Friday, July 10, 2015

Extend and Pretend in Greece

The apparent surrender of Greek's Prime Minister Alexis Tsipras on Thursday to the demands of the Eurozone troika is being cheered by financial markets this morning.  The markets should be crying instead.  Piling on more debt and reinforcing austerity just means that Greece will become a poorer nation with much higher future debt levels.  How can that be a good outcome?

If accepted by the troika, this suggests that more and more debt is ahead for the other countries in the Eurozone.  What is now a sovereign debt crisis across the Eurozone will, within five or ten years, become a debt calamity for which there will be no antidote.

What the Eurozone should do is arrange a "controlled" bankruptcy for Greece.  This would involve putting up $ 100 billion, for example, and buying in all of the outstanding Greek debt.  This would amount to about 30 cents on the dollar.  Then telling Greece: "you're still in the Eurozone, but you are now on your own in the sovereign debt market.  We will never bail you out again in the future and we will not bail out any other Eurozone countries either."

This would enable Greece to make its own decisions about how best to return to the sovereign debt market.  If Greece chooses to make reforms, then it will be successful in returning to the sovereign debt market.  If not, then so be it.  Greece will have to finance its welfare state on its own.  Is there anything wrong with that solution?

Meanwhile, of course, that leaves unsettled what will happen with Spain, Italy, and Ireland -- all of which are struggling under a current Eurozone bailout, with political dynamics similar to that of Greece.  It is possible that the Eurozone will have to cough up another 300 to 400 billion euros to buy in the outstanding debt of these countries (obviously at a discount).

In all, the Eurozone (meaning Germany) will have to provide half a trillion to a trillion euros to settle accounts and then force these countries to pay their own way after a controlled bankruptcy.  This is a pretty high price for something that should not have cost more than 50 billion euros in 2010 if Greece had been permitted to do a workout funded by the Eurozone.  But cooler heads did not prevail, so the costs have skyrocketed while the economies have either collapsed or stagnated.

Under a policy of controlled bankruptcies, Germany would end up having to do a restructuring of its own (meaning Germany as well as France would also have to default in part on their own sovereign debt), but that is the price of underwriting other countries' debt.

But, if a deal is reached for Greece to receive an extended bailout, then the future will be very bleak indeed.  Debt levels, now unsustainable, will, within five or ten years become unfixable.  No amount of euros will solve the problems that lie ahead for the eurozone, if bailouts are extended for Greece, Spain, Italy, and Ireland.  After all, the current debt levels in Germany and France, not accounting for the implicit bailout guarantees, are above sustainable levels already.

As the eurozone careens toward financial calamity, economic stagnation will rob the eurozone of the advantages of economic growth as debt/GDP levels rise to absurd levels.  That will be the outcome of a Greek deal to extend the bailout. Far better would be to face reality today and restructure Greek debt and force Greece to pay its own bills, while remaining in the eurozone.

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