If you want to save Greece, stop lend­ing it money

The Pak Banker - - Front Page - Klaus Adam

THE Greek res­cue pro­gram is se­ri­ously de­railed. By the end of this year, the econ­omy will be a fifth smaller than it was five years ago, and the gov­ern­ment is fore­cast­ing an­other 4.5 per­cent de­cline in 2013. This fig­ure may once again prove overly op­ti­mistic.

The col­lapse helps to ex­plain the high drama in­volved this week, as the Greek gov­ern­ment tries to drive through par­lia­ment a dou­ble dose of aus­ter­ity in the teeth of re­ces­sion, and the coun­try's in­ter­na­tional cred­i­tors worry over whether to give the coun­try its next 31 bil­lion eu­ros ($40 bil­lion) of life sup­port, rather than let it de­fault on debt re­pay­ments later this month and crash out of the euro. Given such a des­per­ate sit­u­a­tion, it's all the more sur­pris­ing that Greece con­tin­ues to bor­row abroad at a stun­ning rate. The cur­rent ac­count deficit, a mea­sure of ex­ter­nal bor­row­ing for the coun­try as a whole, was 21 bil­lion eu­ros in 2011, or about 10 per­cent of gross do­mes­tic prod­uct. While it slowed some­what in 2012, Greek bor­row­ing still ran at an an­nu­al­ized rate of 14 bil­lion eu­ros in the first half of the year.

The con­tin­ued bor­row­ing is of­ten over­looked in the de­bates over how to res­cue Greece, and it in­di­cates that the ef­fort to avoid de­fault is doomed.

Heavy for­eign bor­row­ing is sen­si­ble when a coun­try is faced with a tem­po­rary fall in growth. It can help to cush­ion the ef­fects on do­mes­tic con­sump­tion. But Greece is not suf­fer­ing from a tem­po­rary slow­down in the eco­nomic cy­cle. In a sit­u­a­tion where the de­cline in ac­tiv­ity is more per­ma­nent, large-scale bor­row­ing to sus­tain con­sump­tion only in­creases the pain down the road. It re­quires cut­ting back con­sump­tion to fall in line with lower pro­duc­tion lev­els, as well as ad­di­tional re­duc­tions to ser­vice the ac­cu­mu­lated ex­ter­nal debt.

The para­dox of a si­mul­ta­ne­ous plunge in eco­nomic ac­tiv­ity and in­creased ex­ter­nal bor­row­ing raises the ques­tion of why Greece is bor­row­ing at the rate it is. The an­swer ap­pears to be that the Greek po­lit­i­cal sys­tem is se­ri­ously dys­func­tional. There sim­ply is no cred­i­ble plan for the long term and, cer­tainly, none that would en­vis­age re­pay­ing ex­ter­nal debt.

The past weeks have shown that the rul­ing par­ties in Greece are more fo­cused on fight­ing each other than on re­forms that could sup­port eco­nomic growth and real change in the coun­try. Prime Min­is­ter An­to­nis Sa­ma­ras and his New Democ­racy party are aware of the once-in-a-life­time op­por­tu­nity they now have to marginal­ize their long-stand­ing po­lit­i­cal ri­vals from the mod­er­ate left and to es­tab­lish a new bipo­lar po­lit­i­cal sys­tem, in which the ex­treme left Syriza party fea­tures as their main op­po­nent. Aware of this tac­tic, the mod­er­ateleft par­ties de­cided to op­pose sen­si­ble mea­sures from the so-called troika -- the In­ter­na­tional Mone­tary Fund, the Euro­pean Com­mis­sion and the Euro­pean Cen­tral Bank -- such as lib­er­al­iz­ing the la­bor mar­ket and re­duc­ing pub­lic sec­tor em­ploy­ment, thereby turn­ing them­selves into a threat to New Democ­racy. The re­sult is po­lit­i­cal dead­lock and a rate of in­crease in debt lev­els that even the big­gest res­cue pack­ages can't keep up with.

Pol­icy mak­ers have slowly be­gun to rec­og­nize the un­sus­tain­abil­ity of these debt and bor­row­ing dy­nam­ics. The IMF has been push­ing the euro area to find ways to re­duce Greece's debt, but gov­ern­ments and the ECB, which holds about 45 bil­lion eu­ros of Greek bonds, have re­sisted any sug­ges­tion they should for­give the debt that's owed to them.

Even­tu­ally in­ter­na­tional lenders will have to come to terms with the fact that Greece will sim- ply not be able to re­pay its debt. It is quite pos­si­ble that fur­ther mea­sures, such as mis­guided plans to buy back Greek debt, can tem­po­rar­ily push back this mo­ment of truth. They are un­likely to buy much time so long as Greece is bor­row­ing abroad at a rate of 14 bil­lion to 20 bil­lion eu­ros a year.

Greece will only be truly "saved" once it man­ages to get along with­out ad­di­tional bor­row­ing. Achiev­ing this re­quires that of­fi­cial cred­i­tors stop lend­ing money to the cur­rent Greek elites, that of­fi­cial and pri­vate cred­i­tors write off the coun­try's debt, and that do­mes­tic eco­nomic com­pet­i­tive­ness in­creases to a point where it gives a strong boost to ex­ports.

A Greek debt de­fault and a si­mul­ta­ne­ous euro area exit would achieve all of these goals, vir­tu­ally overnight. Ob­vi­ously, the ad­just­ment would be rough and tur­moil would prob­a­bly pre­vail for a num­ber of months, but the ad­just­ment would take place.

The cur­rent soft ap­proach, in which in­ter­na­tional money is chan­neled to the rul­ing elites with the aim of smooth­ing tran­si­tion to a sus­tain­able po­si­tion within the euro area, has yielded close to noth­ing in terms of struc­tural eco­nomic ad­just­ments. In­stead of a smooth tran­si­tion, Greece is in the midst of a dis­as­trous col­lapse in out­put.

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