This article was originally published in The New York Times
Without outside help, Greece is probably insolvent right now. In evaluating the country’s prospects, it’s worth asking what it would take for Greece to pay all of its bills and what kind of damage we might expect along the way.
The answers are to be found not only in statistics — like the debt-to-G.D.P. ratio, now running at more than 140 percent for Greece, and headed higher — but also in human sentiments and solidarities. A considerable amount of Greek patience and German flexibility and sacrifice are minimum prerequisites for turning back a major disaster in the making.
To put matters in perspective, the Greek economy is less than 2 percent of the overall economy of the European Union. That seems a manageable size for an aid-based solution; estimates in the neighborhood of 200 billion euros in aid (close to $300 billion) are common. The real difficulty is in maintaining global financial confidence while the losses are distributed in an orderly manner.
That isn’t as easy as it may sound. About 30 percent of the Greek debt is held by Greek sources, including the banks and the Greek government, in its social security funds. A default on the latter assets would mean that the Greek government was defaulting on itself. It would still have to come up with much of that money or face a total political and economic meltdown.
The private sector can be persuaded to realize some losses on Greek debt, but there is a risk of setting off a Lehman Brothers-like financial panic, especially if there is a judgment of complete or selective default from the credit agencies. Standard & Poor’s warned of such a judgment last week. Big penalties for private creditors may also have weighty implications, because of the potential for a chain reaction — in which credit dries up for Ireland and for Portugal, which ran into fresh trouble when Moody’s downgraded its debt last week. Furthermore, the private sector holds only about a third of the Greek debt total — and that involvement is falling rapidly — so bondholders cannot be the only fall guys.
Then there is the European Central Bank, which holds about 18 percent of the debt. The wealthier European Union nations could transfer funds to Greece and the central bank as permanent debt relief, rather than continuing with debt rollovers that may look similar to Ponzi schemes. As it stands, vulnerable countries are being pushed into ever-higher debt levels. Yet the central bank has strict rules, including a no-bailout clause and price stability as the sole goal of monetary policy, while the European Union often requires member unanimity for major changes.
In other words, these rules were written to prevent what is now the only coherent response to Greece’s troubles — namely, a timely recognition of the losses and an agreement that they will be shared jointly in some way.
And don’t forget that more than 40 percent of the European Union’s budget is taken up by subsidies to farmers, leaving little room for subsidies required in an emergency like this. The union was not designed to turn on the proverbial dime.
The closer you look, the worse it gets. German politicians promised their voters that the euro would never lead to fiscal union or tax increases, yet aid to Greece would put those issues on the table. Political support for costly transfers also seems weak in the Netherlands, Finland and other northern European nations.
Furthermore, for Greece, such a bailout would not count as a long-term solution. Paying back one’s creditors is not the same as resuming economic growth, and the country would still face the fallout not only from its spending cuts and tax increases, but also from sharing a monetary policy and exchange rate that for it is deflationary. Relative to the size of its economy, the total Greek spending cuts now being contemplated are proportional to the United States government cutting $1.75 trillion. (Even if you believe government needs to shrink, it would be hard to pull off such a big change on short notice.) Right, now Greece’s gross domestic product is falling at a rate of more than 3 percent a year.
Even if a Greek default didn’t wreck broader markets, it wouldn’t cure Greece’s problems. The Greeks are still borrowing, so a default would dry up some of their funds and force the government to make even bigger spending cuts.
If it left the euro zone, Greece could reap the substantial benefits of a currency depreciation, but doing so would also set off huge runs on banks. And the country has no alternative paper currency ready for use.
If you are a euro optimist, you might believe that the day of reckoning for Greece will be stalled long enough for Portugal, Ireland, Spain and possibly Italy and Belgium to recapitalize their banks and trim their government budgets. You might believe that of the Greeks will eventually default, but that by the time the contagion effects are checked, the Greeks will have pulled in some aid, and the global impact will be a mere hiccup instead of a new financial crisis. But that still will leave Greece with no clear economic path forward. For a best-case scenario, that’s not very good.
If you are a pessimist, you might see such a response as an unworkable plan of naïve technocrats. Here’s your line of reasoning: At some point along the way, democracy is likely to intervene: either Greek voters will refuse further austerity and foreign domination, or voters from northern Europe will send a clear electoral message that they don’t support bailouts. And there’s a good chance one or both of those events will happen before a broader European bank recapitalization can be achieved. In the meantime, who wants to put extra capital into those ailing Irish, Portuguese, and Spanish banks anyway?
In an even bleaker scenario, bank recapitalization won’t be realized anytime soon and those same economies will show few signs of growing out of their debts. A broader financial crash will result, and it won’t be contained by an easily affordable bailout.
Those are the choices playing out now, in the streets of Athens and in the halls of power centers like Washington, Brussels, Paris, Frankfurt and Berlin. Stay tuned. There’s a lot of news on the way, but probably very little of it will be good.