Whistling past the graveyard?

Simon Nixon holds that in the years before the financial crisis broke, Greece was flush with money. The Greek governments of the time did the popular thing by increasing pensions and wages for public employees well beyond the level that the feeble Greek economy could sustain in normal times. Then the slump dried up the river of money. Greece faced a crisis; a Greek financial collapse could spread to the rest of the Eurozone; and the European Central Bank, the Eurozone countries, and the International Monetary Fund stepped in with a bailout.[1]

In return for this bail-out, the creditors demanded that Greece make reforms of its unsustainable public-sector and pension systems to reduce spending to a level that the Greek economy could support in normal times. Instead of pursuing this politically unpopular course, Greece laid its main effort on enhanced tax collection and on a reform of the pension system that did not address the real problem. Thus, the number of bureaucrats fell as they were transferred to early retirement. This increased the burden of pensions in the budget rather than reducing it.

The Syriza government argues that budget cuts will just push Greece deeper into recession. They have been asking for an expansionary budget policy combined with more money from the European Union for “investment.”

There is a consensus on the need to “restructure” (greatly reduce) Greece’s debt. There is a consensus among the creditors on the need for serious reforms of Greece’s public sector and pension systems. A deal should be easy to reach. However, the Greeks want the debt reduction to come at the same time as the promise to implement reforms in the future.[2] The creditors don’t trust the Greeks to implement the reforms once they have the money in hand. As a result, they insist that the reforms have to precede any debt restructuring.

Anatole Kaletsky argues that, between the outbreak of the Greek financial crisis in 2009 and the end of 2014, there existed a real danger that a Greek default would be the first domino in a chain that ran through Portugal, Spain, and Italy before crashing down on Germany.[3] In January 2015, however, Mario Draghi, the head of the European Central Bank, won approval for a massive program of bond-buying on the part of the ECB. In essence, the ECB now can print all the money it needs to drown the fires of a financial crisis. Euro-zone countries agreed to this measure in order to build a fire-wall between Greece and the rest of the Eurozone. Now, the dangers of a Greek default are chiefly to the Greeks themselves: default will block access to foreign credits, end ECB support for the Greek banking system, lead to a run on the banks that will leave many people empty handed, and the government will be unable to pay the pensioners and public employees on whose behalf it has been engaged in this game of chicken.

Then there is the collateral damage. A “Grexit” may not do serious damage to the European economy. It will harm the reputation of the IMF. IMF rules bar it from lending to countries that are unlikely to be able to sustain the debt. The Eurozone lured the IMF into participating in the Greek bail-out by warnings of a “financial contagion.” Well, the current level of Greek debt is not sustainable. A Greek default will gore the IMF, which prime minister Tsipras has just denounced as ‘criminal.” That will affect IMF lending programs in several ways for the foreseeable future.

The level of emotional engagement here reminds us that politics isn’t always rational.

[1] Simon Nixon, “Athens and Its Creditors Head for the Brink,” WSJ, 8 June 2015.

[2] See: “I’ll gladly pay you Tuesday for a hamburger today.”

[3] Anatole Kaletsky, “Greek crisis: Europe has nothing to fear from Greek belligerence,” The Guardian, 16 June 2015.


Coming Soon to a Theater Near You: Grexit Rising:

When it comes to tossing around their weight, it doesn’t matter that each country has a single vote at the U.N. General Assembly. There are a few big, important countries and there are many little, unimportant countries. You can see this at work in the current stand-off over the Greek debt issue.

The I.M.F., although chock-full of technical experts, still has an acute political awareness. So, the I.M.F. has long favored pairing a reduction (“restructuring”) of the debt owed by Greece to its European creditors (especially Germany) with economic reforms by Greece. Greek debt is up to 180 percent of GDP. There is no way the Greeks are going to make the sacrifices necessary to pay the debt, but the European creditors have refused to absorb the losses. The Greeks revolted against both austerity and the reforms pushed by the I.M.F. and the European Union. Now there is a dead-lock. However, in public the I.M.F. has laid the blame for the impasse at the feet of the Greek government. Complaints about the intransigence of the creditors were uttered sotto voce.[1] That reflects the importance of Germany and France on the world scene and within the European Union. The harsh stance toward the Greeks also reflects the utter unimportance of their country. Greeks are by nature Hellenophiles, so they have some difficulty registering the reality that no one else cares what happens to Greece.

Before joining the Eurozone, the Greeks could have dealt with their debt problem (and did) by devaluing their currency. Effectively, this robbed their creditors. Served the creditors right for lending to the Greeks. Financial Darwinism in action. Nobody much cared. Joining the Eurozone, with its single exchange rate, robbed Greece of this option.[2]

In a normal bankruptcy, the creditors would have to eat a lot of their claims on the grounds that they had been foolish to lend the money in the first place. The Greek case is different because the crisis arose when it became apparent that several Greek governments representing different parties had “cooked” the national accounts in order to deceive lenders. So, it seems perfectly reasonable to me that Greece would get its head held under the tap while someone (with a German accent) gave them a good scrub with a steel brush. Still, you can’t get blood out of a stone. Why not say “enough is enough”?

