs, and very few fought against corruption, subsidy fraud or unearned privileges. The consequences of these failings are still in full view in northern Greece today, in the region bordering Bulgaria.

Almost all of the many factories and warehouses in the industrial zone of Komotini are now shut down, and yet they look as if they were brand-new. Komotini is a prime example of why the Greek economy doesn’t grow, why it is uncompetitive and why there is no progress in the country.

Most of the companies there never even opened their doors for business. In fact, the abandoned buildings are the ruins of subsidy fraud. Their developers obtained funds and low-interest loans from the government in Athens and from the EU to build the factories and warehouses, but they never intended to do any business there.

Transparency International considers Greece to be the most corrupt country in the EU. Permits and certificates can only be had in return for cash. Not everyone in Greece sees this as a problem. Some see corruption as part of Greek culture, and they also believe that taxes are unnecessary. As a result, the government has a double revenue problem. On the one hand, the bureaucracy prevents some businesses from growing and becoming profitable. On the other hand, the businesses that do grow and realize profits find ways to pay almost no taxes at all. Every year, the Greek state misses out on an estimated €20 billion in unpaid taxes. A third of Greece’s economic activity is untaxed.

Poor Ratings for Greece

In September 2008, when the Lehman bankruptcy wreaked havoc on financial markets, the Greek government believed it had been spared. Greek banks held very few of the supposedly innovative securities that Wall Street’s financial wizards had devised. Nevertheless, in 2008, government debt rose to 110 percent of economic output. Greece’s debt-to-GDP ratio had surpassed Italy’s, and the proportion of its debt that was held by foreign investors was also significantly higher. The country of beautiful islands was in much bigger trouble than it was willing to believe.

The rating agencies, which had declared massive numbers of worthless securities to be safe investments, came under special scrutiny after the Lehman crash. After all, they were also rating entire countries and government bonds. What were their ratings worth? Had they misjudged the quality of national economies just as they had got it wrong with private companies?

For years, the world’s three major rating agencies had unanimously given AAA or AA ratings to the bonds of euro-zone members. On Jan. 14, 2009, one agency, Standard & Poor’s, decided to downgrade Greek government bonds to A-. It was the lowest rating among all the euro zone’s then 16 members. From today’s perspective, it marked the beginning of the crash.

The downgrade set in motion a downward spiral that would show European leaders how fragile their euro is and how contagious conditions in a small country like Greece could be.

Marko Mršnik, a “sovereign credit analyst” responsible for Greek government bonds at Standard & Poor’s, was behind the downgrade. The native Slovenian doesn’t talk to journalists, but his reports provide an indication of how he assesses the markets.

His office is in Canary Wharf in London’s Docklands district, a business center with shimmering façades and coffee bars built on the ruins of the old industrial society. Lehman Brothers also had its offices there, until the end.

The purely economic criteria are readily available in the tables produced by central banks, Eurostat and the IMF. But another aspect, the politics of a country, is not something that can be figured out with a calculator. It has to do with issues such as how well an administration functions, corruption, strong unions, how rebellious a country’s young people are and how strong its leader is. These are the soft — but nonetheless important — criteria.

Explaining the decision to downgrade the country’s debt rating, Mršnik wrote that the ongoing financial and economic crisis had amplified a fundamental loss of competitiveness in the Greek economy. After this assessment was issued, prices plunged on the Athens stock exchange and interest rates rose. The buyers of Greek government bonds, wanting to be compensating for taking on more risk, demanded a higher premium. From then on, if Greece wanted to borrow €1 billion, that is, sell bonds worth €1 billion, it had to promise to pay €2.8 million more in interest than Germany was paying. The debt burden continued to grow and grow.

Alarmed by the downgrade, the European Commission initiated another excessive deficit procedure against Greece. But it was a helpless gesture. Once again, the sanction procedure remained ineffective — not unexpectedly, one might be tempted to say. To this day, not a single euro country has even been penalized, despite the many cases of rule violations. The euro zone’s sanction mechanism is an empty threat. Besides, it was poorly conceived from the start. What good does it do to slap fines on a country that is in financial difficulties?

