By Barry Eichengreen, from VoxEU:
EU and IMF efforts to rescue Greece have failed to stabilise Europe’s financial markets. Now there are significant concerns about Spain and Portugal’s financial circumstances. This column says Europe needs to wake up, face the facts, and take action. It outlines what the IMF, ECB, and Eurozone members need to do to prevent the crisis from spreading. It may be too late for Greece, but it is not too late for Europe.
European leaders and the IMF have badly bungled their efforts to stabilise Europe’s financial markets. They have one last chance, but success will require a radical change in mindset.
First the easy part: Greece will restructure its debt. This point is no longer controversial; the only controversy is why a restructuring was not part of the initial IMF-EU rescue package.
Only the delusional can believe that, when everyone else is taking swingeing cuts, Greece’s creditors can continue receiving 100 cents on the euro. It beggars belief that Greek government debt can top out at 150% of GDP, as the IMF envisages. At this point the government will be transferring well more than 10% of national income to the creditors. In a time of severe austerity, this outcome is unsustainable both economically and politically.
Another explanation is that negotiators thought it prudent to delay the inevitable restructuring until Europe’s financial markets and banks were in better shape. Well, now that financial conditions are deteriorating by the day, this argument no longer holds water.
A final explanation is that debt restructuring is complex, and neither the IMF nor the Greek government had worked out a plan. If true, this is the most damning explanation of all, for it means that the Fund went into negotiations unprepared.
Sooner or later, the creditors will have to exchange their existing bonds for new ones worth at most 50 cents on the euro. This will leave Greece with more public money for basic social services. That in turn will make it a tiny bit easier to achieve social consensus on the needed austerity measures. It will show the Greek in the street that he is not simply making sacrifices to pay the banks. All these are reasons for proceeding sooner rather than later.
Restructuring will not avert the inevitable recession
The Greek government is going to have to reduce its deficit by a further 4% of GDP in each of the next three years. With tax revenues falling, it is going to have to cut spending even more than that. With pensions and salaries being slashed, private spending will be falling as well. Greece will suffer a deep recession even if the government is able to cut interest payments. This is the hangover that follows the drunken binge.
So what can be done? Four things.
First, the IMF and the European Commission can encourage Greece to reach a social consensus on restructuring and reform by showing that the creditors will also contribute.
They can facilitate the inevitable restructuring by using some of their bailout funds to provide credit enhancements, or guarantees, on the new bonds offered the creditors in the exchange.
Second, Portugal and Spain must do more to convince the markets they are not Greece.
Both have smaller deficits and less government debt. But now that the markets have awoken to sovereign risk, Portugal and Spain need to do more to narrow their deficits. Unfortunately, Portugal has announced only increases in capital gains taxation, which is weak soup in an environment where capital gains are scarce. Spain has done even less. Meaningful spending cuts are in order if the Iberians want to avoid becoming two peas in the Greek pod.
The more fundamental problem in Portugal and Spain is structural, a problem that the two countries do, in fact, share with Greece. They need to reform their labour markets, fast. Keeping their debt burdens manageable will require economic growth. It will require exporting. And without labour market reform, growth will disappoint. The days are over when the Iberians can grow on the basis of English expats’ appetite for beachside apartments.
Third, to give the Iberians time, the ECB will have to support their bond markets.
The ECB will have to buy their governments’ bonds directly on the secondary market. Doing so is the only way of preventing them from being further infected by the Greek crisis. With European growth now slowing, there is no reason to worry about the inflationary effects. If Portugal and Spain take meaningful fiscal and structural measures, they deserve the support.
From this point of view, the failure of the ECB to give a stronger statement of intent – and for Mr Trichet to say that the board didn’t even talk about bond buying in its 6 May meeting – is deeply worrying. The charitable interpretation is that the central bank is waiting to first see action from the Spanish and Portuguese governments, at which point it will jump in with both feet. The IMF says that it no longer attaches structural conditions to its financial assistance. Now we are in the bizarre world where the ECB does.
Fourth and finally, the Germans need to support European growth by spending more.
Germans policy makers bemoan the country’s low domestic investment rate. An investment tax credit would address this problem. It would get Europe’s biggest economy growing faster. And faster growth in Europe will help everyone. The problem here is that German policy makers have their heads in the sand.
Summary
It’s not a pretty picture. The IMF botched its rescue. The ECB hesitates to erect the necessary ring-fence around Greece. Portuguese and Spanish policy makers underestimate the gravity of their position. German leaders are in denial. But although it may be too late for Greece, it is still not too late for Europe. That said, a solution will require everyone to wake up.
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That said, a solution will require everyone to wake up.
