Monday, 29 June 2015

There were alternatives to the Greek Crisis - Grexit or No Grexit

The incompetence of the EU's approach to the Greek debt crisis has been staggering. 5 years of failure have gone by and we are closer to Greek default and exit from the euro than ever.  At every stage EU policy has failed to meet its stated objectives while inflicting penury and unemployment on Greece (and other periphery countries) on a scale usually associated with a major war, and which, in this case, was largely avoidable.

It is worth briefly cataloguing just how badly EU policy has failed on its own objectives.  Back in 2010 EU leaders were loudly trumpeting the need for a bailout to avoid 'contagion' of the debt crisis. This was loudly and repeatedly stated until Greece, then Ireland, then Portugal had all fallen like heavily indebted dominoes and Italy and Spain were staring into the brink. It was an odd policy even from the start. If you are really trying to avoid 'contagion' you generally separate yourself from the contaminated object or person: the analogy here would presumably be ejecting Greece from the eurozone. Instead the bailout policy resembled hugging Greece close and giving it a direct person-to-person blood transfusion. Unsurprisingly, when you plug the financial systems of various countries into each other through massive country-to-country loans, the bad blood spreads.

Then the shout was that it was vital for Greece to avoid any default at all. Then in summer Greek 2012 default occurred.  We were told that the ECB couldn't possibly buy government bonds from distressed countries, or engage in general QE, right up until the moment both of those things happened. We were told capital controls were unthinkable, but now, you guessed, they have occurred in both Greece and Cyprus. The list goes on. Perhaps the biggest and saddest lie of all was the idea that the Euro was the great triumph of European solidarity. But in the very first major Euro crisis the rich countries have adopted a policy of taking the poor countries by the throat and squeezing the life out of them.  Where has European solidarity been for the last 5 years, as Greek and Spanish unemployment topped 25% and youth unemployment went over 50%?

At every step the EU has adopted policies that kicked the can down the road for a few weeks or months in the short term but that transparently had no hope of resolving the crisis in the long-term. And all this was predicted as far back as 2010.  There were always alternatives to the ludicrous policy the EU has chosen, and critics and sceptics have been pleading for them ever since this awful mess started.  They have been ignored and the inevitable, predictable results of economic gravity have ensued as sure as someone dropping a rock over their foot.    

There were two quite clear alternatives to the Greek crisis that could have been taken. One that kept Greece within the euro and one that saw it leave back in 2010.

Grexit.

If EU countries weren't willing to give Greece the money it needed to realistically sustain its economy while reducing its deficit then they should have let it leave the eurozone.

Grexit could have been managed in secret over a very short period of time to ensure a minimum of chaos. This would have required some outright lying to the press in advance, as the necessary official preparations were made in secret, but not much more than governments usually engage in. With preparation and support it could all have be done over a long weekend, with the banks able to open the next week in the new currency. Greek euro note and coins would have continued in use for a few weeks while new ones were prepared but now acting in the new currency. Greek banks would have to be shut and capital controls introduced while the change was made, but these could have been raised again relatively quickly once the transition was made.

The new Greek drachma would have immediately devalued massively, this would have sparked significant inflation but this would have been over relatively fast. It would massively increase Greek competitiveness overnight, giving huge boosts to Greek industries such as tourism and shipping and would only have effected international imports. Greece should have defaulted by 30% on all private debt in order to get out from under its debt mountain at that point, and reduce interest payments as a one-off measure.  From that point onwards all debt would be honoured in full.

Some eurosceptics have implied that this could all have occurred totally harmlessly, with a hop and a skip and a jump. This is foolish and ridiculous. The process would not be pain-free. The Greek people would still suffer a big fall in real income due to the inflation but with the advantage that it would be over quickly and Greece would rapidly recommence a real recovery rather than the permanent grinding recession that has seen GDP fall by 25% since 2010.  European governments would still face significant costs.  They would need to bailout their own banks where they had taken big losses in Greece. But from that point on all danger of 'contagion' would be severed as the link to Greek banks would be severed.

The EU would also be wise to sink significant sums into Greece in EU managed structural fund investments to help get the Greek economy back on track. This whole program would be with the aim of a recovered Greece being able to rejoin the Euro on proper terms in 15-20 years. Certain quantities of loans would also be sensible, but massively less than under the two bailouts we have seen thus far. Greek banks would need to be recapitalised but without Greece shifting into hyperinflation due to mass money printing to recapitalise Greek Banks. Hence the wisdom of providing some outside cash to allow Greek banks to rebuild their balance sheets with solid euros rather than just printing drachma.