In October 2009, the new government of Socialist Georgios Papandreou replaced the conservative administration in Athens. After Papandreou’s election win, Mršnik wrote, in a confidential letter to Standard & Poor’s customers, that in light of the repeated budgetary lapses of the various Greek governments, it remained to be seen whether the new administration had the will to implement a credible budget strategy. This sounded diplomatic, but it was pure sarcasm. Investors got the message, namely that the decline of Greek bonds from secure investments to casino chips was accelerating.

The Greek tragedy had begun.

Act III: The Euro Crisis (2010/11)

How Greece becomes a pawn in the hands of investors. How the European Central Bank goes astray. Why the world no longer makes sense to the Greeks. How the Maastricht bet goes bad.

In October 2009, Marko Mršnik’s analysts at rating agency Standard & Poor’s computed that Greece’s debt would increase to 125 percent of economic output in 2010. On the same day, it became more expensive to hedge Greek bonds against default. The default insurance instruments, known in market jargon as credit default swaps (CDS), were an indicator of how bad things stood for Greece. It was now costing $189,000 a year to hedge a $10-million Greek government bond against default. For major investors, it was a signal to get out of Greece.

A few people had also become nervous at the headquarters of the Pacific Investment Company (PIMCO) in Newport Beach, California, about an hour’s drive south of Los Angeles.

PIMCO is by far the world’s largest investor in government bonds. The company lends governments money by buying their bonds. When PIMCO stops buying a country’s bonds, it’s a clear sign that the country is on the verge of crisis and possibly even bankruptcy.

PIMCO controls more than $1.3 trillion (€1.05 trillion) on behalf of its customers. It is an absurd number, even in these times of superlatives, times of bailout funds and banks being supported with billions upon billions in taxpayer money. Though far from a household word, PIMCO has four times the German national budget to invest.

That’s why almost all governments maintain close ties to PIMCO. They send their finance ministers, the heads of their central banks and sometimes even their national leaders to see CEO Mohamed El-Erian and convince him to buy their government bonds.

In the last few weeks of 2009, PIMCO sold all of its Greek bonds. El-Erian says the company wanted to get out before everyone else noticed that the numbers weren’t adding up. The company never relies on outside assessments. Instead, it employs hordes of analysts, some of whom used to work at the International Monetary Fund, where El-Erian began his career.

The analysts spend all of their time digging through large quantities of data and the financial statements of nations, re-calculating, preparing projections and feeding numbers into computers. When they don’t like what they see, PIMCO gets out.

When Greece was accepted into the euro zone, it was one more reason for PIMCO to buy Greek bonds. El-Erian says the sentiment at PIMCO was that if the Greeks were being granted membership in such an elite club, then Athens would follow the rules — or the government would be severely sanctioned if it didn’t. But that didn’t happen. Instead, political concessions were made and the rules were ignored. That, El-Erian argues, is what brought the cancer into the euro zone.

So why didn’t the financial markets penalize Greece earlier? Why was the same yardstick applied to Greek government bonds as to German bonds, until only a few years ago? Why did the markets continue to buy the country’s bonds?

The Crash of Greek Bonds

On April 27, 2010, a country’s debt was downgraded to junk status for the first time in the history of the young currency. Standard & Poor’s downgraded Greece’s bond rating by three notches, to BB+, putting it at the same level as Azerbaijan and Egypt, and just ahead of countries like Ecuador, El Salvador and Zimbabwe.

Mršnik wrote that Greece’s government debt had to be “restructured” — a fancy word for bankruptcy. Restructuring involves a debt haircut, so that owners of Greek bonds might only get 30 percent of their money back, that is, lenders are only repaid a fraction of the money they lent. The markets view a downgrade as the kiss of death. At this point, anyone who was still holding Greek bonds in his portfolio was crazy — or a charitable donor.

But the market is neither crazy nor charitable. As soon as the downgrade was announced, Greek bonds were thrown onto the market, causing their prices to plunge. If the Greek government had introduced two-year bonds into the market at that point, it would have had to promise buyers a 13-percent interest rate, up from only 6.3 percent a few days earlier. The rate for 10-year bonds climbed to above 10 percent.

This came as a shock to many European banks. After the Lehman bankruptcy, they had invested heavily in the supposedly safer government bonds, with small yields that suggested security. But now it wasn’t only Greek bonds that were seen as risky; confidence was also dwindling in Portugal, Ireland, Spain and even Italy.

