Greece And The Fatal Flaw In An IMF Rescue

By Peter Boone and Simon Johnson.  This is a long post, about 3,500 words.

In 2003 the International Monetary Fund published yet another internal review with an impressively dull title “The IMF and Argentina, 1991-2001”.  But hidden in that text is explosive language and great clarity of thought – in essence, the IMF staff belatedly recognized that their decision to repeatedly bailout Argentina from the mid-1990s through 2002 was wrong:

“The IMF should refrain from entering or maintaining a program relationship with a member country when there is no immediate balance of payments need and there are serious political obstacles to needed policy adjustment or structural reform” (p.7, recommendation 4).

If Mr. Trichet (head of the European Central Bank), Ms. Merkel (German Chancellor), and Mr. Sarkozy (French President) have not reviewed this document yet, they should skim it immediately.  Because one day soon Greece will be calling on the IMF for a loan, and it seems mostly likely that the mistakes made in Argentina will be repeated. 

There are disconcerting parallels between Argentina’s catastrophic decade, 1991-2001, which ended in massive default, and Greece’s recent and impending difficulties.  The main difference being that Greece is far more indebted, is much less competitive in global markets, and needs a commensurately greater fiscal and wage adjustment. 

At the end of 2001, Argentina’s public debt GDP ratio was 62%, while at end 2009 Greece’s was 114%.  Argentina’s public deficit reached 6.4% GDP in 2001, while Greece’s was 12.7% GDP (or 16% on a cash basis) in 2009.  Both countries locked themselves into currency regimes which made it extremely painful to exit:  Greece has the euro, while Argentina created a variant of a currency board system tied to the US dollar.  And both countries had seen their competitiveness, as measured by the “real exchange rate” (which reflects differential inflation relative to competitors) worsen by 20% over the previous decade, helping price themselves out of export markets – and boosting their consumption of imports.  In 2009 Greece had a current account deficit equal to 11.2% of GDP, while Argentina’s 2002 current account deficit was a much smaller 1.7% GDP.

The solution to such crises is rarely gradual.  Once financial market confidence is lost, yields on government debt soar, private capital flees, and sharp recessions occur.  The IMF ended up drawing tough conclusions from its Argentine experience – the Fund should have walked away from weak government policy programs earlier in the 1990s.  Most importantly, IMF experts argued that from the start the IMF should have prepared a Plan B, which included restructuring of debts and termination of the currency board regime, since they needed a backstop in case the whole program failed.  By providing more funds, the IMF just kicked the can a short distance down the road, and likely made Argentina’s final collapse even more traumatic than it would otherwise have been.

Sadly, the Greeks are today in a similar situation: the government’s macroeconomic program is not nearly enough to calm markets, or put Greece’s debt on a sustainable path.  By 2012 we estimate Greece’s debt/GDP ratio will rise from 114% of GDP to over 150%.  The interest payments alone on this would amount to 9% of Greek’s incomes at current rates, and almost all those funds are transferred to the German, French, and Swiss debt holders.    

Greece’s 2010 “austerity” program is striking only for its lack of credibility. Under that program Greece, even in 2010, does not pay the interest on its debt – instead the government plans to raise 52bn euros in credit markets to refinance all its interest while at the same time it borrows 4% of GDP more.  A country’s “primary budget” position measures the budget without interest expenses — at the very least, the Greeks need to move from a 4% of GDP primary budget deficit to a 9% of GDP primary surplus – totalling 13% of GDP further fiscal adjustment, in the midst of what will be a massive recession, just to have enough funds to pay annual interest on their 2012 debt.  This is under the rather conservative assumption that interest rates would settle near 6% per year, where they stand today.  The message from these calculations is simple: Greece needs to be far more bold if its austerity program is to have a serious chance of success.

How did Greece manage to get into such a terrible situation?  Local politics that lead to profligate spending is one answer.  But remember that someone needs to supply the money that allows such profligacy.  In this case it was the European Central Bank that handed Greece the keys to the safe. 

The reason Mr. Trichet wants Europe to stand tough against Greece

This may not be obvious, but, creating money in a currency union is no simple task.  In any single country, central banks usually restrict themselves to buying government bonds, and making loans to regulated commercial banks.  Net purchases of these securities by central banks creates what is called “high-powered money”; this feeds into the financial system and results in the creation of what we all use to make payments and store value, i.e., money, plain and simple.

However in the European Monetary Union there are now 17 nations and a plethora of banks.  So, to put it crudely, there is sure to be a fight to decide who gets the newly printed funds.  The ECB resolved this by what seemed like a fair rule:  All commercial banks can borrow from the ECB if they provide collateral, in the form of highly rated government and other securities, to the ECB.  So, for example, a Greek bank can gain liquidity by depositing Greek government bonds with the ECB – as long as those bonds are “investment grade”, i.e., highly rated.

This simple and seemingly reasonable rule created great dangers for the eurozone, which have come back to haunt Mr. Trichet.  The commercial banks in the zone are able to buy government bonds, which “paid” 3-6% long term interest rates (for all the sovereign bonds of members) over the last decade, and then deposit them at the ECB.  They could then borrow from the ECB at the ECB financing rate, which today is 1%, against this collateral so pocketing a profit — and then buy more sovereign bonds with the funds.  Mr. Trichet recognized this system had inherent dangers of turning into a new Ponzi game:  if nations spent too much, and built up too much debt, eventually the system would collapse. So at the foundation of the eurozone, Mr. Trichet led a contingent within the EU that demanded all nations live by a “Growth and Stability Pact”, whereby each nation could only run deficits of 3% of GDP, and they had to keep their debt/GDP ratio below 60% of GDP.

Of course, politics trumped Mr. Trichet – as it always must – and the Greeks, along with the Portuguese, used their new found cheap lending system to run large deficits and build up debt.  The cheap access to money also helped feed the real estate booms in Ireland and Spain. 

Today, Mr. Trichet and Ms. Merkel are desperate for harsh changes to ECB lending rules that will stop this ponzi game.  They want to penalize profligate spenders.  They also want profligate nations to pay more interest.  Soon, due to its poor credit rating, Greek debt will be treated like poor collateral, so banks will no longer be able to borrow as much with Greek debt as collateral.  When these changes at the ECB come into effect in 2011, the days of Greece being able to borrow easily at low interest rates in the euro zone will close once and for all.  

As protector of the euro zone, the ECB does not want to see large bailouts to nations that abused the system.  Marco Kranjec, an ECB council member, recently made the ECB view clear: “Membership in the Euro region dictates a special discipline….only non-euro region EU members, such as Hungary, Latvia and Romania, are eligible for financial aid”.   The non-euro members get aid because they do not have access to the ECB lending window, but, if you abuse that window, you will not get extra help. 

If Greece needs to pay more for its debt, the debt dynamics become ever more unsustainable.  What interest rate should markets charge for a nation that has 120-150% public debt/GDP ratio, a large budget deficit, a recessionary uncompetitive economy, and a bloated public sector that stages frequent and often violent strikes?  The answer is probably around what Argentina paid in the late nineties:  10% per year. But as Greece’s Prime Minister is fully aware when he calls for lower interest rates, Greece cannot afford these rates – their  budget would simply collapse.

If they are permitted to be candid, what choices would the IMF staff present to Greece?

So when the Greeks soon turn up at the IMF, what will the IMF say?  If politics did not circumvent rational economics, the choices are clear:

Choice 1:  True Fiscal Austerity – 10% of GDP, with further measures soon

To gain confidence in markets, the Greeks need to demonstrate that they are prepared to actually stop the rapid rise of their debt relative to income.  This means running a primary surplus in short order. 

For Greece to achieve this, the numbers required are, simply put, staggering.  Lower public spending and higher taxes will lead to a sharp contraction in demand, and it will have repercussions as businesses in Greece see less follow on spending.  Ultimately, every $1 of fiscal tightening may generate $1.50-2.00 in lost domestic demand.  Fiscal tightening only works if the new unemployment leads to wages and prices falling, so making a nation more competitive.  The jury is out whether Greek unions would permit such large wage reductions, but the whole process will surely take several years.  So, in the first year or two, we could expect Greek GDP to fall sharply with a strong austerity program.

This is where the problems set in – and the risk of a viscious downward cycle.  Lower GDP means lower tax revenues, and higher unemployment benefits, and all these things worsen the budget.  Under reasonable assumptions, if the Greeks took an initial 10% of GDP in further fiscal measures, they would still run a budget deficit in 2011 of approximately 5% of GDP.  This deficit would fall as the economy recovered later, and if unemployment fell, but that could take a long time.

We doubt such an austere program could work, and even if it did, someone needs to finance Greece’s budget deficit, and roll over their debt, for 3 or more years.  Markets would undoubtedly be concerned by sharp output declines and ongoing strikes.  The only solution would be for the EU and IMF to step up, and effectively guarantee three years of financing needs, or $150bn in total.  That is seven times the whisper numbers that the European Union is currently considering providing to Greece.

