Europe Faces a Two-headed Monster of Debt and Oil

It looks as though we have a deal between Greece and its private-sector creditors, and not a moment too soon. The announced agreement over the weekend ended months of handwringing and protracted talks between the government of Greek Prime Minister Lucas Papademos and Charles Dallara, head of the Institute of International Finance, which represents most foreign lenders. Final details will be presented this week, according to news reports quoting those close to the talks.

Christine Lagarde, the new managing director of the International Monetary Fund, was notably pointed last week as to the threat a possible Greek default would have not just to the eurozone, but to the global economy. In a warning shot to the European Central Bank, Lagarde stressed the ECB should be willing to share some of the suffering to make the Greek deal work. At present, the ECB, which holds about $70 billion in Greek debt, has declined to accept anything less than face value on its Greek portfolio.

You have to wonder how private creditors will react to that position since they will trade their Greek bonds for new instruments with a 50 percent discount on the face value. With a lower interest rate (between 3 percent and 4 percent, which is very cheap money for the Greeks just now) and a long-term maturity, the total hit for private creditors, who hold slightly more than $263 billion in Greeks bonds, will exceed 70 percent.

It is a “voluntary” agreement, but we cannot do without the quotation marks. Any creditor who does not participate could well find itself with worthless paper. It is also an essential agreement. Once it is sealed, the door is open for Greece to continue drawing on the $171 billion from international lenders fixed as part of a long-term rescue package last October.

This is how the European puzzle will be assembled. But the Continent is hardly out of the woods. On Friday the rating agency, Fitch downgraded five European economies, including Spain and Italy. And there are mounting concerns that Portugal may soon need a second bailout if it is to repay $12 billion in debt due next year. The IMF estimates that even a successful deal now will cut Greece’s debt-to-GDP ratio to 130 percent by 2020, still short of the targeted 120 percent.

In addition, a funny thing happened on the way to the negotiating table last week. You would have thought that the European crisis and the Western allies’ latest confrontation with Iran over its nuclear program were a matter of apples and oranges—or even kumquats. But not in our inextricably interdependent world.

The European Union decided last week to follow the U.S. lead and impose an embargo on Iranian oil imports. But it would delay these until midyear, it said, to give Greece and other hobbling economies time to find alternative supplies. As a whole, Europe imports about 600,000 barrels of Iranian oil daily.

Foolish E.U. for talking openly of its plans. Do those in Brussels think Iranians cannot read English or French or the financial pages? At midweek, the Iranian parliament announced that it was drafting a bill to halt all oil trade with Europe immediately. That pre-emptive step could come as early as this week, right along with news of a successful debt deal.

If no one else will say it, this columnist will: Iran has the West over a barrel, as it were. It can find alternative markets for its oil in the blink of an eye, and it is far from a given that sanctions and embargoes will work in any case. Anyone who knows Iran knows there is no way under the sun it will halt development of its nuclear program in response to Western intimidation. Now we have a European recovery as a potential hostage to America’s and Europe’s ill-considered sanctions and embargoes.

It has been more or less evident for several years that Iran’s likely ambition is to have the capacity to build a bomb but not to have one. This leaves ground for negotiations, which is what the U.S. and the four others members of the U.N. Security Council should be organizing post-haste, before Europe’s hard-won progress on its debt ends up in a heap on the floor—and we all end up in another recession.