Fear in Europe’s Financial Capitals

Fear began to spread in places like Frankfurt and London. European banks had invested more than €700 billion in government bonds from the five crisis-stricken countries. And Greek banks alone were holding €50 billion in Greek government bonds. When the government bond rating was downgraded, so were the ratings of Greek banks, as part of a chain reaction that would not stop at Greece’s borders.

Government bonds also serve as collateral when banks borrow money from the European Central Bank. The bonds are a key link in monetary transactions, and when their value becomes questionable, the supply of money to economies begins to falter.

Greece Adrift

Greece was adrift in a storm of mistrust, unleashed by the rating agencies and reinforced by the financial markets. The lower the country’s rating fell, the more expensive it became to refinance debts, the greater the debts became, the lower the rating went, and so on. All of this spelled a golden opportunity for foreign currency traders, hedge funds and speculators. They could bet on the decline of the euro and on the euro partners bailing out the Greeks. One of the instruments they used was the credit default swap, which the financial crisis had already spread around the globe following the Lehman bankruptcy.

Although CDSs were designed to insure against the risk of credit default, someone who holds government bonds can also use them to speculate. It’s as if someone had purchased fire protection insurance for a house he didn’t own. He could conceivably have a strong interest in the house actually going up in flames. Those who bought CDSs for Greek bonds without owning any bonds themselves were betting that the bonds would lose value. If that happened, they could sell the swaps later on at a higher price.

A €26 trillion gray market for CDSs had developed outside the official markets. The premium that had to be paid to hedge a Greek government bond doubled within a few weeks, and by now it was 10 times as high as the premium for a German bond.

Junk Status

In June 2010, Greece’s credit rating was downgraded by four additional notches, due to “considerable” general economic risk. Greek government securities now had the status of junk bonds. Investors in Greece had already begun moving their money to Cyprus, Malta and Switzerland. Greece had been ejected from the family of creditworthy nations. But the effect of the downgrade was also detrimental to the entire euro project, even through Europe felt that it had reacted firmly and decisively, and that it had the Greek crisis under control.

This belief was triggered by the European Central Bank’s purchase of €25 billion in Greek government bonds only a month earlier, in May 2010. It did this to stabilize prices for the bonds and bring calm to the markets, but the strategy only worked for a few days.

From then on, the ECB would buy more and more Greek bonds, even in 2011, and soon it was also buying Portuguese, Italian and Spanish bonds. The ECB was filling its own house, which had been created as a stronghold of euro stability, a Fort Knox of the new currency, with junk bonds. In doing so, it was ruining the credibility of the euro.

Questions about the beginnings of the euro kept resurfacing. Why did the leaders of France, Germany and nine other countries believe that Greece’s way of running its economy could be compatible with other economies under the umbrella of a common currency? How is it possible that a currency was developed exclusively for good times and phases of growth, only to be dangerously in jeopardy during a crisis?

The Truck Drivers’ Strike

In Greece, the plunge in the value of government bonds triggered unrest, because EU assistance was tied to austerity requirements and demands for tough reforms. The government was to shrink the public sector, which had become inflated over the decades, by one-fifth. And the markets were to be liberalized to facilitate more growth.

As a truck driver, Antonis Dimitriadis belongs to a group known as the “kleista epaggelmata,” which consists of about 70 closed professions, a curiosity of Greek labor law, including attorneys, notaries, architects and taxi drivers. The members of these professions had been protesting since the reforms began, because they were losing their privileges. Until then, their rules had not been set by the market but by the state.

Dimitriadis was one of those who demonstrated in the summer of 2010 against what they believed were unreasonable government austerity measures. Trucking companies nationwide went on strike, shutting everything down. For eight days, filling stations were unable to get gasoline, while supermarkets quickly ran out of fresh products. Tens of thousands of tourists were stranded, flights were delayed and ships were unable to leave port.

There are 33,500 licenses in Greece for independent truckers like Dimitriadis. They were issued under the country’s military junta in the early 1970s, but no new licenses were added after that, even though the Greek economy is now four times as large as it was at the time.

A trucking license became something of a guaranteed livelihood and even a retirement plan. When truckers retired, they would sell their licenses to the highest bidders, and licenses for large tanker trucks were being sold for up to €350,000. But now, under the debt regime dictated by Brussels and Washington, the licenses were to be made available to anyone starting in 2014, which of course caused the value of truck licenses to plunge. Today Dimitriadis’s license is worth only about €12,000-15,000.