Choice 2:  Sovereign default but keep the euro

The second choice means admitting that the fiscal situation is just too painful to solve:  Greece would default on its debt and call a stop to all interest and principal for, say, two years.

The default on debt would have major ramifications.  The government would need to take actions to avoid a run on all the Greek banks – this would need to be coordinated with the ECB to ensure there was liquidity support.  Private creditors would pull loans wherever possible from Greek entities.  In short:  Greece would suffer a large financial and economic collapse, and GDP would decline substantially. 

This financial collapse would mean Greek debt would need to be written down substantially.  We would guess that a 65% write down of face value, bringing total Greek debt to around 50-60% of a lower new GDP, would be reasonable.  Such write downs roughly match the terms that Argentina received after its debt restructuring.

This draconian cut to government debt would not solve Greece’s problems.  It would still need to cut budget spending in order to lower the deficit – and in the aftermath of defaults, there are generally few sympathizers.  Greece could save on interest (which to data it never paid in any case), but it would not be a panacea for the budget or economy.  

Choice 3:  The IMF’s Plan B – Debt default and exit the eurozone

Faced with a collapsing banking system that comes with default on sovereign debt, there is good reason to call for Greece to, at least temporarily, give up the euro.  The advantage of moving to a different currency would be that Greece could generate a rapid increase in competitiveness, and so speed up its transition.  The government could offer to restructure debt into this new currency, or into Euros at a much larger haircut.  The bloated costs of the public sector could be eroded through inflation in the new currency.  This should make it possible to quickly move to a budget surplus and an external surplus.

In Argentina, the government partially indexed deposits at banks, but they forced the deposits to be converted to pesos from dollars.  They similarly required all domestic debt be converted, and they negotiated a sharp reduction in external debt while offering those debt holders the ability to convert debt into pesos.

Argentina’s economic collapse ended roughly six months after they defaulted and ended their peg.  While it was painful, the economic recovery started rapidly; nine months after default and devaluation, GDP began growing rapidly.  This is a trend that continues even today.  The same lesson, that large devaluations and default can result in rapid recoveries, was observed in Russia in 1999, and in the aftermath of the asian crises.

Greece’s recovery would take longer, because they have not yet had many of the adjustments that are needed, but they could probably expect a recovery to decent growth starting H2 2011.

The IMF leadership will want to muddle through, but will Merkel and Trichet play ball?

Will the IMF prepare a program with drastic fiscal cuts, sticking to the lesson it learned from Argentina, in order to bring the nation back into solvency?  Will they turn to the EU and be blunt:  either you need to be prepared to provide Greece 150bn euros of loans over three years as credit lines, at low interest rates so they can afford it, or the program will be underfunded.  Will they walk away from any program if the EU does not promise large enough funding, and the Greeks do not promise drastic enough cuts?  And, would they dare to discuss a “Plan B” for Greece, as their own internal review suggested would have been best for Argentina back in the nineties?

 The answer to all this seems very clear.  The IMF will agree to another program that is very likely to fail, just like they did in Argentina.  There are some obvious reasons why this is likely.  One reason is that it is easy to hide behind a veil of probabilities.  Of course there is some chance that Greece might make it out with little change, so why not wait and see if it works?  The trouble is the odds, for Greece, are slim.  It is impossible to say exactly what the odds are, but suffice it to say, Greece’s external debt and current fiscal difficulties, while tied into a fixed exchange rate regime, mean that nation needs far harsher adjustments than any of the sovereign major defaulters of the last 50 years.  We cannot think of one comparable example of success.  The social and political divisions in Greece, along with the penchant for debilitating strikes, also reduce the odds for success. 

(Some people suggest Ireland is an example – however Ireland started with much lower debt levels, and despite large fiscal cuts they are still running a deficit over 10% of GDP that requires annual financing and a rapid build-up of sovereign debt.  Greece could not get these funds in markets, and they will have trouble repaying that new debt just like the old.)

Meanwhile, the longer we wait for real fiscal adjustments, the more Greece builds up debts and so needs an ever larger adjustment later.  Such an end could be enormously disruptive:  imagine nationwide strikes, violence, and chaotic default.  Consider the burden on others:  while Greece marches on building up debt and sinking ever deeper into problems, how can we expect creditors to feel comfortable lending to Portugal, Ireland or Spain?  The whole euro zone will suffer if Greece defaults, and, they will suffer if Greece does not default.   The IMF concluded that Argentina had a window, in the late nineties when they could possibly have escaped their burdensome debt and currency peg in a planned move – but they missed it.  The euro zone arguably has a chance now to deal resolutely, one way or another, with this problem before the chronic pain impacts others.     

There are also powerful personal interests that will guide these decisions.  Dominique Strauss-Kahn, current head of the IMF, is primarily focused on becoming the next President of France.  It will not look good – to the French electorate – if the IMF is seen forcing a Greek default, nor if it demands that the Europeans provide over a hundred billion euros of long term financing.  So, he surely wants to offer a lax short term program, which is backed up by promises for “greater austerity in the future if needed”.  Greece will march on, mired in recession, with its debt stock growing as the IMF and EU fund them.  The private sector, as in the case of Argentina, will simply not want to touch their debt. Dominique Strauss-Kahn can then declare his candidacy in early 2011, resign from the Fund, and let his successor force the true austerity – at which time Greece will suffer ever more under any solution.

It is also in the interests of most other members of the euro zone to just “kick the can down the road”.  The other debt laden periphery nations are naturally terrified of a Greek collapse that will spill over to their nations.  They will now lobby hard for the IMF to be generous, and they will be satisfied with partial steps.  Perhaps this will give them time to prepare, but more likely, they will just kick the can down the road themselves – as the Portuguese seem to be doing with their lax fiscal budget announced for 2010.  These nations surely underestimate how much worse this may get, and they continue to suckle on the cheap credit window which the ECB has, until now, kept open to them. 

The fight begins:  Will Europe’s “euro visionaries” and the austere Germans force hard decisions today?

However, there are two groups in the euro zone who may still not play this game.  Ms. Merkel knows German taxpayers would loathe any kind of Greek bailout, and Germans inherently care more about the long term stability of the euro than any other nation. 

It is, undoubtedly, in the ECB’s and Germany’s long term interest to force Greece to take tough medicine now, or, to default on their sovereign debts and leave the euro zone.  Having one member be forced out of the eurozone will send a clear message to others. 

There are many nations now waiting on the sidelines:  How can Mr. Trichet and the Germans feel comfortable that new entrants will not copy the Greek Ponzi game once they gain access to ECB’s funding windows if the new entrants see Greece get a new large loan package at subsidized interest rates?   The ECB should be rightly concerned that such actions would only make fiscal probity, and therefore monetary policy, far harder to control in the euro zone.  

Where next for Greece?

Mr. Trichet understands that Greece’s problems reflect a dangerous flaw in the euro zone system, and the solution will set the tone for behaviour of other members for years to come.  He’ll want his pound of flesh before this is done.  The IMF staff surely understands that Greece’s economic problems are critical, and require drastic actions, but the IMF’s managing director just wants to survive to be elected a new President of France in 2012. 

The German population detests providing bailouts to periphery nations, while the debtors of the Euro zone would like the same game to continue a little bit longer.  Meanwhile, the Greeks continue to drag their feet on serious reform while claiming to be “courageous”– presumably they are hoping, magically, that markets will start to want to lend to them again at very low rates in the midst of a fiscal program with little hope for long term success.  It all seems horribly reminiscent to those early days when Argentina slid towards a cruel collapse.

126 thoughts on “Greece And The Fatal Flaw In An IMF Rescue

  1. I sympathize with Greece in some aspects. I don’t want to see anybody in any country suffer. But the bottom line gets down to this: They’re going down either way, so why should other nations get sucked down with them??? I think Germany has to tell them in essence “Sorry, but there’s nothing we can do to change the situation.” It’s a hard hard pill to swallow, but what are the other choices??? Nothing better available.

  2. the new debt is taken up by greek banks. so the (low) intrest payments stay in Greece and the french & germans get their money back.

    the ECB will continue to accept greek bonds as collateral from greek banks, even if it is not investment grade (just like the FED accepts asset backed CDO’s with unclear value).

    What happens next. Nobody knows. Higher inflation I guess.

  3. Greece Rescue = Smoke and Mirrors

    Yves Smith Mar 29, 2010 – excerpts

    “I must admit that the late-night meetings, the dramatic announcement of an agreement, and the press conferences by European leaders are highly effective tools to impress the outside world. Ms Merkel in particular is a very persuasive politician. But the politics of smoke and mirrors cannot fool all the people all of the time. This will not end well….

    I suspect that Greece has already gone beyond the point of no return with a public debt nearing 135pc of GDP by 2011 (Commission data). If so, the most likely way out is default within EMU. Athens can craft a “pre-emptive debt-restructuring” with the help of the IMF along the lines of Uruguay’s controlled default in 2003. But first we must go through the etiquette of exhausting all the options. “The game plan is to hope for miraculous growth,” said Mr Rogoff. Let us pray.”

