Standoff on Greece Driven by Short-Sighted Europolitics

http://www.forbes.com/sites/karlwhelan/2012/11/22/standoff-on-greece-driven-by-short-sighted-europolitics/

Forbes

Karl Whelan, Contributor

Economist focused on European macro issues

As Greece comes ever-closer to running out of money, the Eurozone finance ministers and the IMF have now met for two weeks in a row and failed to agree a new deal to loan Greece any additional funds.

Many of the headlines suggest that these negotiations relate to technical discussions about steps that Greece needs to take to reform its public finances. In truth, the discussions are really about the political requirement for Eurozone leaders to ignore reality.

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As Greece comes ever-closer to running out of money, the Eurozone finance ministers and the IMF have now met for two weeks in a row and failed to agree a new deal to loan Greece any additional funds. Many of the headlines suggest that these negotiations relate to technical discussions about steps that Greece needs to take to reform its public finances. In truth, the discussions are really about the political requirement for Eurozone leaders to ignore reality.

In late 2009, a new Greek government came to office and admitted that the previous government had been “cooking the books” and its debt situation was worse than had been admitted.  By early 2010, Greece’s deficit was being revised up from 3.7% of GDP to 12.5% while its debt-to-GDP ratio was sailing over 120%.

To financial markets and most outside observers, it was clear the Greek debt burden was unsustainable and that a default of some sort was inevitable.  What did Europe’s leaders to? What they do best: Deny reality.

In January 2010, the Economics Commissioner, Joaquin Almunia, said

 ”No Greece will not default. Please. In the euro area, the default does not exist,”

He also said there was no special plan for Greece. To admit a Greek default could happen was embarrassing for Europe and the so-called “no bailout clause” was interpreted as preventing the other EU countries from providing assistance.

By April 2010, Almunia’s replacement, Olli Rehn, admitted there was a plan to provide Greece with loans from the EU but still maintained “There will be no default.”

Thus began a period in which many of Greece’s private creditors were paid off in full using money provided by the Euro area member states and the IMF.  Only by summer of 2011 did the Eurozone admit that a default on Greek debt was required but, by the time the default was implemented in early 2012, Greece now had a mountain of official sector debt.

As sovereign debt lawyer, Lee Buchheit pointed out in this fascinating interview with Felix Salmon, this year’s Greek debt restructuring was unique among debt defaults because it still left the country with a debt level that everyone knew could not be paid back.  This is because politics dictated that EU leaders were unwilling to admit they wouldn’t be getting paid back in full.

In the meantime, while Europe has fiddled and denied reality, the Greek economy, labouring under a completely unsustainable burden and a debilitating level of uncertainty, has imploded. The grim facts about Greece’s debt situation are known to all and laid out in detail in this leaked EU report.  Greece’s economy is in an ongoing depression that has already lasted five years and its debt-GDP ratio is projected to reach a completely unsustainable 190 percent next year.

By that stage, about two-thirds of the Greece’s debt will be official debt owed to IMF and the Euro area member states, with the vast majority of it being owed to the latter.   After years of budget cuts, Greece’s primary balance is scheduled to reach zero next year, meaning Greece will only have a budget deficit because of the interest payments on its unsustainable debt.

Up to now, the Euro area member state’s response has been to pretend that by 2020 Greece can reach a debt ratio of 120 percent and then further pretend that this will allow Greece to return to funding itself (highly unlikely for a country with Greece’s reputation for fiscal management).  Unfortunately for the EU leaders, this arithmetic simply doesn’t add up and, faced with reports from the IMF and from their own officials showing such a target cannot be reached, the Eurozone leaders have a choice: Accept they won’t be paid back all their money or deny reality.

As always, they’ve chosen the latter, arguing the timetable for Greece’s return to a debt ratio of 120% of GDP should be pushed out to 2022.  The one concrete proposal they are keen on—voluntary debt buy-backs from private investors who are sure they are going to be restructured again—is notoriously unpopular among economists.  Commonly known as the “buyback boondoggle” this approach reduces the headline debt figure by wasting public money on providing private bondholders with a better payoff than they had been expected.  It’s an approach that looks like it’s improving things while usually making them worse.

Politicians generally have a short time-horizon.  Germany’s leaders, for instance, are looking towards next year’s election and don’t fancy admitting they chucked lots of taxpayers money into Greece and now it won’t be paid back.  But that’s the reality.

Thankfully, the IMF are now refusing to play along with the EU’s Greek fantasy. They are insisting on sticking with the 2020 deadline for meeting the 120% target, which is effectively code for the Eurozone restructuring its loans to Greece.

I suspect Europe’s politicians are greatly underestimating their voters. People know the situation in Greece is unsustainable and I doubt if many people will be surprised that the Eurozone isn’t getting all its money back.  But a program to end the austerity in Greece and restore that country to stability would have benefits for Europe that would go well beyond Greek borders. It’s time for Europe to do the right thing instead of picking the politically expedient option.