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A Greek tragedy - the final act?

David Bassanese
Wednesday, June 17, 2015

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By David Bassanese

There are no winners or heroes in the Greek debt debacle, which now seems likely to wreak a little havoc across global markets for at least the short-term. This will make us all losers. It’s a cliché of course, but this is a classic Greek tragedy.

Europe is at fault on several grounds, the first being not tackling Greece’s debt problems earlier. Quite clearly, Greece has been cooking its fiscal books for some time, in cloak and mirror manoeuvres, even invented by notable Wall Street investment banks, to help it meet the conditions for entry into the Eurozone in the first place.

The scene is set

European officials may be silly, but not that stupid, and I suspect they tacitly looked the other way in the political interest – not economic – of expanding the Eurozone further. After all, even France, and by all accounts Germany, engaged in little accounting creativity in the past to keep their budget deficits under the Eurozone sanctioned level of 3% of GDP. And in 2003, both simply floated this stipulation all together – with no fines being imposed by the European Commission.

When Greece finally came clean and admitted its budget deficits and debt levels were much higher than previously indicated, the knee-jerk reaction was to insist – IMF style – that Greece slash public spending and bring its deficit under control in exchange for stop-gap financing.

The inevitable result of such cut backs – along with the rising outflows of smart people and capital – was to send the economy into depression. In turn, this made Greece’s deficit problems even worse.

We now have a farcical situation where Europe and the IMF are still insisting on fiscal austerity whilst Greek unemployment is at 25% - and only so Greece can get the money it needs to service existing debts to the EU and IMF.

Greece, of course, has plenty to answer for. It’s excessively generous welfare system, refusal to privatise poorly performing state enterprises, and cavalier attitude to tax collection, were well known before entry into the Eurozone. The hope was that the disciplines of being a member of the single currency union would force it to change its ways. It did not. Not only did Eurozone entry not discipline Greece, it allowed it to borrow even more at cheaper rates!

Not helping, of course, is Greece’s unstable political system, where government needs to be formed among unsteady coalitions of rival parties. Tough reform always opens scope for one member of the coalition to complain, end the relationship, and demand fresh elections.

The current crisis was an opportunity for the any Greek Government – or at least a serious political party - to be honest with its people and engage once and for all in far reaching reforms that could place its finances on a sounder footing. But the system – and ultimately Greek voters – simply refused to listen to reason.

The fatal flaw

Ultimately, this Greek tragedy reflects the fatal flaw in the single currency system – lack of centralised control over public finances at the member state level. But again, for the sake of “political compromise” no country wanted to cede this control.

It’s hard to know how the current episode in this long-running saga will resolve itself. Most in the market assume a last minute compromise will again be reached – “kicking the can” down the road a little further. And perhaps it might.

But this time I’m not so sure. I suspect Europe is simply sick and tired of bailing Greece out – and rightly so. After all, it only means the crisis will come back again later. Instead, Europe seems to be quietly preparing itself for a Greek default.

I’ve long argued default is Greece’s only real answer. It can never hope to repay its debt under present circumstances, and everyone knows it. At face value, the fallout from default should now be more manageable than in earlier years - less than one-fifth of Greece’s debt is now owned by the private sector. Instead, most is owned by other European Governments (60%), and the IMF and ECB (around 10% each).

What’s less clear is how the apparently far larger tangled web of derivative contracts across the investment banking sector – in various ways betting on Greek outcomes – will be managed in the event of default. In some respects, this is a bit like the global financial crisis – at face value, the extent of US sub-prime mortgage loans did not seem that large, but it was the trillions in “side bets” on mortgage performance via derivatives that caused the system to implode.

This could be Europe’s Lehman moment.

What I can say, however, is how the crisis could and should be resolved. I’d prefer to see a mutually agreed default process (essentially a “debt forgiveness”) but with the iron clad proviso – perhaps voted by the EU - that Greece will never again get official assistance to repay any new borrowing. Indeed, this could be generalised to all member states, which could also help stem the risk of contagion.

With capital controls, continued ECB support of the banks, and perhaps a non-repayable grant equal to any Greek currently estimated primary deficit shortfall for the next two years (thereby avoiding the need for immediate budget cuts or a “parallel currency” to pay public servants and pensioners) this could keep Greece in the Eurozone.

But going forward, should Greece ever want to borrow Euros to fund its deficit, it will have to do so on the open market and pay the interest rates that the market demands.
And for anyone buying Greek debt, it will be a case of “buyer beware”.

Hopefully, this will create the long-term incentives needed for Greece to finally get its fiscal house in order.

Either way, the next few weeks will make for very interesting times across global markets.

Published: Wednesday, June 17, 2015

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