Greek Prime Minister Papandreou made a stand this week. Even though he was backed down, this column argues that he did the EZ a favor by providing an opportunity to change course. One way or another, a disorderly Greek default is in the cards with its attendant contagion. At that point a real solution is inevitable – one that requires EZ leaders and the ECB to play on the same side with credible rules for all.
The Greek revolt, even if short lived, is good news on the European crisis front – it might provoke the long-awaited policy turnaround that is necessary to end the Eurozone crisis. It may finally awaken EZ leaders to the futility of the path they’ve chosen. Cherry on the pie: the unexpected interest rate cut by the ECB signals the advent of a less dogmatic central bank in the face of an impending recession.
The Greeks have a point
Greek sovereignty has been trampled over again and again.
- The Greeks were told to not go to the IMF, to not restructure their debts, and instead to run their economy to the ground.
- Then they were told that turning to the IMF is OK.
Under pressure from EZ leaders – not the IMF – they have been given loans on conditions far worse and more intrusive than those for which the IMF has been crucified – rightly so – after the Asian crisis.
- Most recently, they were told that a debt restructuring will be negotiated on their behalf with the banks.
None of that is part of the European Treaties – in fact it runs against the spirit of the no-bailout clause. The Greek people never signed up for such treatment.
The Greeks have remained complaisant far too long. As a sovereign country, these are decisions that they should be able to make, certainly after consultations with fellow Eurozone members.
There is nothing wrong with an attempt to restore sovereignty and with a message from its inventors that democracy is a fundamental value, even if it is difficult, even if it stands in the way of the technocratic approach that has prevailed all along.
Following the wrong road to the bitter end
From the very beginning of the sovereign crisis, it was clear that an austerity package imposed on a country in a deep recession would fail. It was clear that Greece would have to restructure its debt.
- After more than year of denial and negation, EZ leaders finally accepted that Greece could default. We are, however, far from implementation.
- The October Summit has been long on words but short on precision; the 50% voluntary orderly debt-cancellation is an oxymoron.
The Summit strengthened the austerity measures imposed on Greece and sent a team to go deeper into its internal accounts to ensure compliance.
But the worst news from the Summit is the announcement that EZ leaders believe the fiction that somehow the EFSF can be leveraged up to €1 trillion without adding fresh commitments from the stronger Eurozone countries.
And finally, the Summit ignored the unavoidable fact that the ECB will have to carry out most of the rescue operation, an idea that is finally seeping through.
All along, the only question was whether they would realize their own mistakes and change track, or persist and run into a wall.
The attempted rebellion by Papandreou, which seems on the verge of fizzling out, throws a wrench into yet another flawed plan. Will the European leaders reconsider their strategy? This is unlikely.
What happens next? Default and contagion
The political situation in Greece is murky so detailed predictions are implausible. Some basic principles, however, are likely to prevail, as indeed they have done over the last two years.
- It is likely that Greece will be cut out from external funding, so it will default.
- The long feared but unavoidable involuntary and disorderly default will prompt a banking crisis, certainly in Greece but possibly elsewhere as the collapse of MF Global suggests.
- Contagion will soon follow.
Will it be Portugal? Will it be Italy? Probably both will go the IMF and greet the Troika in their respective capitals. More banks will fail in Europe and elsewhere. At that stage, France will come to the front line. This will be a repeat, of worse, of what followed Lehman Brothers, but unlike the Lehman’s debacle, this outcome was clear from the start. Any clearheaded scholar of debt crises could see how this would end. The writing was on the wall all along.
The bright spot is that such a crash may bring us closer to the beginning of the end of the crisis.
An alternative is that a new Greek government, coalition or not, promptly agrees to the new package. The economy will keep contracting and the deficit will not be significantly reduced. In this case, European policymakers will feel vindicated and they will insist on pursuing the strategy of the October Summit.
No matter what, however, the debt will still have to be restructured and it will be disorderly, so we revert to the previous scenario.
Maybe this is when policies will finally be reappraised. A few more months will have been lost and the costs – in terms of unemployment, lost income, and debt accumulation – will have increased further. For example, in 2008, the Greek debt stood at 110% of GDP. Today it is about 170% and the debt restructuring plan aims at bringing it down to 120%, higher than when it was first deemed unsustainable.
Where is the end of the road?
At some point down the road, the ECB will accept that it is a lender of last resort. It will backstop Eurozone public debts. It may be too late for Greece, but will it be before the disorderly default of Portugal? Or before Italy? Probably before France. There is a precedent for those who, at the ECB, insist on wearing the mantle of the Bundesbank. In 1993, the Bundesbank let Italy, Britain, and Spain fall in the face of currency attacks only to draw the line before contagion hit France, Denmark, and Belgium.
What the right road looks like
An ECB backstop does not mean underwriting banks and sovereigns. The ECB guarantee should be partial to protect the ECB and to force a debt restructuring for countries that face unbearably high interest rates.
- Banks will have to be bailed out, possibly with EFSF resources, but in the Bagehot way that minimizes moral hazard and maximizes taxpayer protection.
- That means wiping out shareholders and, if need be, unsecured bondholders.
This is what Sweden did in the early 1990s; it even hired foreign managers – foreign to the web of cross-interests that link bankers and politicians – to quickly return the nationalized banks to profitability and thus protect the taxpayers.
Then, when the crisis is over, the time will come to fix the Eurozone flaws. This means imposing fiscal self-discipline and getting serious about bank regulation.
It was clear from May 2010 that Eurozone leaders took the wrong path because they fundamentally misunderstood the nature and depth of the problem. They thought they could brazen their way out and things would go back to like they were in the 2000s.
But the global crisis, with its extra debt and slow growth, revealed all the flaws that growth had hidden in the euro’s first ten years. Fixing these will require the Eurozone leaders and the ECB to be playing on the same side with credible rules that clearly define each player’s behavior.
Wyplosz, C (2010a), “And now? A dark scenario”. VoxEU.org, 3 May.
Wyplosz, C (2010b) “The Eurozone slides into a vicious cycle”, VoxEU.org, 3 December.
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