He received the license, which guarantees him his profession, as a gift from his father in 1993, for whom he had worked since he was 13. He cleaned the truck, filled the gas tank and accompanied his father throughout Greece, just as his 11-year-old son Manolis does today — as if it were a law of nature. Of course, Dimitriadis took care of his father after he had given him the keys to this truck, if only in gratitude for the truck license, and he would expect the same from his own son.

Family is everything in Greece, a country of pre-modern, almost archaic labor structures that have been cemented into law in the form of an elaborate system of rules and regulations. As a result, the family-owned business has remained the DNA of the Greek economy. Of Greece’s working population of 4.4 million, roughly 1.5 million people work for the government, while another 1.5 million are employed in small businesses with between one and nine employees, or are self-employed. And these people were now being expected to accept, in the space of a few weeks, changes to a system that had developed over decades. An economy dominated by guilds and family owned businesses was to be converted into a market economy that satisfied the requirements of politicians in Brussels and Berlin.

A Country on the Verge of a Nervous Breakdown

The truck drivers’ strike did immense damage to Greece’s image around the world. Until the summer of 2010, the Greek crisis had remained a relatively abstract phenomenon for the global public, one that was analyzed primarily in the business sections of newspapers. But now there were images the media could use, images that portrayed a country on the verge of a nervous breakdown, images of irate tourists, empty shelves and barricaded streets, and of soldiers driving truckloads of kerosene, gasoline and diesel around the country. The images depicted a country that was no longer functioning and was unlikely to become functional again in the foreseeable future.

They also depicted a society deeply suspicious of its own government. With tax revenues of less than 30 percent of economic output, Greece has the second-lowest tax rate of all euro-zone countries. The Foundation for Economic and Industrial Research (IOBE) in Athens estimates annual black-market sales at €59 billion — a quarter of the official economy.

Outsiders may be shaking their heads about all of this, about the Greeks and their stubbornness and backwardness, about their way of doing business in general, which is alien to the economic systems in Central and Northern Europe. But they should be even more taken aback by Europe’s politicians and its movers and shakers, and the years they spent doggedly looking the other way, repressing and denying the realities of the Greek economy.

Design Defects, Political Weakness, Public Disinterest

The architects of the euro and their successors have lost the Maastricht Treaty bet. They have jeopardized an agreement made by 12 countries in the hope that the markets wouldn’t notice how fragile their shiny new currency really is. And what the founders of the euro left in the way of loopholes in the original treaty — which was aimed at providing a stable foundation for the common currency — their successors have used in the course of 10 years to make the euro even more vulnerable.

In defiance of all rules, the euro countries have almost doubled their combined national debt since 1997. It has grown by close to €2 trillion, or 30 percent, in the last three years alone. Without the costs incurred as a result of the financial crisis, perhaps it would have taken longer for the bet to turn sour, but it would have done so nonetheless. The euro had too many design defects, the European political class was too weak to correct them, and Europeans themselves were too disinterested in the entire massive project.

A Dangerously Unstable Network

The four main promises of the euro, as put forth in the Maastricht Treaty, were all broken: government debt was not limited, but in fact doubled, with only five of the 17 euro countries still falling below the debt ceiling of 60-percent of gross domestic product permitted in the agreement’s Growth and Stability Pact; budget deficits were not capped, and only four countries are now below the norm; the ban on bailouts was violated; and the European Central Bank, no longer independent, has turned into a bad bank for the bonds of ailing governments.

It isn’t just a matter of political failure, which would have been as inconsequential as any broken election promise. In fact, it is a matter of the failures of two generations of political leaders, which have resulted in Europe now being blanketed in a dangerously unstable network of countries, their central banks, the ECB, the banks and investors.

The nations of the euro zone are in debt to the tune of €8 trillion, while banks hold European government bonds at a face value of €1 trillion on their books. The central banks of Greece, Italy, Portugal and Spain owe Germany’s Bundesbank €348 billion. The ECB has purchased €150 billion in government bonds, and the banks, fearing loan defaults, would rather park up to €150 billion with the ECB than lend money.

