Thursday, 16 June 2011

An inevitable Greek tragedy?

By Neil McCulloch

A Greek tragedy is unfolding as the world watches furious Greek protestors demonstrate against the extreme austerity measures imposed by their government. As the Economist argues; there would be few who would not react in such a way.

The fact is Greece is bankrupt. It owes well over 100 per cent of its GDP and has no realistic prospect of being able to pay it soon. Much of the blame lies with itself – it ran extravagant policies for far too long and fiddled (legally) the numbers to make things seem better than they were. The financial crisis laid bare the nation’s finances and plunged it into its worst financial crisis since the Second World War. 

If a firm goes bankrupt, the solution is easy, albeit painful: investors lose their money; and creditors, too, are usually forced to take a hit as the remaining assets are distributed between the competing claims. Countries are not firms – but it is abundantly clear that something similar is needed for Greece.  Bluntly put, holders of Greek bonds are not going to get their money back; the best thing to do therefore would be to acknowledge this and immediately give substantial debt relief, or equivalent, to Greece.

Sadly, this is not going to happen.  The European Central Bank is strongly against any kind of write down (or even extending the maturity) of the debt, because, inevitably this means a further bail-out from the ECB.  European voters from countries that are not in a mess, are fed up of bailing out countries that are and so their politicians are not in a generous mood.  “The Greeks themselves must pay, through austerity and structural adjustment” is the cry.  Europe’s leaders therefore will do enough to allow Greece to limp on, but no more.

So, as Greece’s politicians surely knew, complete default is political suicide because of the chaos that would ensue, and is in fact happening on the world stage.  They therefore accepted whatever funds they could get and promised reform.  But they know full well that there was no chance of delivering it.  No politician in their right mind could stick to a plan that forces such pain on the people that vote them into office.  So they have slipped, and will inevitably beg for more money and further relief, which in turn will be given, resentfully, by the rest of Europe because, at any point in time, it will always be easier politically to roll over the debt one more time, than to bite the bullet and cancel it.

We have been here before.  During the 1980s, there was a Latin American debt crisis.  Several Latin American nations were insolvent - but it took a decade or so before the Brady Plan began to seriously address the solvency issue that was obvious from the start. In the 1980s and 1990s several African countries were mired in debt levels similar to those of Greece today.  They were forced to “structurally adjust”.  Many were, unsurprisingly, unenthusiastic about such reforms – but they did so to enable the debts to be rolled over, again and again, until finally the HIPC initiative and the Gleneagles Agreement in 2005 recognised reality and gave significant debt relief.

We know from history that generous debt relief now would save the Greeks from a decade of misery... and we know from history that it isn’t going to happen. That is a true Greek tragedy.


JamesG said...

Couldn't agree more - look forward to sharing these views when I am over there in September. The UK media coverage entirely fails to grasp this dimension instead focusing solely on the potential impact on the Euro and our own economy.

Carlos Fortin said...

I fully agree with Neil that the Greek government “ran extravagant policies for far too long and fiddled (legally) the numbers to make things seem better than they were.” Just two bits of context in this connection:
-the policies included extravagant military expenditure. In the 1990s the figures were fiddled vis-à-vis the EU, but an audit ran by Eurostat for the period 1997-2003 showed real expenditure exceeded the reported figure by some 8.4 billion euros (compare with the total fiscal deficit for 2010 of about 23 billion euros). Clearly tackling military expenditure must be a major component of any adjustment effort.
- the legal fiddling was encouraged and carried out by international banks, notably Goldman Sachs, and involved using complex derivative instruments to channel resources to the Greek government that would not appear as loans in the fiscal accounts and therefore affect its standing in the UE. The current government stopped that practice, described by the New York Times as akin to “taking out a second mortgage to pay credit card debt”.