What will happen to Greek debt?

Source: extranea.wordpress.com

It would appear that all of a sudden, the question of what will become of the Greek debt (currently at 170% of the country's GDP) has arisen. While everyone seemingly had forgotten about it over the past couple of months when the Troika negotiations had been going on, now long talks and negotiations between the IMF and the EU are taking place to settle this issue.

German Finance Minister Wolfgang Schäuble is strongly opposing IMF chief Christine Lagarde who proposes that Germany and other creditors forgive a portion of Greece's debt in order for it to become sustainable. Such a development would mean that Germany's fears about not being able to protect the German taxpayer, with whose money they have financed Greek deficits, would materialize in the worst possible way. From what we can read, Schäuble will propose that a solution for reducing the debt levels would be for the Greek government to buy back 50% of the remaining private sector debt at a 25% of its value. This would mean that if a bank or any other investor had bought Greek bonds of €100, after last year's haircut the bonds are only worth €21. Under Schäuble's plan, the investor would essentially sell the bonds for approximately €5. This would essentially mean that 50% of the investors would lose approximately 95% of their invested money. (Nevertheless, as it appears that this piece of news only appeared in Greek media, I would have serious thoughts about its validity)

Yet, as a compromise has not been reached yet, the question remains: how will the Greek debt be reduced to bearable levels? There are only two simple solutions which come to my mind:

1. Interest payments for the outstanding public debt should be paused for a period of 5 years. 

This would allow Greece to use its primary surplus to finance its current needs as well as repay a portion of the current debt load. The Greek statistical service reports that the country will need to repay approximately €55 billion of debt in the next 5 years; giving it the opportunity not to pay any interest rates in the next 5 years would mean that Greece could return to growth in 2014-2015 and then make it easier for the nation to cover its loans. This way, the German taxpayer (or any other taxpayer in the EU) does not have to worry about losing her money; she would just receive less profit on the amount loaned.

2. The ECB should directly fund any financial needs Greece has from now on.

By doing this, it would mean that no taxpayer in any country will be worried about her government losing her hard-worked money due to Greece. By having the ECB fund the debt, the country would have to pay much less interest rates than otherwise, and this would lead to an opportunity for a quicker repayment of debt.

Solution 1 is actually easier to be implemented than solution 2, with the added advantage that it will bring results much sooner than its alternatives. Given that the prerequisite for countries to approve of a solution is that they will not lose any money of those they have invested so far, they should take this into serious consideration.

A Good Day For Europe

At last, after months of discussions and speculation, the German Federal Constitutional Court has given the green light towards the creation of the European Stability Fund (ESM). This means that the Fund can give up to €500 billion of loans to Member-States in need. In addition to Draghi's announced bond-buying program, this is expected to bring a new era of calm in the markets. However, what is more important is that they are giving out the signal that both the EU and the common currency are here to stay.

In essence, this would mean that all rumors and speculation concerning the fall of the euro, the Union, a sovereign exit or bankruptcy are unfounded. Thus, after these are refuted, stability and calmness is expected to appear on the markets, in contrast to the panic which lasted for almost a year. Nevertheless, not to be forgotten is that individual nations are still struggling to survive
, and for some (Cyprus, Italy and Spain), the worst is yet to come.

Tomorrow, in Nicosia, Cyprus, the Greek Prime Minister, Antonis Samaras, is expected to announce the new austerity measures at the Eurozone finance ministers meeting. Although the flow of cash to Greece is not expected to halt as none of the decision-makers has ever stated such an interest, the Troikans will issue their next report in October where the Greek government is expected to come short of its targets. In the same meeting the situation in Spain is expected to be discussed. Even though a package of €100 billion has been made available

An Alternative to the Greek Bailout

Don't know if you heard it but EU officials state that they plan to do another, smaller haircut to Greek bonds to make the debt level fall to about 100% of GDP thus theoretically making it more viable. This makes us understand the reasoning behind EU policymakers decisions: If one mistake doesn't fix things why not try two? Well gee guys did you have to do a PhD to learn that?

Without a doubt the Greek haircut was a mistake. All it did was make the banking system more fragile than it already was (let us not forget that it had already faced a sub-prime lending crisis which had barely finished when this started) and countries who thought had no financial problems turn to the ECB and the IMF for funding to rescue their banks. Another stupid idea is as I have mentioned in a previous article using the IMF to fund European countries. If the ECB will not act as a normal central bank then why bother with the Union and the common currency? Just make trade agreements and return to national currencies. Either we become the United States of Europe or we shut this thing up before it blows in our faces. But I am getting out of subject.

As usual, my friend Wolfgang (whom you have met here) will ask what alternative I would propose for the Greek Debt. Which is simple. Make a separate entity, like for example the EFSF, and let it buy all Greek debt. Since the entity will be funded by the ECB it will have no liquidity problems as the Greeks will slowly (as if now they are really fast in repaying it right Wolfgang?) repay their debt. The entity would control the old bonds and slowly repay the banks as the flow of cash increases with a flat interest rate for all bonds. The banks' Greek bonds would have been held in the entity without them being able to sell or otherwise use them; however this would be much better than taking losses of tens of billions of euros over a year. Ask any bank in Spain. Italy, Cyprus or Greece if you don't believe me!