Yes, it’s not a good sign when everybody keeps looking at it like this:
Keeping their debt burdens manageable will require economic growth.
I guess it’s the ol’ “Lord, give me virtue, but not yet.”
The real problem here is that exponential debt/growth itself is unsustainable. Nothing which remains in denial about this can ever be part of any solution.
Herman Daly is a name which should be much better known, and the steady state economy is a concept everybody needs to get familiar with, since with the end of the cheap oil blip that’s where we’re headed, back to the normal economic activity of normal history, whether we like it or not.
Here’s an introductory piece:
http://www.theoildrum.com/node/3941
ECB buying greek bonds from the secondary? How the heck is it going to help Greece? Why all these “experts” continue to propagate such garbage?!
“How the heck is it going to help Greece?”
It isn’t. It’s meant to help Portugal and Spain turning into Greece.
Oh, and this:
“Fourth and finally, the Germans need to support European growth by spending more.”
So it’s hopeless, then. Too bad this wasn’t at the front – I could have skipped the rest.
Plus, Eichengreen glides over another Iberian problem, which is that their banking systems will be pushed into insolvency by the fiscal adjustment that is coming. So public debt turns out to be quite a bit larger than what appears on the books just now.
So who is going to bail out California when it finally goes tits up? California makes the PIGS look like fiscal management champions.
I think the Fed is already bailing out Calfornia we just haven’t been told….They gave out IOU remember and have not cut their spending as needed…..So you and I have provided a bailout already…
How about the German cities and Lander. Aren’t many of them near-broke?
Last week the markets were hammered due to the spreading of the Greek contagion with Euro falling , sovereign debt CDS of the PIIGS increasing daily and markets dropping at a frightening pace. Give this backdrop you would expect some sort of a Weekend Measure from the EU which has come in this form of a Stabilization Fund.Both the French and German leaders are going to defend the Euro against the “speculators”.More details later but I think most measures would provide only a temporary stablization at best. The EU problems will not stop unless they address the core problems.Rather than trying to solve the fundamental issues behind this crisis the European leaders are at their favorite pastime of blaming the “speculators” and the Markets
The most likely outcome is going to be the continuation of wealth destruction by Central Banks by increasing quantitative easing therefore destroying currencies.
The only way out is too painful for Governments and its government agencies (Central banks and financial system) to follow. Besides would eliminate the special advantages these interest groups have.
http://montyhallparadox.blogspot.com/2010/05/most-likely-outcome-continuation-of.html
They’ve done everything wrong so far, so I’m skeptical . . . not that they can’t avert THIS crisis but that they will make matters worse for themselves over the long run.
Market movements have caused real capitulation . . . of the EU political establishment. Now they will do “whatever it takes” – read “whatever the bankers tell us to do.”
its the latin american austerity plan 2.0. help out banks and kill the real economy. worked real well for them.
What chapter on we on this debt story – chapter 7, chapter 11 or chapter 13?
Can’s wait to reach the end of the book.
The austerity measures are ‘intended’ to cause protests that in turn cause reforms via political pressure that occurs when elected officials realize that they will lose their jobs if they fail to make the hard choices and then act on those choices. Thinking that “EU and IMF efforts to rescue Greece have failed to stabilise Europe’s financial markets”, is part of a counter-factual fantasy that is based on a shallow notion that nations can be rescued from extreme cases of corruption and debt dependence with nothing more that an increase in the very thing that caused the problem in the first place: debt dependence. The “efforts” have not “failed” because there was not any chance of stabilizing Europe’s financial markets without a solution to the lack of global aggregate demand and so there will be some ‘instability’, somewhere, until the larger demand problem is solved, or… until the global economy has contracted down to whatever size is required to match demand to supply. Until that match-up occurs, there will be some instability, which will most likely hit the least productive, the most corrupt, and the most debt burdened economies the hardest, and that which results in only ‘instability’ should be seen as somewhat of a success.
“The Greek government is going to have to reduce its deficit by a further 4% of GDP in each of the next three years. With tax revenues falling, it is going to have to cut spending even more than that. With pensions and salaries being slashed, private spending will be falling as well. Greece will suffer a deep recession even if the government is able to cut interest payments. This is the hangover that follows the drunken binge”
Maybe I missed it but where are the “drunken” bankers who lent Greece all the money in the first place? Seems like Greece wasn’t the only one doing some bingeing. This is what I really hate about these one-sided dump all the blame on the most obvious target narratives. They miss the point that to every transaction there are at least two parties.
