A realistic approach to the Greek crisis
Over the past months the Greek crisis has taken on dramatic proportions, creating a serious risk of disintegration of the Euro-zone.
With enormous difficulty, the members, jointly with the International Monetary Fund, have committed loans amounting to 110 billion €uro. On its side the European Central Bank has finally resolved to derogate to its announced policy: it will continue to accept Greek paper as valid collateral. A program of quantitative easing is also mentioned as a further and last measure.
As a condition to this extraordinary help, a punitive program of cost cutting is imposed on Greece which faces a decade of deflation or at best very low growth. Perhaps more ominously social unrest is looming, the consequences of which could be far reaching.
And despite this extraordinary effort, skepticism prevails. Both the Greek debt and the €uro continue to be dumped in the markets. If we take into account the possibility of a crisis affecting other members (Portugal, Spain) it is clear that this approach is bound to fail, with devastating consequences.
Is not it time to step back and recognize that Greece faces a problem of solvency beyond the pressing liquidity needs?
The successful precedent of the Brady Bonds could be used to support an entirely different approach to the problem.
The Banks holding Greek Bonds (French, German, others) would be invited to swap them for newly issued obligations on the same terms but with much longer maturities - 20-30 years. Actuaries calculate that this restructuring would be equivalent to a “haircut of 20 to 25%” (because of the low interest rates for a considerable number of years). This may be sufficient to restore Greek solvency whilst at the same time providing the needed liquidity. Instead of committing hard cash the members of the Euro-zone (Germany, France , others) would underwrite the ultimate repayment of the bonds. The Banks involved would sacrifice the extra yield that bonds issued on the open market would command, but no loss as regards redemption. They could also refinance this paper with the European Central Bank.
Concomitant with the restructuring, Greece would be invited to resign from the Euro-zone perhaps temporarily. Greece could continue to use the €uro for its international transactions including the billing of services such as tourism. But the drachma would be reintroduced for the domestic economy.
This realistic approach would achieve several objectives:
- It would save the €uro-zone from gangrene from the poor performers: gangrene of the financial system and perhaps more importantly spreading of social unrest.
- It would send a strong signal to other potential defaulters to put their house in order before it is too late.
- It would crystallize a reality: so long as the members remain sovereign states, the €uro-zone must function as a club. In the last resort the members unwilling or unable to comply with the rules must be expelled.
- Finally it should galvanize the whole Community to improve the monitoring and coordination of policies, leading perhaps to closer institutional links, once the current crisis of Euro-skepticism is overcome.
A correspondent has responded by direct e-mail to me.
ReplyDeleteI quote below excerpts of his message and add a few comments
“Whilst the Brady Bond suggestion would provide an immediate fix..[this] would only defer the requirement of Western Europe ..and to a lesser degree the USA to face up to its fundamental problems exacerbated with the advancement of the BRICS..;
Europe and especially the UK is underproductive, overpriced overpopulated and overregulated and .. the solution needs a complete re-think based on a ten year outcome and a prolonged deflationary scenario”
I would agree that our fundamental challenge is to restructure our economies to become competitive again . Germany showed that it is possible to succeed whilst maintaining high social standards and a strong currency.
Distinguished economists have argued that its model cannot be replicated, because it is based on high savings and exports: this necessarily implies - they argue - that the trading partners run a deficit.
I do not share their view precisely because the emerging economies provide dramatic prospects of growth. For this reason Europe and the USA do not operate within the constraints of a zero sum equation.
But clearly we must get organized to take a significant market share. This involves profound economic reforms, a more austere culture coupled with dynamism not retrenchment. At best positive results are to be expected over a long period (five to ten years).
This being said the international monetary system is critically important. If it ceases to function, disaster is likely to follow, perhaps abruptly. But if it works it can provide a powerful ingredient for growth as Britain showed during the Victorian era.
During the first ten years of its existence the €uro has delivered benefits acknowledged by most observers. Before the crisis, progress was even being made towards the status of reserve currency, a major advantage.
The Greek tragedy has revealed its fault lines, essentially lack of political solidarity, and - because the rules were not enforced - an inducement to profligacy. This is why I think that until closer fiscal integration can be achieved, the €-zone should function as a club, with the consequence that non complying members should be expelled as a last resort.
If Greece can adhere to the announced austerity program, the Euro-zone will have demonstrated its cohesion. Conversely if finally Greece defaults, the Euro will undergo a severe setback. The resources allocated to the failed rescue could have been better used to assist other members, with better prospects of success.
I realize that expelling a member involves a contagion risk - the domino effect or the Lehman syndrome. In my opinion this risk is less grave than wasting resources on a lost case. Market fever sometimes results from the herd instinct. But frequently an objective analytical process precedes the unleashing of speculation. My contention is that by eliminating the members who may drag the €uro down to breaking point, the €uro project would be strengthened. It would also impress upon the members the overriding need for rigor.