  4. My sympathy goes to Greece. Athens does not deserve to be addressed by the EU so like in the recent weeks. This really applies to any other EU member as well. Where is the EU solidarity for other members? This means that (1) Merkel and Sarkozy have no vision for either the EU or for otherwise, and (2) the ECB has failed. Remember: the ECB has increased the interest rates in the summer of 2008 before the worst recession since the 1930s instead of lowering them. No wonder that the IMF now takes over the helm in Europe.

  5. I believe the real question will actually end up being how much pain the Greek government will be able to get their people to accept. While the union leaders may be able to be convinced to go along with huge cuts in wages and benefits, there’s hardly a tradition in Greece of the people meekly accepting what they see as injustices from their government.

    Austerity measures may make good macroeconomic sense (though there are even arguments to be made against that), but if attempting to impose them is going to push the populace into widespread strikes and rioting (or even further) then they have little practical value.

  6. What do you think will happen in a system which gives out loans continually to the most irresponsible member of the group???

    Mr. Dispinar, if you ever start a co-op please let me know. I’m tired of paying for my own alcoholic beverages.

  7. Go for choice three, but don’t expect public sector surpluses any time soon. The external surplus will probably take care of itself through exchange rate adjustments. I’m re-posting a comment I made on an earlier blog about the Greece debt crisis:

    “Greece should look to how Argentina solved its financial difficulties stemming from their misguided attempt to peg their currency to the dollar.

    1) Greece should leave the European Monetary Union and default on all debts denominated in Euros. Greece can then offer to pay back a certain percentage of any foreign held debt in its own currency. This solves the solvency issue.

    2) The Greek government should allow the new sovereign currency to float against the Euro and all other foreign currencies. This solves the trade imbalance issue (well, maybe solves is too strong a word, but it will certainly help).

    3) The Greek government should inform its citizens that all debts private and public are now only redeemable in the new sovereign currency and that the federal government will convert any private Euro holdings into the new sovereign currency at some fixed exchange rate. This will probably be the most difficult step as there is the possibility that widespread panic and currency speculation will occur as individuals unsure of the viability of the new currency seek safety in more established currencies or other hard assets. However, if the experience of Argentina is a reliable guide to what will occur if Greece pursues this path, then history suggests any disruption will be short lived.

    When Argentina defaulted on its dollar denominated debt there was a good deal of hysteria about how Argentina would be cut off from international capital markets and that without foreign investment the economy would wither, but as it turned out these dire warning turned out to be mostly baseless. Argentina showed that an economy can grow and prosper through social policies designed to encourage human capital development and promote strong domestic investment. If Argentina could do it so can Greece.”

    An essential component of Argentina’s recovery was significant domestic spending targeted at improving the well-being of the poorest members of its society. This created a significant amount of aggregate demand, which in turn sparked domestic investment. Probably the most important domestic policy initiative undertaken by the Argentinian government after defaulting on its dollar debt was the “Jefes y Jefas de Hogar,” Plan (Head of Households Plan). This plan was a job guarantee offered by the federal government to anyone who desired work. It created jobs for over 2 million participants which was around 13 per cent of the labor force at the time. This not only helped to quell social unrest by providing income to Argentina’s poorest families, but it also put the economy on the road to recovery. However, it cost a lot of money, which is why I say ditch the plans for public sector surpluses. If the Greek economy starts to overheat and the external surpluses start to get out of control then maybe think about fiscal consolidation to stem inflation. Until then forget about it. The Greek government needs to start worrying about its middle class and, gasp yes, even its poorest citizens. The EMU has been a boon for professionals and international finance types. How’s that worked out?

  8. Absolutely, Greece needs to go over to default, reversion to their own currency and adjudication of their own bankruptcy as a sovereign state. That means, unilateral settlement of Euro debts in their own currency. NKlein covers the choice beautifully. Greece must look to it’s own best interests as must Portugal, Ireland, Italy and Spain. I should think that the leadership of the five PIIGS states would act together instead of reacting separately.

  9. Your analysis of the choices facing Greece is convincing, but it makes me wonder about the dangers of contagion. Global market often react poorly to govt defaults, with financial contagion to “similar” nations a common result. Do you think that Choice 3 (and possibly Choice 2) make it probable that other Eurozone members with high government debt and deficits, but much larger banking sectors, will come under severe financing pressure?

    I hope that your analogy with Argentina is the right one, because no one wants this to be another Lehman Bros.

  10. Governments that are not sovereign in their own currency have to finance their spending. Governments that are sovereign in their own countries do not. That countries that are sovereign in their own currencies issue debt to cover their spending dollar for dollar (or whatever their currency is) has to do with:

    1) Allowing the Central Bank to maintain a target interest rate. When the Treasury spends it credits bank accounts or issues checks. When checks are deposited reserves build up in the interbank system and competition puts downward pressure on interest rates (note this is the opposite of the usual crowding out story where deficits push interest rates up). In order to maintain its target interest rate the Central Bank has to “sterilize,” these additional reserves so it sells government bonds. This withdraws reserves from the system, which ensures the Federal Funds Effective Rate does not diverge significantly from the target rate. An alternative strategy that is currently being pursued is to simply pay interest on excess reserves.

    2) Political considerations. There is a belief that matching spending dollar for dollar with debt issuance is less inflationary than simply spending without any debt issuance. Debt issuance is therefore seen as a way to “discipline,” government spending. Personally, I don’t buy this story and haven’t seen much evidence that the link between bank reserves and inflation is anything more than tenuous at best. However, I admit it is a possibility. In any case, if inflation where to become an issue I feel appropriate fiscal policies could be devised fairly easily.

    So in conclusion, the idea that sovereign governments can come under severe “financing,” pressure is not applicable. The bogey here is inflation. Despite what the credit rating agencies say there is no credit risk for sovereign nations. There may be interest rate and inflation risks, however. In any case, Treasury bonds are constitutionally guaranteed. I don’t know how to say this any more clearly: insolvency is simply not possible for a sovereign government unless a) it makes a political decision to declare bankruptcy (the Russians did this in the early 90’s), or b) the government is overthrown through domestic insurrection or foreign invasion.

  11. “When Argentina defaulted on its dollar denominated debt there was a good deal of hysteria about how Argentina would be cut off from international capital markets and that without foreign investment the economy would wither, but as it turned out these dire warning turned out to be mostly baseless.”

    I absolutely agree – and it’s why everyone in power (notably, Greece’s creditors) wants to delay as long as possible until the current politically connected bagholders can find new bagholders to absorb the losses.

    For all the threats of “never borrowing again” that have been thrown at Latin America – all the fear of “loss of access to capital markets” – just take a gander at Argentina’s GDP… Note the inflection point after debt default.

  12. Not entirely correct. Many antions issue bonds in major currencies and when they cannot pay the interest or refinance the issue they declare default. This is what happoened to Argentina. Their bonds were issued in USD. Same with Russia. of course, this is not the case for bonds issued in local currency but most foreign investors do not touvh those unless they can hedge them. That is usually hard. So yes, sovereign nations can easily become insolvent of they do not have enough foreign currency rederves to repay their foreign currency denominated debt.

    Greece is a situation where although the debts are in local currency, the country is not a sovereign state in terms of printing money. They have assigned that right to the ECB (germans essentially). Germans drive them to default essentially. Most of the money Greeks borrowed they spent buying German durable goods. Nice German number, the EU I mean.

  13. In essence, “Bail us out or else!”

    I take a contrary position – the fallout from Lehman could have been heavily contained by a more aggressive monetary and fiscal response, instead of the complete incompetence and impotence – or, the pretense at impotence – which was designed to convince Congress that it had no options other than a bailout of politically connected financiers.

    aka, the Hank Paulson special

    Given a choice between TARP and nothing, I have repeatedly argued for TARP. But that continues to be a false choice – yet one that even Obama frames.

  14. Just for fun, here are examples of United States issued sovereign currency.

    When the United States was on the Gold Standard and under the Federal Reserve System break in period, the US had both legal tender currency and national currency issued by national banks. There also were Federal Reserve Notes and Silver and Gold Certificates. Specie too. Off and on during the history of the United States Treasury Notes were also currency. In fact, the most rare US currency is the $1000 1890 Treasury Note.

    My point here is to show actual examples of the various US currencies which existed in phase out to only Federal Reserve Notes in 1980.

    Greece is fully capable as a sovereign to create it’s own currency again and like US ” Legals” settle up it’s debts in Euro’s with this physical currency. If Greece is not able to do this it does not possess sovereignty. A sovereign is an entity that admits no higher power than itself.

    All during the time the United States was legally issuing and coining ten different kinds of currencies, bank assets were the backing of bank demand deposits just as they are today.

    The real crux of Greece or any other state settling up it’s debt with currency is the problem of conversion of the currency to electronic form that has evolved in terms of the massive anmounts of physical currency that would otherwise suddenly be circulating with no use other than as a medium of exchange in Greece.