What about refinancing then? Well here the idea would have remained the same. The country would have to go through severe structural changes, cuts in government spending, etc etc and the refinancing would be made by the ECB. This way the only country that would have been "punished" would have been the one which made the mistakes who led it there.

Had this occurred we wouldn't be talking about banking problems in almost any country. The only countries which might have faced that would have been Greece and Cyprus. If the banking sector problems had not occurred then the rating agencies would not have degraded most of the countries they had. Thus, with only some budget cuts the Eurozone would have been a happier place.

P.S. OK Wolfgang I admit it. The above plan has a caveat: It would essentially mean that Silvio Berlusconi (you remember him right? The bunga bunga guy!) would have remained in power. Oh well, I guess we would have to live with it. (Sorry Angela!)

Impressions from a Southern European Country

After watching that Cyprus has also applied for a bailout from the EFSF/ESM fund (following Greece, Ireland, Spain and Italy) I decided to to watch a bit more carefully on how the situation will be handled this time. From what I can see in the news, the group of experts (or technocrats if you prefer) of the International Monetary Fund, the European Commission and the European Central Bank (the so-called troika) have reached the same conclusions as they had done before for the case of Greece, Ireland, Spain and Italy: Austerity Measures. Surprise, Surprise! As if any European citizen was expecting anything else.

News stories of what they intend to propose specify things like large cuts on government expenses, decreases in civil servant wages and benefits and increases in direct and indirect taxes. Although I am positive that the Cypriot state needs to perform some sort of rationalization over its expenses (the Southern European states have a much deserved reputation of not being very logical when it comes to government spending. An excellent example of such irrationalities is Greek government's allowance to the civil workers who arrived at work on time) this sort of thinking and acting will not ease the burden of a sovereign debt crisis. Judging however of the ease at which the troikans believe that austerity measures are a panacea I would propose that the next country that will need a bailout ship its accounting books to them and spare the EU some money on traveling!

As one may observe, austerity measures have not so far helped in easing the effects of the near-bankruptcy of Greece. In Spain, unemployment has reached 25% amongst the population and about one out of two youths under 25 is jobless. And yet, Mariano Rajoy's government announced huge cuts in the nation's budget which will only worsen the situation. Mario Monti's government of technocrats in Italy (in my opinion the best leader in the EU at the moment) has only taken 30bn euros worth of measures, and those in December 2011. In comparing the two states it would now seem that prospects seem slightly brighter for the Italians as per the spring 2012 European Commission forecasts. (for more details read the European Commission Economic Forecast. Be warned it is 190 pages long!)

As one may observe the Commission states that after 2012, a bright future awaits the Union.However I do not believe that such a comeback will be feasible so easily. In an already depressed economy the cost of slashing government spending is going to be more than the amount of money not spend.

As one may see from Google's public data Spain had negative growth only twice in the last 50 years while the more politically unstable Greece and Italy have had more ups and downs. On the other hand Cyprus's only year of negative growth since 1961 was 2009 (wouldn't it be nice if they could just keep it up? Damned bank exposure to Greece!). However, if you exclude the 1974 change in Greek authorities after the 1967 coup d'état, a year which was marked by a 6,44% Greece had not faced major economic downturns. The same holds for the Italians whose worst year was 1975 with a 2,09% drop.

According to the Debt-Deflation Theory of the Great Depression by Irving Fisher and the academics who have studied and written about it over the years (one of which in the Governor of the Bank of England Mervyn King) a large government sector has stabilizing consequences to an economy. In Hyman Minsky's Stabilizing an Unstable Economy (you can find it here) this idea is revisited and it is once again shown that a large government (up to a point obviously) is beneficial for the financial stability of a nation. (I am under the impression that the troika will not especially enjoy this paragraph) Thus the danger that may arise from an excess of austerity measures is to make the already fragile system more prone to future crises.

Following this ideas it is more essential to provide incentives for growth and then impose austerity measures. The logic behind the EFSF so far has been: we give you money if you promise to be frugal with them. Well gee EFSF thanks a lot! What would actually make sense would a be a policy of ''we give you money, spend them to boost the economy, and then impose some austerity measures". (If you are one of those who like to derive examples from economic history you may use the one of Theodore Roosevelt and the Great Depression) I once again state that I am not against the rationalization of government expenses. However, this should be done after the economy stabilizes and not before! If the economy does not grow how is the nation going to pay back it's lenders?

I guess that following the traditional German logic of keeping inflation low and finances tight at all costs led us to where we are now (a note on the solution of the Greek debt haircut on posts to come) and will keep us there until the Germans realize that the hyperinflation of the 1920's will not occur if the let the ECB act as regular central bank and print money. It would even make the value of the dollar fall which would help German exports! 

(Mrs Merkel please listen to reason! Most Europeans are bored of the same meetings with the same conclusions!)