There are more than two choices over Greek tangle
If this was meant to be the challenge to German economic orthodoxy, it failed. The compromise reached in Brussels on the extension of the Greek bailout was not the deal the new Syriza government sought. Its negotiating position was weak for two reasons.
On Friday, Greek depositors transferred more than €1 billion of bank deposits abroad. The bank system would have collapsed within days without an extension. And Athens had no plan for a euro exit.
It had no choice but to cut a deal in which the Germans prevailed on all the substantive issues.
Then again, the deal runs for only four months — time to prepare for the battle that matters most: determining the long-term trajectory of the Greek fiscal position. Under its old agreement with creditors, Athens was meant to run a primary budget surplus — before payment of interest on its debts — of 3 per cent this year, and 4.5 per cent in 2016.
The EU wants Greece to pay down its debt, currently 175 per cent of gross domestic product, to 110 per cent by 2022.
Economic history tells us adjustments of such scale do not work because electorates do not stand for it. One of Syriza’s main pre-election demands was a debt conference, in which Greece and its creditors would agree a formal “haircut” — a reduction in the nominal value of the outstanding debt — to allow the country to remain in the Eurozone.
The lower the level of the debt, the lower the required primary surplus needed to achieve any given debt target.
For the creditors this demand was an absolute taboo. Their preferred strategy is to extend the loans, cut interest rates on the Greek loans a little and pretend the country is still solvent. The question then becomes: how far would you have to go in this direction to make the required primary surplus more tolerable?
The Greeks want a primary surplus of 1.5 per cent of GDP from now — which seems reasonable, given the state of their economy. Let us say they accept 2 per cent. And now think of the primary surplus as the money a country has for debt servicing and repayment.
At present, Greece is not paying any interest at all on its loans from European creditors; this is not supposed to start until 2023. The reason the creditors are asking Greece to run a large primary surplus is to make room for the interest payments that start then.
The level of debt is thus closely related to the surpluses Greece needs to run. They are not independent variables you can adjust at will. A German official told me that, to justify a cut in the primary surplus as big as Athens wants, you would also need a haircut on the debt.
Since the Germans oppose a haircut, they will oppose a cut in the primary surplus too. So there is a huge battle ahead over this — much bigger than anything we saw last week.
Ability to survive
What is at stake for Greece now is its very ability to survive economically. That would require an exit from the vicious cycle between debt and deflation in which it has been caught for the past five years. One extreme solution to the debt-deflation problem would be Grexit.
It would be very costly at the start but would allow Greece to default on its official creditors, devalue its currency, and run much lower primary surpluses than those required now.
A less risky, and less costly, solution would be a debt restructuring inside the Eurozone; not an outright haircut but something similar. A sovereign equivalent to a debt-forequity swap would be one option. While you cannot own shares in a country you could, for instance, tie the interest rate on a sovereign bond directly to GDP. A GDP-linked bond is not a silver bullet, however, not least because it would give countries an incentive to under-report GDP figures.
Another option could be a debt obligation that has some characteristics of money — a parallel currency. It could be used as a medium of exchange, though not necessarily as a unit of account. Its value would still be expressed in euros.
There is room for creative solutions. The choices are not binary: German-imposed austerity versus Grexit. There are intermediate options superior to both.
The smartest choice would probably be to combine a number of instruments — a haircut, GDP-linked bonds, maturity extensions, interest rate reductions — and hope that the overall effect is sufficient to allow Greece to run permanently lower primary surpluses.
This is what the upcoming negotiations will be about. For Greece to prosper in the Eurozone will require a shift of thinking among its creditors that goes beyond the marginal degree of flexibility they were ready to agree last week.
It was Plato who remarked in his Laws that a statesman is likely to fail if he legislates only for peace. Prime Minister Alexis Tsipras and his finance minister should follow this advice. They will need a fully worked-out plan B to signal to their partners that Greece is determined to achieve sustainability — inside or outside the Eurozone — whatever it takes.
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