    The United States could simply declare Treasury Bonds to be currency if it wished to do so. Similarly, the Treasuries could be settled with United States Notes. In 1950, as an example, banks settled corresponding accounts between themselves using currency like the $100,000 Federal Reserve Note . Before 1933, banks also settled literally in specie or Gold Certificates , as well.

    Settlement today is very much different.

  15. Gee, what a burst of sunny, polyanish, exuberant optimism. But thanks for laying our the issue so clearly.

  16. Greece not paying interest…? How can this be anything other than a technical default? So, Greece has already defaulted in 2010.

    “Greece, even in 2010, does not pay the interest on its debt – instead the government plans to raise 52bn euros in credit markets to refinance all its interest while at the same time it borrows 4% of GDP more.”

  17. Given the big banks are again healthy and profitable, would it not be possible to sell back the toxic assets to the banks at the same price as purchased? If this causes bank difficulties, have the bank’s shareholders eat the problem? Require bank dividends and bonuses to rank below mending capital problems (clawbacks?).

    Great idea nab. No more public debt! Would you like job running Treasury or the Fed? Easy peasy? Would this work?

  18. “I don’t know how to say this any more clearly: insolvency is simply not possible for a sovereign government unless a) it makes a political decision to declare bankruptcy (the Russians did this in the early 90’s), or b) the government is overthrown through domestic insurrection or foreign invasion.”

    Absolutely retarded. Adam Smith figured out that no government had ever repaid its debt. That was 300 years ago!

  19. I am quite bothered that Argentina is being held up as a positive example here. It was a chaotic, horribly managed debacle, only somewhat less disruptive than Lehman as international investors were well prepared. (And like Greeks, wealthy Argentines hid their income and savings far away from where they could be devalued or confiscated). For Argentines, yes, growth resumed quickly, but only after a devastating fall in output and wealth that took years to recover from. Unemployment soared to 20+%, and was over 10% even in the boom times of 2006. Inflation went to over 40%. There is no “nice” way to default, but like a nuclear reactor that needs to be shut down, the process should be planned and managed carefully; Ford’s or Uruguay’s restructurings are much better examples.

    Even if a default can avoid contagion, the problem is that many Western European banks would have much (if not all) of their equity wiped out by these losses. They would then need the bailout, or we’re back in 2008 again.

    Finally, Simon & Peter are right that the adjustment needed is very large. On the fiscal front this is self-evident, and the risk of a negative feedback loop is high. On the REER side, an additional concern is that Greece is not very open (oddly for a shipping country in economic union with the largest economic entity on the planet). That is, exports are tiny, and even imports relatively small, relative to GDP. Thus the devaluation (through deflation and wage cuts) needed to adjust the BoP and generate hard currency to create surpluses is very large. This was the case with Argentina in the late 1990’s as well.

  20. Looks at the Arab convenience store clerk. “I’ll take a 2 bottles of malt liquor, the Hank Paulson special, and a glazed donut…………………..ta go.”

  21. Since late 2009 in my letters to FT, I have held that having Greece defaulting offering to repay with some few Euros guaranteed by ECB and some New Drachmas at very long term and at low interest rates, would be the only way to stop entering into a prolonged agony that could bring much worse things than Greece being considered a New Argentina.

    And also that it would be easier to keep the Eurozone together with a default of Greece than having it pay to avoid a default, even though the Eurozone will suffer most of the losses of a default.

    Now if I was Europe I would leave the door open for Greece to return… when behaving like a German.

  22. If you’re interested in a book about the history of U.S. currency I highly recommend “A Nation of Counterfeiters: Capitalists, Con Men, and the Making of the United States,” by Stephen Mihm:

    It covers the pre-revolutionary war period to the end the emergence of greenbacks and the end of the Civil War. One of my favorite economic history books of all time.

  23. I don’t mean to make it seem like what’s coming for Greece will be easy. It’s going to be very messy. Consumers are going to be especially hard hit and will have to adjust their standard of living to accommodate the fact that their currency will probably not be able to buy them much of anything produced outside their borders. But is continuing on the same path any better? If there is a choice between the Greek currency bearing the adjustment or the Greek people bearing the adjustment through a prolonged period of unemployment I don’t know how anyone can consciously choose the latter.

  24. The U.S. paid back its national debt during the presidency of Andrew Jackson, in 1831 I believe. Shortly thereafter a severe recession followed. The two are not unrelated.

  25. Behaving like a German? You mean trashing their domestic labor market to keep real wages low and exports up? I don’t know if that’s the model I would want to follow. I think what the world needs now is a more domestic orientated development path. For all the talk about the benefits to be had from globalization and free-trade, I just don’t see how regular working folks have gained.

  26. Thank you Mike. I should have been clear that I meant there is no credit risk for debt issued in currency a nation is sovereign in. Foreign denominated debt does have credit risk attached to it. This is why governments should never take on foreign denominated debt. Better to not issue debt at all (the Soviet Union did this). Another alternative would be a “tap system,” where the government sets the interest rate and then supplies as many bonds to investors as are demanded. If investors do not purchase all the debt required to “fund,” the spending the Central Bank can come in and buy the debt itself. Australia had such a system until the mid 1980’s I believe. There are other alternatives as well. The U.S. auction system is not sacrosanct. Contracting in foreign currency is the worst of all possible worlds.

  27. For the good of their people it seems clear to me that Ireland, Spain, Greece and Portugal all need to find a way out of the Euro. The mechanics of that are near impossible, but they better find a way.

  28. Yes, whatever happens will be messy. Banks will write off the loans long dead before the fact of the journal entry. Equity will be killed.

    But first and foremost, loans made are already lost. No amount of posturing will change the fact of loss. Bankers should understand the first rule of receivable collections… you do not chase what cannot be recovered. You chase what can be salvaged net of cost of collections. To that end, reschedule to the far future what has been actually lost and ride herd on collecting what is possible. Or simply forgive it and be done.

    Will some big banks require seizure and recapitalization from creditor balances due? The answer seems to be understood by most commentators… yes.

  29. It just occurred to me don that you might be referring to my claim that there is no risk of insolvency for governments that are sovereign in their own currencies. I’m going to stand by that claim. When I manage to actually save some money (they really need to start paying beginning teachers that live in NYC more) I’ll even put my money where my mouth is. That is, I’ll be shorting sovereign US CDS every time it spikes.

  30. Choice 2 is a no go. That would have enormous negative effects on the already sickly looking euro. Choice 3 seems to be the most sensible one. If only it were as easy as picking one of these then I am sure it would have been done already. Sadly politicians never see the solutions in front of them. Greece is only the opening act.

  31. What a friggin surprise here, Yanks and Brits wanting Greece to get rid off euro! Especially for Brits it must be double-plus BAD to have ALL of the former enemies in one currency union (France, Spain, Holland, Germany). We are going to get YA Englangers this time!

    UK and US are going down like drunken sailors in Titanic, offering “good” advices to everybody all the way. Don’t do as we do but what we say…

  32. Can someone explain why Greece has to settle their Euro denominated debts? Why not just give creditors the finger entirely? Surely they’d have a better chance of solving their economic problems without a massive debt overhang.

    Why would they honor old debts? The threat of war? Am I missing something?

    Felix Salmon said he is looking for information on Basel 3. I recommend if you know some things about Basel 3 to send some e-mails and links to Felix Salmon.

  34. Excellent post on Greece, one of the best I’ve seen. Kudos.

    “The default on debt would have major ramifications. The government would need to take actions to avoid a run on all the Greek banks – this would need to be coordinated with the ECB to ensure there was liquidity support.”

    I don’t think a run can be avoided with liquidity – the problem is solvency. And you can’s solve a solvency issue with liquidity.

    Suppose Greece defaults. Then the Greek bonds that the banks are holding (and they’re holding a lot – e.g. it’s Greek banks which bought all of the bonds at the beginning of this year) are worthless. Either they have given these to the ECB as collateral for euros, or they’re holding them on their books. In the first case expect the ECB to digitally delete the euros that they have given the Greek banks. So, in the first case, the banks have lost the value of the bonds. In the second case they also have lost the value of the bonds. So in either case, should Greece default, the assets of the Greek banks are vaporized.

    OK the assets vaporize. So the liabilities have to be brought down to equal the assets. This means depositors, globally, need to lose a lot of money. If this is done by government decree, over the week-end, a run can be avoided, by having all depositors share in the pain. The run, then, is not avoided by providing by liquidity, but by forcing everyone to take a loss. Otherwise, a run is unavoidable, because those who withdrawal first will get their money back, while everyone behind will receive less.

    I would add that smart depositors will take their money out of Greek banks now and put it somewhere else, to avoid any risk of losing their money later. So I suggest, if you look closely, there is *already* a run on Greek banks.