I conjecture that there are several reasons. First, once all is forgiven, and the debt has been written down, and the Greeks have agreed to some cosmetic reforms of unions and pensions, and enough time has passed for people in financial markets to forget about the whole thing[3], the Greeks will do it again. There is no solution to this problem except to boot the Greeks out of the Eurozone. Second, what will be the effect of a Greek default on the creditors? Back in August 2012, it was estimated that the Eurozone Central Banks could lose as much as 100 billion Euros from a Greek default, with the German Central Bank getting soaked for up to 27 billion Euros.[4] I have not seen much discussion of the impact on the creditor economies of a Greek default (but maybe I wasn’t looking). Economically, but even more politically, accepting that the money is gone will be hard for democracies to choke down. Still, push is coming to shove. Either before or after a new “extension,” the Greeks will get shoved out the door.

[1] Liz Alderman and Landon Thomas, Jr., “I.M.F. Recalls Negotiators as Deadline Looms for Greek Deal,” NYT, 12 June 2015.

[2] In exchange, the Greeks gained the transient psychic benefit of believing that they did not live in a banana republic.

[3] In all likelihood a relatively short span of time. Which should make Americans wonder whether anyone learned any lessons from our own “recent unpleasantness.”

[4] See: https://en.wikipedia.org/wiki/European_debt_crisis#Greece

Playing Chicken.

Architects of the Euro-zone sought a stronger, more prosperous, and more harmonious union.[1] The inauguration of the Euro in 1999 began a period of low interest rates for member countries. Low interest rate led to heavy borrowing by both public (Greece) and private (Spain, Ireland) sectors. When the world economy slowed down after the American financial crisis, debt-service became a problem.

The architects had not then—and have not yet—resolved all of the problems. One worm in the apple is that the single currency serves 19 sovereign states. Those states do not pursue uniform economic policies. Nor do all national cultures celebrate the same values.[2] German hostility to budget deficits closed off large-scale counter-cyclical spending as a policy tool. Instead, states were to pursue limiting deficits as a share of Gross Domestic Product (GDP).

The pursuit of austerity policies has had different effects in different countries.[3] The GDP of Germany has risen about 10 percent from 2009. The GDP of Portugal, Spain, and Italy are all down about 10 percent. The GDP of Greece is down more than 20 percent. The decline in GDP has increased the burden of the government debt financed by taxation. Government debt as a share of GDP has risen from about 30 percent to about 70 percent in Spain; from 90 percent to about 110 percent in Italy; and from 60 percent to about 120 percent in Portugal. Greek government debt as a share of GDP has risen from about 110 percent to about 170 percent. (Thus, austerity has pushed Italy and Portugal into the same territory from which Greece began.) This raises the danger that bigger, more severe crises lie over the horizon.

The the creditor countries could pursue expansionary policies that might fuel demand for goods from the debtor countries. Once again, different national politics and cultures come into play. The northern creditor countries don’t want to abandon the policies that they associate with their own success, least of all to bail out the improvident.[4]

The concept of the Euro-zone was that—like Mr. Lincoln’s theory of the Union—the members had formed an indissoluble bond.[5] The Greek crisis threatens that idea. If Greece was to be forced out, then any other country that got into serious financial difficulty in the future might suffer the same fate. Countries at risk would have to pay extremely high risk premiums for financing public debt. The whole Euro-zone could unravel from the bottom like a sweater. Crisis after crisis would gnaw at a union that seeks the benefits of stability.

Hard-liners have not said so, but it might turn out to be a way of finally enforcing the economic doctrines of the northern creditor countries on the southern debtor countries.[6] Any country that did not wish to pay high risk premiums to lenders would have to pursue “sound” finances. That, in turn, could force a reform of social and economic policies.

The Greek “Syritza” and Spanish “Podemos” parties have drawn strong support for demands to end austerity and for debt repudiation. Many American observers seem to think that the Germans and other creditors should be happy to get robbed by the Greeks and other debtors for the greater good. The long Republican counter-attack against high taxes since the Reagan Administration shows something different. People who feel victimized will fight back. Right now, the focus is on angry Greeks and Spaniards. In the future it’s likely to be angry Germans.

[1] Eduardo Porter, “Local Politics Are Fracturing European Unity,” NYT, 3 February 2015.

[2] Flexibility, thrift, and probity, for example.

[3] See the charts in Porter, “Local Politics.”

[4] The limited historical knowledge of many economic commentators leads them to make frequent references to the post-First World War inflation as a formative experience. They ignore the “cigarette economy” that flourished after the Second World War and the heavy burdens carried by West Germans after absorption of the defunct German Democratic Republic in 1989. Germans today have a far more vivid set of memories shaping their behavior.

[5] Stephen Fidler, “Europe Weights Costs of Casting Greece Aside,” WSJ, 6 February 2015.

[6] As Voltaire quipped after the Royal Navy executed Admiral John Byng, “They shoot one to encourage the others.”