The ECB should've at the same time cut interest rates to 0.5% and launch a large bank support program for Ireland, Italy, Spain, Portugal, but with the safety of knowing they no-longer had responsibility for Greece, by far the worst case. Ireland would still need a bailout, which should have been conducted on more generous terms, and maybe Portugal.  But with proper ECB assistance Italy and Spain should have been able to avoid the stress they came under in mid 2011, and hence so would the rest of the Eurozone. This should mean the entire 2012 double-dip recession could have been avoided, saving European countries billions more in gained output than they may have cost helping Greece with structural funds.

Immediate exit from the the euro and default would probably have produced a significant negative shock to GDP.  I have no idea how big, but even if it had been 10% of GDP, if it meant growth had returned within a year or so, then by now Greece would almost certainly be in a vastly better position, as would the rest of the Eurozone. Greece would probably have almost returned to 2010 levels by now instead of still being down by almost a quarter of its economy compared to 2010.

If such a program had been launched in full in 2010 then Greece should have rapidly returned to significant growth by 2012-ish and by now we could be discussing the Greek and Eurozone recovery, falling Greek debt burdens and the prospect of Greek readmission to the Euro (under more stringent regulation and monitoring) in perhaps another 10 years max.

No Grexit.


If Greek exit from the Euro was truly unacceptable to Eurozone countries then there was an alternative that kept Greece within the EU and alive. A lot of the stages would actually be remarkably similar. Rather than actually raising interest rates in 2010 the ECB should have immediately cut interest rates to 0.5% that summer. What inflation there was in the Eurozone was down to commodity price rises and would soon be quenched by the economic downturn. Slashing interest rates immediately would have helped give some small support to periphery country debt costs.

The ECB should furthermore have launched an immediate and substantial program of QE or bank support, as it eventually did.  €1 trillion euros of support whether aimed at states or banks would have been a good start, supporting distressed countries on a formula that mixed need and size. Crucially this should have been done before markets began attacking weak states, not some time afterwards when damage had already been done to investment and trade.

Greece would need to be bailed out, but on considerably more generous terms. A 30% default should again have been enacted immediately to reduce debt payments and levels. The bailout should have been considerably more generous, with Greece charged for support strictly at the rate of cost to the lending countries of raising the money. This should have been combined with an expanded program of infrastructure support projects, effectively grants, run through Brussels directly though so as to avoid any perception of the Greeks wasting the money.

Support to Greece should have concentrated on a more gradual reduction of the Greek deficit towards a current surplus, with deliberate efforts to maintain Greek economic activity. There would still need to be significant, cuts, tax rises and privatisations but with an eye on headline GDP and employment. Direct cash transfers and low taxes on poorer consumers, as well as infrastructure spending, should have been protected, while at the same time tax rises should be concentrated on wealthier Greeks and land and property, while spending cuts were concentrated on relatively economically unproductive public services.  The overall purpose of this would have been to conserve economic demand as far as possible while making significant but not suicidal progress in reducing the deficit.

Support should have come in large quantities not just in the form of loans, but also technical support in improving public sector productivity, privatisations, and improving the Greek tax take.  Tax avoiders and evaders of all classes should have been gone after like police hunting down terrorists, as a matter of national security.

While such a program would have probably taken more money than was included in the first round of Greek bailout in 2010, some €110 billion, it would almost certainly have not taken more money than was included in both rounds of bailout put together, a total of €240 billion euros. When combined with the fact that it would have hopefully seen a much smaller fall in Greek GDP, Greek debt levels should have been LOWER under this plan than what has actually happened.


Conclusion.

The counter-productive effect of current policy has been massive.  Greece has suffered a 25% recession to cut their deficit by 12%. That is €1 cut from headline GDP has only reduced the deficit by 50c while inflicting utter devastation on the Greek people. This in turn contributed to a double-dip recession across the Eurozone as a whole. If Greeks had borrowed just as many euros as they currently have, but their economy was the same size now as in 2010, then their debt burden would be only 120% of GDP instead of the 180% it is at the moment, just due to the effect of dividing the debt in euros by a larger GDP figure.

Leading politicians such as Merkel should have clearly said that you don't make yourselves rich by beggaring your customers; nor by producing a rolling 5-year crisis without any hint of resolution, which has just shook confidence across the entire EU and particularly within the other weakened countries: Spain, Italy, Ireland, Portugal. Merkel's policies (Merkelism if you will) could be fairly characterised as Thatcherism without all the upsides. Being a Leader involves, you know, leadership, and that means taking people where they need to go, not pandering to their daftest instincts.

Which brings us to our present moment. On Friday Greece will vote in a referendum on its future. Greece has never been so close to an messy euro-exit. Vote No and such an exit might give the country a chance of a better economic future, but in a severely more messy manner than could have been possible with a structured Grexit back in 2010. Vote Yes and there is nothing to look forward to other than years more grinding poverty and mass unemployment. Either way it is an utter shambles.

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