  35. For his attacks on the big banks and deregulation policies some have labeled Simon Johnson a ‘leftist’. Yet in Argentina as in other Latin American countries in the 1980s and 1990s the level of IMF-backed conditionality he now proposes for Greece would have been considered draconian and uncaring market fundamentalism (i.e. permission given for creative destruction). This may simply indicate how much the world has changed. Or perhaps it only reveals belated recognition that old-fashioned tough IMF conditionality was always the sensible policy. The problem or irony now is that the IMF’s leadership is not only political rather than technocratic — it is in fact socialist. Interesting times.

  36. “European solidarity”? Is this a troll?

    Greece not only lives beyond its means for years, but covers up the evidence of its true borrowing.

    Then, when the time comes to pay the piper, Greece runs to the ECB, EU, Germany to get help paying its bills.

    To top it all off, certain members of the Greek government refuse to accept IMF aid because the conditions are too strict.

    Please Mr. Dispinar, I want to join your co-op too!

  37. Well if anyone was puritan enough to choose the latter it would not matter. All Greeks would be moving to an easier life in Frankfurt.

  38. I am not so sure because if we are going to have a chance for a more sustainable world we might all benefit from being more German frugal… and by the way the regular working Germans will be better off than their Greek, Spanish and Portuguese colleagues. They might not have such a fun and lively life but they will sure have more of that boredom so many look for in a too interesting world.

  39. Romania did too in the 80s. From 1982 to 1989 about 15000 people died annually from from starvation, cold and shortages as all national resources were directed to creditors. It ended in revolution.

  40. “Contracting in foreign currency is the worst of all possible worlds.”

    That might be but governments often do that because the markets, especially the foreign, trusts more the foreign currency than the local and so to take the debt in local currency would also imply having to pay much higher rates.

    If debt is contracted to do something that will provide for its repayment and leave something over it is great. If debt is contracted just to consume and leave the burden to those after you it is truly not so great. And the previously applies no matter what currency you contract the debt in.

    I invite you to read what I wrote some years ago on the unsustainable debt-sustainability theories.

  41. Frugality does not generate exports. Krugman has been fighting this fallacy for decades. But you don’t have to be an economist to understand why it can’t work. Greece needs to export more to balance it’s trade. So does Spain, Portugal, Ireland, France, Italy etc. Who is going to be the buyer? Germany can be Germany only because others are not. Unless this is acknowledged european integration is doomed.

  42. “the problem is that many Western European banks would have much (if not all) of their equity wiped out by these losses.”

    It is even worse, to begin with, courtesy of the Basel Committee, they were not required to have any equity that could be wiped out by these losses.

    Basel II Capital requirements for banks on sovereign risks
    Rating Weight Cap-Req. Leverage
    AAA to AA- 0% 0% ∞
    A+ to A- 20% 1.6% 62.5 to 1
    BBB+ to BBB- 50% 4.0% 25.0 to 1

  43. food for thought

    I wonder who are actually holding Greek Government bonds outside of Greece.. and what the mark-to-market implications of a bond sell-off will do to their presumably highly-leveraged balance sheets…?

  44. Or to my main point? The countries with large external surpluses need to generate more internal demand otherwise the countries with deficits will never be able to recover. That’s pretty much a tautology although German politicians (understandably) refuse to acknowledge it or act on it. Greece was not always this bad. As competitiveness eroded over the years manufacturers went bust and importers multiplied.

    I will answer your question anyway. Here’s a couple of links to help you:

  45. BTW Germans are not asked to import Greek products. They are asked to increase wages and allow some inflation so prices can go up. Germans are essentially asked to allow their products to be more expensive. There’s a world of difference.

  46. Because the day after the default they will have to borrow again. You can’t just kick your creditors in the nuts.

  47. “The countries with large external surpluses need to generate more internal demand otherwise the countries with deficits will never be able to recover.”

    Yes but the generate more internal demand part is clearly so that it imports more from deficit countries, and so I ask again… what is that the German who want to help out should import from Greece and that it will not import from China instead making the Chinese surplus even bigger.

    Yes I have seen the links… but clearly what´s there is not sufficient… at least if the prices of the Greek exports are not made much much more competitive.

    Felix Salmon said he is looking for information on Basel 3. I recommend if you know some things about Basel 3 to send some e-mails and links to Felix Salmon.

  49. What do you mean “covers up the evidence”? Greek debt to GDP has been hovering around 100% througout the last decade. It was a well known fact. The structural problems of ghe greek economy were well known too. The debt was kept in check only because of the high growth rates, growth fuelled by credit based private consumption. The “surprised officials” act the europeans are putting on now is pure hypocrisy. They made a mistake in allowing Greece into the eurozone and they made more mistakes in not doing nearly enough to monitor and control the situation and now they pretend they were deceived.

  50. But the fact of life is that after you have decided not to pay some creditors, and gotten away with it, then suddenly you appear to be a quite creditworthy borrower to a new generation of gullible investors pushed on by fee-driven brokers.

  51. “Yes but the generate more internal demand part is clearly so that it imports more from deficit countries”

    Nope. It will export less of it’s own.

  52. Those creditors probably shouldn’t have lend you anyway so they got what they deserved. Fact of life.

  53. “because of the low capital requirements”

    Correct… though sometimes, in the case of AAA to AA- sovereigns, they are not low, they simply do not exist… courtesy of some crazy regulators wanting to suck up to their employers, who keep them as financial regulatory experts in the Basel Committee and the Financial Stability Board

  54. Sounds like Minsky’s “Ponzi unit”, except that asset sales have been replaced with separate financing of interest payments.

    Greece needs to get off the Euro any way it can. Fiscal austerity measures implemented in an attempt to keep them on the Euro will only make things much worse.

  55. Generally I agree with Krugman. But not on this.On this I agree with Stiglitz, who Krugman seems thrilled to present as fallacious.

    Krugman’s claim to a “fallacy” is obviously erroneous, as I just pointed on his blog, with a baby counterexample. Moreover, France’s Lagarde recently asked Germany to realize it cannot keep on exporting its lack of internal demand away (implicitly proving Krugman wrong again, in a very practical way).


  56. Ok let me try to explain because we’re doing circles: Greece obviously needs to be more competitive, no objection there. Greece will try but it will not be enough because:
    a) Other countries with trade deficits will try the same thing and
    b)Germany must become less competitive otherwise this will be a pointless race to the bottom. And Germany does not show any sign of acknowledging this simple fact. Clear?

  57. Increased savings will reduce internal demand for local and imported products. The balance between the two does not have to be affected. Krugman argues that in fact it will not unless some other factor (exchange rate) kicks in.

  58. And those credit rating agencies that said it was safe and those regulators who empowered the credit rating agencies will not see anything happening to them… facts ol life

  59. “Germany must become less competitive”

    That might be true, for the good of others, but it is indeed a crazy message to give to any country!

  60. Euro area imbalances are demand related. It is a matter of economic growth policy forced by Germany (unilateral export oriented) and supported by the restrictive monetary policy of the ECB. Wage dumping in Germany contributes to a insufficient consumption and weak investment. While exports have risen in the past 10 years price adjusted by 70%, the domestic demand can hardly come from spot. In no other country in Europe nominal wages have risen during this period as little as in Germany. In 2008 real wages were (gross as net) approximately 2% below the level of 2000. German banks have a huge exposure to the rest of EU particularly in Spain, Portugal and Greece. That loans led to a boom especially in housing sector for example in Spain. Spanish wages pulled up ending in a budget deficit. Spain cannot devalue because they have got euro. In sequence of massive capital flows unit labor costs increased in this EU-Member countires. But in Germany the labor costs decreased which made German exports more competitive. The main source of economic porblems in EU is a failed economic model, not fiscal policy failure of Spain or Greece.

  61. Creditors took a risk and risks have a natural tendency to come back to bite you. They priced it, they charged higher rates for it, they insured it and they knew perfectly well what they were doing. And now they wiil probably negotiate the best possible deal for themselves when Greece eventually defaults, as it should. Millions of people that had nothing to do with this scam will pay a much more painful price. The bankers are the ones “getting away with it” not the people.

  62. “That might be true, for the good of others, but it is indeed a crazy message to give to any country!”

    True, but without it the EMU and possible the EU as well may me impossible.

  63. You are correct – the lure is always present to borrow in a foreign currency to obtain a lower rate, and the question is whether the borrowed money will be well invested. Too often, however, it is used by one crop of political leaders – or one age cohort – to borrow for general consumption to preserve an illusion of financial health.

    Nonetheless, it is a recipe for disaster. The same is true, BTW, if the US becomes more heavily reliant on TIPS and/or short term frequently rolled over notes (which occurred between 2000-2008).

    Frankly, national constitutions should ban borrowing in other currencies – unless the contract specifies that the national government will not absorb an excessive loss (but that the borrower may instead claim a specific asset). But in that case, it’s a short step to FDI (foreign direct investment). And I’ve read material which suggets FDI (with appropriate regulations) is a better way for countries to develop than borrowing in foreign currencies.

  64. To restate Kyriakos’ point:

    Not every nation can run a trade surplus. So making a statement like: “Everyone should be Germany” is either very ignorant or intentionally malificent.