The sum of all credit default swaps for Greece is unknown, as is the identity of the banks that hold them, which makes their risks incalculable. Large European banks have so many bonds of vulnerable countries on their books that, according to the IMF, they would need €200 billion in additional capital to pull through in the event of large-scale defaults. This has already prompted the rating agencies to downgrade some of the banks.

The Euro Is a House without Keepers

This highly explosive network of mutual dependencies makes the euro unstable in times of crisis. But it becomes vulnerable and truly dangerous as a result of a unique feature that distinguishes it from the dollar, the yuan and all other currencies: The euro is a house without keepers, a currency without political protection, without a uniform fiscal policy, and without the ability to forcefully defend itself against speculative attacks.

For a monetary union to function, the economies of its member states cannot drift too far apart, because it lacks the usual balancing mechanism, the exchange rate. Normally a country depreciates its currency when its economy falters. This makes its goods cheaper on the world market, allowing it to increase exports and thereby reduce its deficits. But this doesn’t work in a monetary union. If one country doesn’t manage its economy effectively, the common currency acts as a manacle.

If Greece were a state in a United States of Europe with a common fiscal and economic policy, it would be just as protected as the city-state of Bremen, also deeply in debt, is by the Federal Republic of Germany. But because there is no common European fiscal policy, Greece, as the weakest country in the European Union — and despite the fact that it only contributes three percent to the total economic output of the euro countries — becomes a systemic threat for 16 countries and 320 million Europeans. And the euro, intended as a means of protecting Europe against the imponderables of globalization, becomes the most dangerous currency in the world.

Are European Rescue Efforts Doomed to Fail?

Act IV: The Future of the Euro (2011 to ?)

Why Jacques Delors, one of the founding fathers of the Europe , still believes in the common currency. Why economist Kenneth Rogoff feels that his nightmare scenario is realistic. And why Mohammed El-Erian, CEO of the world’s largest bond trader, says that he isn’t making any bets on the demise of the euro.

What will happen to Europe in the coming weeks and months has much to do with Greece, but it has also long been detached from the drama in Athens. In fact, it is the continuation of the financial tragedy that began in New York in 2007. According to American economist Kenneth Rogoff, what began in New York was not a normal recession, albeit somewhat more severe than usual, but a “great contraction” of the sort that happens only once every 75 years in global economic history. This circumstance, says Rogoff, has not been recognized to this day. In his view, this is why Europe’s crisis, which began as a crisis of confidence, turned into a debt and liquidity crisis and finally led to multiple solvency crises, is not ending.

“The current policy is to act as if a liquidity crisis could be overcome,” says Rogoff, “and as if all it took were to hand out enough loans to jump-start growth once. But it’s the wrong diagnosis. We have a solvency crisis, and we have European countries and regions that are fundamentally bankrupt. No loan in the world, no matter how big, will save Greece, nor will it save Portugal and probably not Ireland, either, and Italy is also very worrisome.”

Band-Aids Where Surgery Is Needed?

If this conclusion is correct, it means that the new European Financial Stability Fund (EFSF), established for ailing euro countries, is pointless. It means that the ECB’s new policy of financing the national debts of countries will fail. It also means that Europe’s leaders, as they rush from one crisis meeting to the next, are merely handing out Band-Aids where surgery of the inner organs of the Union would be necessary. “The goal now should be to trim debt,” says Rogoff, “declare bankruptcy and start over again.” According to Rogoff, Greece is so insolvent that it will only have a future if 50 to 75 percent of its government debt is written off, and the situation in Ireland and Portugal isn’t all that different.

If strong medication isn’t administered to Europe now, says El-Erian, notwithstanding its adverse side effects, the infection will soon reach the heart and the brain: France and Germany.

Either way, says Rogoff, the euro project is at a crossroads. The European partners must either enter into a forced marriage, a shotgun marriage, or the union will break apart sooner or later. “And, of course, it’s questionable whether the people of Europe are willing to enter into such an unromantic marriage.”

The Germans, says Rogoff, play a critical role. And if they want to save Greece, they should take a sober look at the situation.

They should look to Italy, says Rogoff, where the northern part of the country has been paying the bills for southern Italy for 90 years. And they should ask themselves whether they are prepared to pay Greece’s bills for the next 90 years.

‘A Risk Bordering on Madness’?