Even with austerity Greece can’t pay its debts. So why exactly impose a pointless austerity program? Catharsis? Because of some misguided notion that finance should operate like a morality play? If it were, shouldn’t we be burning the German banking witches who so ensorceled the Greeks? Absolutely a restructuring is needed but the idea of slamming the Greeks and then letting the Germans off with a vague exhortation to invest, come on, the real power is among the Germans, French, and Benelux. If you want restructuring and reform, that is where you should really start, you know, where the money is.
Funnily its the Greeks, who asked for the bailout, and the German gov’t has been quite reluctant to lend money to Greece.
As a result people even at this site called the German gov’t xenophobic.
Hugh says>>Maybe I missed it but where are the “drunken” bankers who lent Greece all the money in the first place? Seems like Greece wasn’t the only one doing some bingeing. This is what I really hate about these one-sided dump all the blame on the most obvious target narratives. They miss the point that to every transaction there are at least two parties.
Even with austerity Greece can’t pay its debts. So why exactly impose a pointless austerity program? Catharsis? Because of some misguided notion that finance should operate like a morality play?<<<
Did you sleep through the class on Goldman Sacs??..LOL
The banks made the loans so that they had a product that they could sell on the open market. Then as much as possible they offset the risk with CDS insurance which they kept after the bonds had been dumped. When you add those reciepts to the earnings from spreads and commisions, it makes atidy pile…:)
These so called solutions are nonsensical in my view.
“The Germans have to spend more …”
Give me a break. The Euro is a zombie currency supported by a delusional view of Europe. It is not a viable currency, and the nations involved will be better off to default on their debts, drop the Euro and go back to their old nationalist currencies (with strict austerity measures to reassure the bond market).
When are economists going to figure out you can pour good money after bad and have a happy result?
On the bright side, this should do wonders for gold.
http://whatisthatwhistlingsound.blogspot.com/2010/05/is-gold-preparing-for-parabolic-move.html
The ECB has long since needed to take all the market-pressured bonds unconditonally as repos _and_ to buy Greek government bonds on the open market. They have the firepower, and a creditable intervention of that kind is a real promise of support. All this ka-jiggering of bilateral ‘loans’ is the Euro-way, but insubstantial flubbery far behind the time curve. All of what I’ve just written has been evident since the inception of the Fall of Greece. Or Fail if you prefer.
The issue with confederations is that they lack the institutional framework for authorized decision-making and centralized response. That is a feature not a bug of such organizations: both a fear of autarkial tyrrany and an unwillingness to cede local prerogatives for financial peculation underwrite limited political union. To this point, the EU has been a confederation, by design. But it faces a crises which puts it up against its design limits.
It is worth noting that confederations of various kinds have been typical in the gradual unification of states in Europe and of Europe itself. The coalescence of that entity called ‘Switzerland’ might be noted as one instance. A crucial issue has been whether political integration has been voluntary or involuntary (i.e. conquest or forcible union externally composed in the latter case). The involuntary unions have been long run failures. Hispania itself might be a relevant example. The EU has been a voluntary affair, but now the weaknesses of confederation are under the noses of all—and stinking. Will the next step be taken? Thank heavens nothing crucial rests upon this learning experience or . . . well; not. States tend to evolve by crises more often than by design, as we see again here.
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It beggars belief that Greek government debt can top out at 150% of GDP, as the IMF envisages. At this point the government will be transferring well more than 10% of national income to the creditors.
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Why, exactly, it beggars belief ? It works out at 6.67% interest rate per year. EU funding is at 5% and IMF much lower. No new borrowing for Greece, apart from these two sources is allowed in the next three years. And these are nominal rates ! If there gets to be some little inflation in the euro, the real rate can be that much lower. Guess who appears to have come unprepared to the table ?
Second, much of the public spending that will be slashed in Greece is waste, pure and simple. It should have been done in the name of social justice ages ago. Public sector employees cost 35% more than private sector employees in equivalent jobs, while they are immune from dismissal and are not, in fact, required to do any work. Unemployment insurance can and should be cheaper.
Third, whatever happened to the small open economy argument ? Recession due to cuts in domestic demand can be made good by exporting.
Fourth, Greece outperformed significantly every single Euro zone country in 1994-2001 in terms of real growth, while running primary public sector surpluses and having no drachma devaluation. Public debt kept falling as a percentage of GDP. Why can it not repeat that performance ?
Fifth, the EU structural funds still provide a good positive flow of income to Greece. What incentive do the Greeks have to default and risk losing that income flow ?
Sixth, the 150% figure is not the debt as defined by the standing EU methodology. It includes outstanding guarantees given out by the Greek state, guarantees that may or may not be called. Could Professor Eichengreen provide comparable figures for other EU Member States ? I am sure they would make for very interesting reading.
Seventh, I am in the market for Greek debt at 50 cents to the euro. Any sellers ?