    Germany is like a company that extended credit to buyers it knew could not afford to repay, in order to sell them goods they did not need – then righteously blames the buyer for agreeing to take the credit.

    … kind of like a US mortgage company.

  65. “If I am a German and want to help out…what can I import from Greece?”

    You can travel to Greece on vacation. I don’t have any hard numbers, but it is my understanding that tourism is a pretty significant part of the Greek economy.

  66. Besides direct foreign investment another option for those worried about high rates could be for the Federal Government to instruct the Central Bank to manage the yield curve. There is some disagreement over the effectiveness of this alternative, but in theory it can be accomplished by having the Central Bank promise to purchase a virtually unlimited amount of government bonds at the desired interest rate. The U.S. tried something like this in the early 1960’s with mixed results. It was called “Operation Twist.” The main objection is the possibility that the Central Bank ends up being the only holder of Treasury bonds. So rates on the agreed upon bonds can clearly be managed, but as for other long term rates, the jury is still out. There was a pretty good BIS paper on this recently you can read here:

    Click to access r_qt0906.pdf

    Also, Marshall Auerback and Rob Parenteau did a blog post at the New Economic Perspectives from Kansas City website recently exploring the possibility of implementing a modern version of Operation Twist. You can read their summary here:

  67. The relevant section of the BIS report starts on page 41 by the way. The heading is “Government Debt Management at Low Interest Rates.” Operation Twist is discussed on page 51.

  68. Yes tourism is already significant but to squeeze out what is needed we would have to stop going to London, Paris and Rome plus some Caribbean islands

  69. It seems that we will soon find out what the EU support mechanism is actually about. There has been a big sell-off of greek bonds in the past 2 days. The word is that short traders (mainly Citi, BoA and GS) are testing the conviction of the Europeans to bail-out Greece, but long traders are selling as well. The spread over the german bund for 10yr bonds has reached 412 bp. with 450 being the limit for liquidation mechanisms to trigger. Fortunately, Greece doesn’t need to borrow yet and this man is probably the only thing that stands between Greece and default right now.

  70. The chain of events you mentioned… Once financial market confidence is lost, yields on government debt soar, private capital flees, and sharp recessions occur…. is totally right! thanks, excellent analysis!

  71. Excellent post, and comments. That IMF report on Argentina was controversial when it was written. It was also a watershed in terms of the stark language used throughout when identifying publicly policy mistakes.

    Let me suggest one additional factor likely to be influencing the ECB’s reluctance to support IMF engagement in Greece. The minute that the IMF has a program in place with Greece, it has a solid platform from which it can criticize the ECB’s monetary policy choices and the euro’s internal functioning. For a relatively new central bank that spent many of its recent pre-crisis years defending its independence from political pressure (mostly, but not exclusively, from France), empowering an external entity to opine on the ECB’s monetary policy as it affects the adjustment process in Greece would certainly be problematic….particularly given the institutional weaknesses you correctly identify.

    It will be interesting to see how the partnership between the EU and the IMF works itself out in Greece. Early indications suggest it will be a rocky relationship. Should be an interesting Spring Meeting at the end of the month.

  72. Thanks for the link. German and French banks have a nominal collection problem treating Greece in isolation. Scared bankers are doing their Kabuki Dance to stave off the monster problems relating to holdings of Irish and Spanish debt. German and French banks are using the state as their Luca Brasi against the one state they can always back off on by rolling over their holdings. The Irish and Spanish reaction is what is important here. That and indications of pure fantasy ideas of strength in the minds of German and French bankers.

    The essential point here is what are the actual compulsion strengths the German and French banks may apply? Do these banks actually have any compulsions to apply other than a bluff? There is a very obvious strategic weakness showing here. The German and French banks moved against the weakest point. Thus loss here points out the gross weakness against the Irish and Spanish banks.

    Strategically, have the really big creditor banks shot off their ammo up before the fact? So far , I see some very poor negotiating being demonstrated on the wrong party. They now must win or else with a poor hand. The Greek Mouse can roar out of all proportion to the consequences to the creditors.

  73. As a business, Greece needs to make a viable business plan. If they want to continue as a business, they should consider cutting costs and showing where new revenue will come from. For example, taxes and exports.

  74. Why would the German and French banks generate so much media hype to no advantage? Greek debt could have been quietly rolled over with quiet very advance private notice to Greece by the German and Greek banks that they would no longer participate in the market. They could also have required a twenty year amortization. This all could have been done a year ago. No hype. No comments. Just roll it over. Obviously, to do this, both groups of banks keep the state entirely out of the process.
    The real key is no participation in future debt issues. Now , the problem is a Greek political problem raising new debt.

    I see accounting issues at the German and French banks intervening in operational decisions. So, arrange the nominal Greek amortization so that the incoming cash flow demonstrates that the loans are performing. In short, make it obvious that the Greeks will continue payments on these loans out of sheer advantage. These banks have far bigger worries . Now the lowest participant loss or resistance determines the pattern for Irish and Spanish debt. The banks needed to buy time and put the failure entirely on the Greek politicians. Too late now. Still, the banks must recognize internally that the loans are a developing partial loss but not necessarily requiring write off except as technical write off conditions develop.

    Do these German and French banks actually pursue their gotterdamerung out of rigid capture by rules?

  75. Mr Cezmi

    I suggest you check your numbers first: Wages in Germany are among the highest in the world. In addition, workers at Volkswagen have a 28 hrs week. They have 3.7m unemployed and 6.7m on benefits on some 30m +/-x working (many for the huge state bureaucracy). No one but Germans can cope with this (I’m not a German, nor sympathetic – but these are facts).

    Consumption is chocked by high tax + social security which is 170% of UK’s.

  76. Hmm, a large part of the Argentina problems was a pushing of a neo-conservative agenda. Instead of trying to help Argentina’s economy grow, the IMF pushed Argentina to open its borders to cheap imports, to privatize everything, which then led to massive unemployment and spiraling(up) prices. Then the clincher is that the IMF loaned a bunch of money to one regime just before another regime (violently) took over, putting the new regime on the hook for all that money, even if they didn’t need it. The same thing was done in South Africa just before Nelson Mandela took charge. South Africa didn’t /need/ the loans, but the new regime was on the hook, and it hurt South Africa drastically.

    IMF policy needs to be reformed so its not abused in the same way in the future, AND, countries that were abused in this way are worked with to find a fair and equitable plan for both parties.

    I suggest you read Naomi Klein’s The Shock Doctrine:

  77. Ted K, “sorry but there’s nothing we can do’ is, on the face of it, a reasonable response – unless you have contributed to the problem. I’m afraid government mismanagement is not the entire Greek story.

    The euro was principally the brainchild of the European business community. A single currency would enormously profit this community – with German business the main exporting powerhouse in the EU.

    It should have been the responsibility of the European Central bank and the Eurogroup to make sure that countries joining the euro are structurally sound. Instead, the only criteria were things like the size of the deficit. Well, the size of the deficit may change tomorrow – as it has in several cases across Europe – and then where will you be? Socioeconomic issues, such as the size and productivity of the public sector, unfortunately were never part of the Euro criteria. Clearly, Greece has had such structural problems for decades – and the EU never forced Greece to address them.

    But it’s not ethical to profit from a bad situation – as the stronger Euro countries have done from the euro – and then walk away from the mess you yourself have contributed to through your own lax oversight, indifference to meaningful change, and short-term thinking.

  78. If I were a Greek geek, I´d like to say the same. You enjoyed live and had “dolce vita” with our money. Now it´s time to pay back or to leave the family. Hey guys, you wasted our money-don´t forget about that. Next destiantion: “beggar´s day”. Have fun

  79. This a nice idea. Just think about tourism: nowadays it´s cheaper to go to Asian countris and have your holidays than going to Greece, Italy or Spain. I don´t know so much people here at Germany to go to those countries on a 2500-km-trip just to pay 40-50 Euros for a mere place on the camping ground over there. You can have it back home for 10-18 Euros or got to Asia and have some nice time for about 350 Euros at 5 weeks. You ned to change a lot at Greece and those other PIIGS and first you have to change public mind. Game over…..

  80. Do You really expect those criminals leading our banks to take back that chunk of garbage? They are greedy but not idiots. They are happy to give it to You and me and all those other stupid taxpayers. So, You really believe them to take it back? LOLL

  81. Hostage taking of Greeks in Germany or France is probably off the table and shelling Pireaus costs a pretty penny. If Greece can keep from descending into near (or actual) civil war when the money runs out, there aren’t so many credible levers the creditors might reach for. Bailing out is the one big lever, but if Germany and France think it better to take the hit so as to keep Spain, Portugal, Ireland and maybe Italy from thinking about it, well that is their choice. As far as Greece, ex-Euro, exporting its way back to some kind of economic health they weren’t much of a powerhouse when they had the Drach back in the day and they won’t be one when they get it back. I recall going to one of the state-owned companies in the afternoon and finding no one there apart from the floorwasher. Q: Doesn’t anyone work in the afternoon? A: No, that’s in the morning. In the afternoon they aren’t here.

