Greek debt and a default of statesmanship

Creating euro zone is members’ second-worst monetary idea, a break-up is the worst

Presidential guards parade before newly appointed ministers and deputy ministers at a swearing in ceremony outside the presidential palace in Athens on January 27th, 2015. Photograph: Marko Djurica/Reuters

Presidential guards parade before newly appointed ministers and deputy ministers at a swearing in ceremony outside the presidential palace in Athens on January 27th, 2015. Photograph: Marko Djurica/Reuters

 

Sometimes the right thing to do is the wise thing. That is the case now for Greece. Done correctly, debt reduction would benefit Greece and the rest of the euro zone. It would create difficulties. But these would be smaller than those created by throwing Greece to the wolves. Unfortunately, reaching such an agreement may be impossible. That is why the belief that the euro zone crisis is over is mistaken.

Nobody can be surprised by the victory of Greece’s left-wing Syriza party. In the midst of a “recovery”, unemployment is reported at 26 per cent of the labour force and youth unemployment at over 50 per cent. Gross domestic product is also 26 per cent below its pre-crisis peak. But GDP is a particularly inappropriate measure of the fall in economic welfare in this case. The current account balance was minus 15 per cent of GDP in the third quarter of 2008, but has been in surplus since the second half of 2013. So spending by Greeks on goods and services has in fact fallen by at least 40 per cent.

Given this catastrophe, it is hardly surprising that the voters have rejected the previous government and the policies that, at the behest of the creditors, it – somewhat halfheartedly – pursued. As Alexis Tsipras, the new prime minister, has said, Europe is founded on the principle of democracy. The people of Greece have spoken. At the very least, the powers that be need to listen.

Moralistic blocks

The first proposition is that the Greeks borrowed the money and so are duty bound to pay it back, how ever much it costs them.

This was very much the attitude that sustained debtors’ prisons.

The truth, however, is that creditors have a moral responsibility to lend wisely. If they fail to do due diligence on their borrowers, they deserve what is going to happen. In the case of Greece, the scale of the external deficits, in particular, was obvious. So, too, was the way the Greek state was run.

The second proposition is that, since the crisis hit, the rest of the euro zone has been extraordinarily generous to Greece. This, too, is false. True, the loans supplied by the euro zone and the International Monetary Fund amount to the huge sum of €226.7 billion (about 125 per cent of GDP), which is roughly two-thirds of total public debt of 175 per cent of GDP.

But this went overwhelmingly not to benefiting Greeks but to avoiding the writedown of bad loans to the Greek government and Greek banks.

Just 11 per cent of the loans directly financed government activities. Another 16 per cent went on interest payments.

The rest went on capital operations of various kinds: the money came in and then flowed out again.

A more honest policy would have been to bail lenders out directly. But this would have been too embarrassing.

As the Greeks point out, debt relief is normal. Germany, a serial defaulter on its domestic and external debt in the 20th century, has been a beneficiary. What cannot be paid will not be paid.

The idea that the Greeks will run large fiscal surpluses for a generation, to pay back money creditor governments used to rescue private lenders from their folly, is a delusion.

So what should be done? The choice is between the right, the convenient and the dangerous.

As Reza Moghadam, former head of the IMF’s European department, argues: “Europe should offer substantial debt relief – halving Greece’s debt and halving the required fiscal balance – in exchange for reform.”

This, he adds, would be consistent with debt substantially below 110 per cent of GDP, which euro zone ministers agreed to in 2012. But such reductions should not be done unconditionally.

The best approach was set out in the “heavily indebted poor countries” initiative of the IMF and the World Bank, which began in 1996. Under this, debt relief is granted only after the country meets precise criteria for reform. Such a programme would be of benefit to Greece, which needs political and economic modernisation.

The politically convenient approach is to continue to “extend and pretend”. Undoubtedly, there are ways of pushing off the day of reckoning still further. There are also ways of lowering the present value of interest and repayments without lowering the face value.

Transparent outcome

Ireland

The dangerous approach is to push Greece towards default. This is likely to create a situation in which the European Central Bank would no longer feel able to operate as Greece’s central bank. That then would force an exit. The result for Greece would certainly be catastrophic in the short term.

My guess is that it would also reverse any move towards modernity for a generation. But the damage would not just be to Greece. It would show that monetary union in the euro zone is not irreversible but merely a hard exchange-rate peg.

That would be the worst of both worlds: the rigidity of pegs, without the credibility of a monetary union.

In every future crisis, the question would be whether this was the “exit moment”. Chronic instability would be the result.

Creating the euro zone is the second-worst monetary idea its members are ever likely to have. Breaking it up is the worst. Yet that is where pushing Greece into exit might lead.

The right course is to recognise the case for debt relief, conditional on achievement of verifiable reforms. Politicians will reject the idea. Statesmen will seize upon it. We will soon know which of the two they are.

The Irish Times Logo
Commenting on The Irish Times has changed. To comment you must now be an Irish Times subscriber.
SUBSCRIBE
GO BACK
Error Image
The account details entered are not currently associated with an Irish Times subscription. Please subscribe to sign in to comment.
Comment Sign In

Forgot password?
The Irish Times Logo
Thank you
You should receive instructions for resetting your password. When you have reset your password, you can Sign In.
The Irish Times Logo
Please choose a screen name. This name will appear beside any comments you post. Your screen name should follow the standards set out in our community standards.
Screen Name Selection

Hello

Please choose a screen name. This name will appear beside any comments you post. Your screen name should follow the standards set out in our community standards.

The Irish Times Logo
Commenting on The Irish Times has changed. To comment you must now be an Irish Times subscriber.
SUBSCRIBE
Forgot Password
Please enter your email address so we can send you a link to reset your password.

Sign In

Your Comments
We reserve the right to remove any content at any time from this Community, including without limitation if it violates the Community Standards. We ask that you report content that you in good faith believe violates the above rules by clicking the Flag link next to the offending comment or by filling out this form. New comments are only accepted for 3 days from the date of publication.