What is Plan B for Greece?

Financial Mirror (Cyprus) - - FRONT PAGE -

Fi­nan­cial mar­kets have greeted the elec­tion of Greece’s new far-left gov­ern­ment in pre­dictable fash­ion. But, though the Syriza party’s victory sent Greek eq­ui­ties and bonds plum­met­ing, there is lit­tle sign of contagion to other dis­tressed coun­tries on the eu­ro­zone pe­riph­ery. Span­ish ten-year bonds, for ex­am­ple, are still trad­ing at in­ter­est rates be­low US Trea­suries. The ques­tion is how long this rel­a­tive calm will pre­vail.

Greece’s fire-breath­ing new gov­ern­ment, it is gen­er­ally as­sumed, will have lit­tle choice but to stick to its pre­de­ces­sor’s pro­gramme of struc­tural re­form, per­haps in re­turn for a mod­est re­lax­ation of fis­cal aus­ter­ity. Nonethe­less, the po­lit­i­cal, so­cial, and eco­nomic di­men­sions of Syriza’s victory are too sig­nif­i­cant to be ig­nored. In­deed, it is im­pos­si­ble to rule out com­pletely a hard Greek exit from the euro (“Grexit”), much less cap­i­tal con­trols that ef­fec­tively make a euro in­side Greece worth less else­where.

Some eu­ro­zone pol­i­cy­mak­ers seem to be con­fi­dent that a Greek exit from the euro, hard or soft, will no longer pose a threat to the other pe­riph­ery coun­tries. They might be right; then again, back in 2008, US pol­i­cy­mak­ers thought that the col­lapse of one in­vest­ment house, Bear Stearns, had pre­pared mar­kets for the bank­ruptcy of an­other, Lehman Broth­ers. We know how that turned out.

True, there have been some im­por­tant pol­icy and in­sti­tu­tional ad­vances since early 2010, when the Greek cri­sis first be­gan to un­fold. The new bank­ing union, how­ever im­per­fect, and the Euro­pean Cen­tral Bank’s vow to save the euro by do­ing “what­ever it takes,” are es­sen­tial to sus­tain­ing the mon­e­tary union. An­other cru­cial in­no­va­tion has been the devel­op­ment of the Euro­pean Sta­bil­ity Mech­a­nism, which, like the In­ter­na­tional Mon­e­tary Fund, has the ca­pac­ity to ex­e­cute vast fi­nan­cial bailouts, sub­ject to con­di­tion­al­ity.

And yet, even with th­ese new in­sti­tu­tional back­stops, the global fi­nan­cial risks of Greece’s in­sta­bil­ity re­main pro­found. It is not hard to imag­ine Greece’s brash new lead­ers un­der­es­ti­mat­ing Ger­many’s in­tran­si­gence on debt re­lief or rene­go­ti­a­tion of struc­tural-re­form packages. It is also not hard to imag­ine Eu­ro­crats mis­cal­cu­lat­ing po­lit­i­cal dy­nam­ics in Greece.

In any sce­nario, most of the bur­den of ad­just­ment will fall on Greece. Any prof­li­gate coun­try that is sud­denly forced to live within its means has a huge ad­just­ment to make, even if all of its past debts are for­given. And Greece’s profli­gacy was epic. In the run-up to its debt cri­sis in 2010, the gov­ern­ment’s pri­mary bud­get deficit (the amount by which gov­ern­ment ex­pen­di­ture on goods and ser­vices ex­ceeds rev­enues, ex­clud­ing in­ter­est pay­ments on its debt) was equiv­a­lent to an as­ton­ish­ing 10% of na­tional in­come.

Once the cri­sis erupted and Greece lost ac­cess to new pri­vate lend­ing, the “troika” (the IMF, the ECB, and the Euro­pean Com­mis­sion) pro­vided mas­sively sub­sidised long-term fi­nanc­ing. But even if Greece’s debt had been com­pletely wiped out, go­ing from a pri­mary deficit of 10% of GDP to a bal­anced bud­get re­quires mas­sive belt tight­en­ing – and, in­evitably, re­ces­sion. Ger­mans have a point when they ar­gue that com­plaints about “aus­ter­ity” ought to be di­rected at Greece’s pre­vi­ous gov­ern­ments. Th­ese gov­ern­ments’ ex­cesses lifted Greek con­sump­tion far above a sus­tain­able level; a fall to earth was un­avoid­able.

Nonethe­less, Europe needs to be much more gen­er­ous in per­ma­nently writ­ing down debt and, even more ur­gently, in re­duc­ing short-term re­pay­ment flows. The first is nec­es­sary to re­duce long-term un­cer­tainty; the sec­ond is es­sen­tial to fa­cil­i­tate near-term growth.

Let’s face it: Greece’s bind to­day is hardly all of its own mak­ing. (Greece’s young peo­ple – who now of­ten take a cou­ple of ex­tra years to com­plete col­lege, be­cause their teach­ers are so of­ten on strike – cer­tainly did not cause it.)

First and fore­most, the eu­ro­zone coun­tries’ de­ci­sion to ad­mit Greece to the sin­gle cur­rency in 2002 was woe­fully ir­re­spon­si­ble, with French ad­vo­cacy de­serv­ing much of the blame. Back then, Greece con­spic­u­ously failed to meet a plethora of ba­sic con­ver­gence cri­te­ria, ow­ing to its mas­sive debt and its rel­a­tive eco­nomic and po­lit­i­cal back­ward­ness.

Sec­ond, much of the fi­nanc­ing for Greece’s debts came from Ger­man and French banks that earned huge prof­its by in­ter­me­di­at­ing loans from their own coun­tries and from Asia. They poured this money into a frag­ile state whose fis­cal cred­i­bil­ity ul­ti­mately rested on be­ing bailed out by other euro mem­bers.

Third, Greece’s eu­ro­zone part­ners wield a mas­sive stick that is typ­i­cally ab­sent in sovereign-debt ne­go­ti­a­tions. If Greece does not ac­cept the con­di­tions im­posed on it to main­tain its membership in the sin­gle cur­rency, it risks be­ing thrown out of the Euro­pean Union al­to­gether.

Even af­ter two bailout packages, it is un­re­al­is­tic to ex­pect Greek tax­pay­ers to start mak­ing large re­pay­ments any­time soon – not with un­em­ploy­ment at 25% (and above 50% for young peo­ple). Ger­many and other hawk­ish north­ern Euro­peans are right to in­sist that Greece ad­here to its com­mit­ments on struc­tural re­form, so that eco­nomic con­ver­gence with the rest of the eu­ro­zone can oc­cur one day. But they ought to be mak­ing even deeper con­ces­sions on debt re­pay­ments, where the over­hang still cre­ates con­sid­er­able pol­icy un­cer­tainty for in­vestors.

If con­ces­sions to Greece cre­ate a prece­dent that other coun­tries might ex­ploit, so be it. Sooner rather than later, other pe­riph­ery coun­tries will also need help. Greece, one hopes, will not be forced to leave the eu­ro­zone, though tem­po­rary op­tions such as i mpos­ing cap­i­tal con­trols may ul­ti­mately prove nec­es­sary to pre­vent a fi­nan­cial melt­down. The eu­ro­zone must con­tinue to bend, if it is not to break.

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