  82. I guess the question is that once Greece goes to the IMF and defaults/restructures debt with a new currency allowing for monetary flexibility how will the other PIGS react from a fiscal perspective. Will they accept more painful austerity measures (over next two years) if growth levels remain under levels sufficient to reduce debt/defecit to market acceptable levels, or will they not, and go down a slippery Greek road. Ofcourse one can always hope there will be enough growth to solve the problem….but this over the next two years??? maybe not even in the medium term. Tricky times that need strong medecine to stop the illness.

  83. Joanne,
    I agree with you. The Euro is an impossible currency. 16 fiscal policies and 1 monetary policy will not can not work. I think there are 3 things that can be done but only the 3rd will save the Euro in the long run. And make no mistake it is about the future of the Euro that we are discussing and the future of Greece.
    1. they can do some sort of loan package (I think it should be the strong Euro governments and not the IMF) This would as the author said only cover up the problem.
    2. They can throw Greece, then Portugal, Spain, Ireland and maybe Italy out of the Euro. In case your counting that about 1/4 of the Euro countries. This too is in reality only kicking the can to the next crisis. What is going to happen when Germany and France need different monetary policies?
    3. The Euro countries can unite, their fiscal policies. Put aside their differences and ethnic problems and truly become a US of Europe. One fiscal policy one monetary policy they are all in it together sink or swim.
    The dirty little truth that no one admits is that they knew this all along.

  84. Why pay back and suffer decades of misery to benefit some people you don’t even know?

    Just Default and get it over with!

    In less than five years all is forgotten and “investors” will be sucking up Greek bonds again like there is no tomorrow.

  85. Yes you can – repeatedly!

    The only worry a sovereign state has in that regard is keeping the population well fed and entertained so they don’t revolt.

    Decades of austerity measures to benefit foreign creditors and local cronies will end in revolt and default by the new hard-line-nationalist government anyway, so one might as well skip the unpleasantness and go straight to “Finish”.

  86. Default on the debt.

    Keep the euro.

    Let the banks fail.

    The monetary emission 2002 in Argentina to prevent banks from failing caused an inflation that placed 25% of people in indigence, not poverty. 6 months later, children starting dying of starvation. Banks were kept standing, but over bodies of starved children.

    And that was in a food exporter. Is Greece one?

  87. BTW, in Argentina 2002 there physical pesos already printed and in circulation country-wide. Were are the physical drachmas in Greece today? Those promoting “drachmatization” are ignoring logistics.

  88. > rapid recoveries, was observed in Russia in 1999, and in the aftermath of the asian crises.

    … in spite of the IMF’s best efforts.

  89. I am an EU civil servant but that does not prevent me to see the reality. There is no euro monetary policy, only German needs matter to the ECB (it is not by chance that it is located in Frankfurt). With different economic conditions it is impossible to have a robust monetary policy.
    Spain and Portugal are in the situation they are right now because low interest rates demanding by Germany from the late 90s early 00s.

  90. The big picture

    This is an excellent post as food for thought and the comments very interesting as well, exploring many aspects of what is happening.

    But getting too much into accounting etc. details can make everyone lose sight of some very important issues on the big picture.

    I am surprised to see very little, if any, reference to the internal EU politics that are an integral and indispensable part of the Greek debt situation. Of course, in previous comments there were some exchanges reproducing the current debate about Germany and Greece as the two opposite development and fiscal management models, but that is not the most important factor here.

    We need to remind ourselves that we are witnessing original historic developments without precedent; it is the first sovereign debt crisis around a nation that shares comon curency with other sovereign states, with which it forms an inter-governmental union (or “union” if you will) where all are bound by common traties.

    As a result, whilst the technical consistency of the (by now famous) “Baseline Scenario” is admirable, it might be misguided to draw too many analogies with previous crises such as Argentina’s, tempting though it may be. I could argue this long, but suffices to say that, for Greece to go to the IMF like Argentina and many others before, it needs to secure the agreement of its EU partners who hold a blocking minority at the IMF Board itself – so Greece is inescapably bound by whatever is decided (or not) within the Eurozone.

    To paraphrase H.L.Menken, in every intricate and complex problem (in this case, whether Eurozone – read Germany – should assist Greece) there is usually an answer that is very neat, very plausible, and very wrong. In popular narrative within Germany this complex issue has been reduced in “paying for the profligacy of others”, while this is not the whole story. And it is important to understand what the story is, from an EU political standpoint.

    As other commentators have noted, there are imbalances in the Eurozone and it is wrong to view them as zero-sum productivity balances. It is absurd to ask the Germans to be less productive or suggest that if other become more productive, Germany will be worse of, even in relative terms. The real issue, the hidden, ugly reality that dare not spek its name, is that sustained and prolonged imbalances would make national interests diverge to such an extent that the whole union would eventually collapse. The only two ways to avoid this outcome would be to reduce the imbalances and this is what everyone wishes, although nobody spells out how this is going to be achieved.

    The current narrative from Germany is that there would be no imbalances it everyone were (or will be) as virtuous as the Germans (or the Dutch). At face value, this borders on the religious and would certainly fail the H.L.Menken test. Although there is much German-bashing by analysts at the moment, nobody should believe that the German elite is so simple-minded.

    Enter “economic governance”. Which nobody knows what it is but everyone secretly accepts as the only way for the Eurozone to manage their way to the holy grail of imbalance reduction. As it happens so often in history, the first steps to an entirely new direction are taken as forced movements in response to crises. And it so happens that the first real step in this direction seems to be the still-elusive aid package to Greece. Where, far from “picking up the tab after someone else’s party”, what is proposed is a sensible loan facility at a modest rate premium that may still not be entirely punishing for Greeks because that would be self-defeating.

    Or at least this is the prevailing assumption from news reports as I write. This could change over the weekend, but whatever you may think for or against this move, don’t judge it on any terms other than purely political.

    For the euro itself was in reality a political project that came into being pushed by Kohl, Mitterand and Delors in the late 80s and early 90s. Does anyone today seriously question that the end goal was to use the monetary union as a step to a closer political union? I don’t think so.

    Of course history took a different path and further integration in the EU all but stopped. So now this “economic governance” is the only way forward, starting small with some fiscal coordination, and then possibly more, always for “the stability of the euro”.

    It is often that the strength of a chain is tested in its weakest link, and Greece is the wekest link of the Eurozone. We will see how this is handled by the Eurozone but the first move in this game is by them. What they do and how they do it will determine the new course of the euro and the Eurozone, and will show to the world to what extent this is still a political project. Despite the hard line of Merkel so far, this game is far from over and any careful observer should note that even these hard positions still leave plenty of room for Germany to agree to a political settlement.

    It appears we will know soon. Perhaps the most compelling analogy I have read in recent days was the phrase (don’t remember if it was in the FT or WSJ) that “in this poker game, the markets may be getting to the point where they will ask to see the EU’s hand”. For a poker game this has been, and surely the bond market has asked to see the contents of that aid-package.

    It is hard to see how Eurozone governments can get away with not doing their bit to ease Greece’s borrowing costs. I agree that the debt dynamics are such that this would only be some breathing space, but what matters most for the rest of the world are the political consequences of what the EU does.

    As previously, the cacophony is always a prelude to any action. Or inaction. The jury is still out.

  91. Please bear in mind that some 60B of the debt come from German pension funds and some 40B more from French ones. It is not that easy to just abandon it.

  92. I am a Greek citizen and since I have lived and worked abroad I can tell all of you one thing:

    Greece is heading to bankruptcy because it has a huge and incompetent public sector, is totally unproductive and is very unfriendly to business.

    The other governments should NOT bail Greece out because if they do, structural changes will never take place and the devious Greek people and politicians will keep sucking Europe dry from funds that could have been productively invested somewhere else.

  93. House swapping seems to be called for.

    5 million Greeks go up to Germany and to their increase demand act and 5 million Germans to Greece with their productivity stunt!

  94. Moral indignation and condemnation may be more or less justified acording to the context and every individual’s personal beliefs and viewpoints. But they rarely make a sound basis for judgment and decision-making when complicated and difficult questions pose themselves.

  95. It begins.

    EU FinMins have, through teleconferencing, this afternoon agreed on €30B loans to Greece. All Eurozone members will participate; the IMF contribution is said to be 10%. No word whatsoever on problems of Portugal, Spain & Ireland.

    Sigh: personally I don’t think markets will buy it (for very long).

  96. So, the Eurozone is still a political project.

    The IMF cotributin will be another 10-15 bn. And should there be a similar need of other countries, the mechanism will have to be similar.

    Now the real test is the market opening Monday morning. Greece would rather not tap the standby facility, but this is now in the hands of the bond market.

    It willbe interesting to see the movement in other bonds too, not just the Greek ones.

  97. Alt. A. If Europe helps out Greece, in fact by refinancing all the Euros already financed to Greece, in fact postponing having to account for the losses today, in fact meaning that Greece will not pay a Euro on those debts for as long as needed, then the Euro will be seen as weak and lira like and the Euro will go down.