“That’s what is involved when we talk about a transfer union. It’s certainly possible. Germany is probably strong enough to pay all the bills, presumably to the tune of 150 percent of its own economic output, and the markets would somehow play along. Germany would then be the super-European, and everyone would love Germany. But, to be honest, for the Germans it would be a risk bordering on madness.”

When politicians ask him for advice these days, Rogoff suggests starting with a debt haircut as quickly as possible, but even this solution would be very costly. To avoid simply pushing the affected countries over the brink, Europe — and Germany in particular — would have to find a way to deal with the bankrupt states.

Rogoff could imagine the Europeans guaranteeing the debts of a country’s central government, but nothing more than that. In the case of Ireland, this would mean that no guarantees would be assumed for the banks. And in the case of Spain, it would mean that the immense debts of its cities and towns, such as Barcelona’s, would remain Spain’s problem. And finally, in that of Greece, it would mean that only the government’s most critical expenses would be assumed, but nothing more.

It would mean that Europe would enter a very difficult period. “That’s the problem with big crises,” says Rogoff. “In the end, they create many more losers than winners.”

While this is the scenario Rogoff, an American expert on financial crises, paints, European politicians like Jacques Delors stand by their vision of a great Europe. Delors, the founding father of modern Europe, cannot imagine that the euro zone, by and large, will break apart. “It would be too expensive, and I think that no one wants to take this risk.” Europe, says Delors, is a moral obligation, something that today’s politicians have apparently forgotten. “They run around like disorganized firefighters, and they still believe that they can put out all the fires.” But what is really necessary, says Delors, is a strong central government in Brussels that coordinates the efforts, as well as new, robust institutions.

Do Only Two Possibilities Remain for Saving Euro?

The proposals to solve the euro crisis are manifold — reducing debt with or without withdrawal from the euro zone, a European finance minister or even a European economic government — but they have become little more than an expression of the cluelessness of economists and politicians. There is no precedent for this crisis, nor is there a recipe that could be applied to resolve it. Europe’s politicians have maneuvered themselves and their people into an unparalleled situation. It scares some of them more than it scares their voters, because politicians already know what voters don’t even suspect yet.

In the end, only two possibilities will remain: a transfer union, in which the strong countries pay for the weak; or a smaller monetary union, a core Europe of sorts, that would consist of only relatively comparable economies.

A transfer and liability union requires new political institutions, and individual countries would have to confer a significant portion of their powers on Brussels. Some politicians are warming up to this idea as they consider an economic government or even a United States of Europe, but without explaining exactly what this means.

The second path is the more likely one. It will not be easier, and it might not be any less costly, either. First a firewall would have to be erected between the countries that are in fact insolvent and do not stand a chance of ever repaying their debts, like Greece, and others that have only a short-term liquidity problem. Then the banks would have to be provided with government funds, so that the financial system does not collapse when banks are forced to write off some of the government bonds on their balance sheets. Finally, the countries exiting the euro zone would require continued support, because Europe cannot simply look on as countries like Greece descend into chaos.

‘That Doesn’t Look Not Dangerous’

Horst Reichenbach will still be needed in either case. In his first tour through the offices of Athens cabinet ministers, the director of the EU Task Force is embarking on a battle against 10 years of mismanagement, 100 years of slowness and the pride of 3,000 years of history. Reichenbach is a mathematician, an economist and a technocrat with decades of experience in the Brussels bureaucracy, and generally a well-tempered man with an aura of extremely professional and esthetic austerity. He is an envoy from another time zone, an envoy from the future.

While waiting for the elevator, Reichenbach says that he feels “extremely welcome” wherever he goes. He attributes this to the fact that he is, after all, the “good guy” in this game, whereas the representatives of the so-called troika, consisting of the European Commission, the IMF and the ECB, who are there to monitor compliance with requirements, are “regarded less favorably” in Greece.

When he drives through Athens, what he sees looks like a dynamic European city through the tinted windows of his dark-blue Renault Espace, the Task Force’s official vehicle. Traffic is light now that 15,000 striking taxi drivers have disappeared from the streets of Athens.

He has to slow down at one point, where the other side of the road is blocked. Reichenbach slowly maneuvers his Renault past a burning car in front of the US Embassy. He says, “oops!” and looks out the window, but then he concludes: “That doesn’t look not dangerous.”


Translated from the German by Christopher Sultan



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