    Alt. B. If Europe does not help Greece, and in fact has to absorb as losses all the Euros already financed to Greece, in fact meaning that Greece will not pay a Euro on those debts ever, then the Euro will be seen as strong and deutsche mark like, and the Euro will go up.

    Exactly the same results for Greece… and totally different short term outcomes for the Euro.

    Though Europeans would in fact favor a weaker Euro, there is not enough political commitment among the “strongest” to shoulder the burden of those considered the “weakest”.

    Does the €30-40 billion mean they are going for A or B? My gut reaction tells me the markets are going to interpret it as too little and therefore a political way of talking about A… while going to B.

  98. “You enjoyed live and had “dolce vita” with our money.”
    Well, this is not very accurate.

    For instance, let’see some facts concerning Germany and Greece :

    -The money that was given to the Greek Economy by EU was not stolen.
    It is true that Greek governments did not take advantage of this money to develop the country, but just gave them to the people (massive recruiting in public sector, unsustainable investments to private sector etc), also keeping some for themselves.
    YES the government has to be blamed but NOT THE PEOPLE.

    – Greeks are working MORE than Germans. Public sector is exception.
    Private sector people usually work 9-11 hours a day mostly with no overtime, with salaries about half than German, but with a similar cost of life. YES we are NOT competitive because we lack organization but not lazy.
    And YES we like Dolce Vita but this is GOOD FOR GERMANY that sells its products. If we prefered to save our money, we would not buy them.

    – Germany has managed to re-unify , financing the beggards of the eastern part, in fact with OUR money.
    With the money of the south PIGGS countries that joined European Union facilitating German exports of electrinics, services, technology, BMWs and MERCEDES.
    So the Central Europe countries should not blame South for Dolce Vita with their maney, or want them out of EURO.
    – According to more and more financial analysts, a solution to the problem of EURO could be that Germany moves out, leaving the “LAZY” south PIIGS in.
    But if they stay, they should see Europe as ONE FINANCIAL NATION, with its “rich” and “poor” provinces.

    At the end, It’s simple: Whoever like to stay stays,
    whoever likes to leave leaves !!!

  99. Friend, let me share a comment I included in my Voice and Noise 2006

    “Early 1983, after Venezuela’s defaulted on servicing its foreign public debt, I remember some foreign bankers visiting me. They had until quite recently been praising the country and doing their utmost to sell their unneeded credits to earn their commissions and now they were all complaining in rage. “You mismanaged, you wasted all the resources we lent you. Have you no shame?”

    And on and on they went. After I while, I got fed up and told them: “Sorry gentlemen. We did not mismanage or waste the resources you lent us. Let me guarantee you that we Venezuelans, we truly enjoyed them.” Thereafter blissful tranquility reigned.” eoq.

  100. Yeah, I admit we had fun, by buying your Audis, Mercs, BMWs and Porsches by the tens of thousands and thus supporting your exports (and jobs and trade surpluses). Irresponsible from our side, cynical from yours. Make no mistake, the Euro is the brainchild of Germany and it is Germany’s interests that it primarily takes care of.
    Instead of waging wars it is far easier to dominate Europe by other means. End of story (and I’m not saying that to imply that common people think of dominance but to demonstrate how financial elites operate).

  101. So, economics technicalities aside, in a nutshell, the proposal is to increase the competitiveness of incompetent nations (Greeks) by decreasing the competitiveness of competent nations (Germans).

    Someone said something about a “race to the bottom”?

  102. Sirs,

    I have spent a long time reading all the comments posted and some are good some are harsh but they are all enlightening.

    However, the comon approach is that we live in the Europe alone and that there isnothing out of the area like China etc, and this is wrong.

    I am Greek and on many occasions frustrated by my country’s system but there are some buts to the whole discussion.

    I am not an economist (the science that explains why something went wrong after it has happened), but a naval architect involved in Greek Shipping and have seen most of the world that we all live in.

    So we live in a world of huge imbalances and somehow we have to manage that.

    If and this is a big IF we take the Eurozone and the EU as an entity, then this entity will have to compete with the likes of China, India, Brazil, Indonesia etc. So what the EU is doing, it is exporting for the time being the knowhow, machinery etc to this part of the world that will soon take over and will not need EU. We need a strong Euro so that we make them pay high prices for this.

    When the Wall fell, the industrial nations of the EU subcontracted fabrication to the cheaper eastern areas and this is how profitability was sustained.

    Greece and the south were left out of this game, and while big industries prospered, whole countries were left in the illusion that things could just go on, since the EU paid money for infrastructure.

    People in Greece, thought it was very nice that ineterst rates were so low, they heard that in all other countries people borrowso they did the same thing, people and the state they just kept borrowing.

    The biggest problem, the public sector, just got out of control.

    So now it is payback time and I think that number crunching is not the right approach to this matter, since according to many of the learnt opinions above we cannot get the numbers right and a lot of people will suffer.

    My personall belief is that all of the above calculations are wrong since the black economy in Greece is huge and that the GDP is much higher.

    However, Greeks do not trust that if taxes are paid they will go for a good cause and will not be wasted in corruption which is both local and imported.

    Greece also spends huge money on defense, and by the way imports from the industial north most of the equipment. If the EU was to guarantee the borders, Greece could reduce GDP spending by more than 5% immediately.

    Salaries in Greece are low so I do not think that reduction of salaries is the answer to the problem.

    What we need is a radical shake up of the way we think and the realization that the free lunch is over

  103. The German competiveness model if failed and not related to the PIGS problem. Germany tries to compete not by innovating or substantially increasing productivity but by lowering wages in 100-years old industries (auto, telecoms) essentially trying to compete a) head to head with China (see Volvo) and b) with illegal payments to government officials and briberies (should the Greek people demand from the German companies their money BACK?)
    USA has Apple, Microsoft and IBM, Finland has Nokia, Sweden Ericson Germany has auto industries and world class bribery houses such as Siemens and HDW and banks that led us generously at the good days.
    What a failed development model and enough with this self pitty motto.

  104. I am Greek. See what happened to the Athens Stock Exchange a few years ago. Everybody and I mean all the Greeks think that we deserve to buy the super douper car and 300m3 house. Most of us work a lot of hours but produce nothing. Our fathers make money by the Greek dept and left nothing for their children. We totaly deserve it. Lets just make some good old self-criticism and see what we achived as a nation, country or individuals the last 30 years. No need to say…I bet that at least we will “apreciate” the good old days and where these led us. (sorry for my English)

  105. Dear All,

    After reading carefully your blogs i have to say that,
    The effort and time taken by some people here in order to be able to contribute something of substance is truly impressive.

    Some other seem to be your average and about bigot-zealot, cynic-hatred fused and consecutively pointless internet based rant.

    I am afraid though that the first is not enough as it is also over-simplistic.

    To get the full story here we need to successfully draw back both in E.U. , E.M.U. Member States and Greece’s histories as separate entities right up to today and pinpoint all significantly relevant political,economical,social and other FACTS including their complete account of interactions leading up to the union and beyond that,right up to today.

    While this is definitely not an easy task,
    It is essential in finding the truth,thus educating ourselves so we might one day be able to avert such a catastrophe from happening again.

  106. I cannot agree with fajensen more.
    This is the way to go, default and get over with it instead of 50 years bleeding Merkel’s 5% interest!

    what hypocrites those EU “partners”! they want IMF in with 3.2% interest to keep greece in life support so they can bleed it slowly at 5%!

    default and get over with it!

  107. Greece, italy and spain should export more. What they can export? Surely the services (tourism) come to the mind.

    The problem is, that by cheating their way into the euro, overvaluing their currencies in the transitions, they made themselves deeply non-competitive.

    Nowadays europeans go to holidays to asia, carribean and africa, since the greece has become too expensive for what they offer (and spain & italy had become too expensive even before that).

    Since there is hardly any way to force costs down in these countries, expulsion from Eurozone would be in their interests as well. I would book the holidays in greece in a heartbeat, if they would be for example at 50% of the current prices – but now I am going to Cuba.

    I visited greece four times. It was getting more and more expensive each year, and I am not surprised that basically as a country they have almost nothing to export at competitive price. This is the direct consequence of cheating to join EMU.

  108. Indeed, this is ridiculous. Greeks should take care that they increase their competitiveness, not protesting essentially that German workforce tolerates austerity measures – and by that somehow “profiting” from the fact that Greeks don’t want similar course. WTF?

  109. What is happenning in Greece will never stop happenning again…Greece structural reform has not taken place . Human Rights are at beloww minimun level, if not the same with Iran. De facto Greek politics is run by its Orthodox Church that is oppresing all others. Greece is not not in peace with the definition of what e Greek should be…Greece is living with Middle Age mentality. This will bring it again in failure regardless the fact that how much money they will get from the outside World. Greece needs CHANGE or let go…

  110. Greeks- Let’s get the F out of the euro now, before we’re literally starving in another IMF famine! It’s Bono’s cause!

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