The ever-evolving rescue plans are — so far — just Kabuki. It’s obvious, but seldom acknowledged — as explained in this excerpt from “Europe’s bazooka is not enough“, Models and Agents, 8 April 2010:
- Back in August 2008, Hank Paulson, then US Treasury Secretary, went to Congress to request the mandate for a potential financial backstop of Fannie Mae and Freddie Mac, in the event of a loss in market confidence. Faced with the Congress’ inherent aversion to an explicit government guarantee on the two companies, Mr. Paulson’s argument was raw, yet forceful: “If you have a bazooka in your pocket and people know it, you probably won’t have to use it.”
- We all know how this ended. Less than two months later, the US government was forced to put both companies into “conservatorship”, as markets decided to test Hank’s resolve to put his powerful weapon to use.
- Europe’s EUR30bn financial package to Greece is the new bazooka on the block. Even the Greek Prime Minister himself, George Papandreou, seemed keen on recycling the analogy: “The gun is now loaded” he said to a Greek newspaper, perhaps unaware of the fate of its US precedent. As it happens, the European backstop alone does not provide a permanent solution. This is because it continues to treat the Greek crisis as a liquidity problem, when many in the markets believe it’s a solvency one.
- A permanent solution *has* to involve an IMF program, with a clear and feasible framework for swift debt reduction.
The Greek rescue plans look like a confused application of Walter Bagehot’s rule for crisis lending by central banks: “lend freely at a penalty rate” (current dogma considers unnecessary for governments the last part of the formula: “on good collateral”). That works for a liquidity crisis of a solvent institution (e.g., a run on a good bank). It does not work — or even make sense — for an overindebted entity, for whom the addition of more debt at a high rate of interest increases the risk of insolvency.
The theory is that a deep recession can accompany massive reform of the Greek political regime (e.g., they pay much more taxes) and society (e.g., they work longer). The likely result of this process is the same as for the US government-sponsored mortgage enterprises: a massive flow of government lending, which funds the deficits AND substitutes for private loans as they mature. This buys time for a combination of fiscal and debt restructuring (extending maturities, plus reductions in interest rates and principal). But will the people of Europe’s core — its creditor nations, esp Germany — approve?
Perhaps the plan is not what it seems — ad hoc negotiating — but is in fact a political subterfuge to overcome strong opposition to aiding Greece (and Italy, Spain, Portugal, etc). If so, the supposedly contingent government lending is planned aid — Europe’s leaders know the loans will quickly be triggered, followed eventually by an inevitable debt restructuring. This implies that Europe’s elites have established the nature of the new union; they’re just negotiating about the price everybody pays. Europe’s peoples will just have to go with the program.
Of course, the Greek people have another alternative if they consider the price demanded from them too large : forced restructuring, aka default. Slowly this fact emerges from the shadows into public discussion, as in this excerpt from “Funds shun Europe as ‘no-go zone’ after Greek crisis“, Ambrose Evans-Pritchard, The Daily Telegraph, 13 April 2010 — “Global fund managers have changed their views of the euro area dramatically since the Greek crisis erupted last year and exposed the deep structural flaws in monetary union.”
“There are still questions that need to be answered on the EU deal,” said Julian Callow from Barclays Capital. “Greece has a Herculean task ahead. The economy is contracting yet fiscal tightening has hardly begun. We expect growth of minus 4.3pc this year, and minus 1.9pc in 2011 which will be difficult for debt dynamics.”
Opposition politicians in Athens have begun to question whether it is in the country’s interests to accept harsh wage deflation in order to pay foreign creditors. “This is usury: we need restructuring of debts,” said the Righti-wing LAOS party. Such views are gaining support in parts of the ruling PASOK party, raising the risk that it will splinter as further austerity is imposed. Diplomats see a direct parallel with Oskar Lafontaine’s Linke movement drawn from the Left-wing of Germany’s Social Democrats.
File under “duh”. The longer Greece wait to default, the more pain and suffering. Default is an option; the national interest of Greece requires considering it now. And using it soon.
A note about Kabuki
By Kabuki, I mean a highly stylized, formal, predictable art form — usually tragedy. I don’t mean it in the ways described in “It’s Time To Retire Kabuki – The word doesn’t mean what pundits think it does“, Jon Lackman, Slate, 14 April 2010.
For more about government defaults, and the financial crisis in Europe
The best soure of daily coverage of the Greek-EU crisis: Eurintelligence.
From other sources:
- “Can Euroland Survive?“, Stephanie A. Kelton and L. Randall Wray, Levy Institute, November 2009
- “Withdrawal and expulsion from the EU and EMU: some reflections“, Phoebus Athanassiou, European Central Bank, December 2009.
- “Greece’s financial crisis puts the future of the euro in question“, The Observer, 7 February 2010
- “Europe Risks Another Global Depression“, Simon Johnson (former Chief Economist of the IMF), The Baseline Scenario, 7 February 2010
- “Greece threatens more than the euro“, Gideon Rachman, Financial Times, 23 February 2010
- “Default settings“, The Economist, 31 March 2010 — “Sovereign defaults do not typically lead to economic catastrophe. How much comfort should that give?”
- “The future of public debt: prospects and implications“, Stephen G Cecchetti, M S Mohanty and Fabrizio Zampolli, Bank for International Settlements, March 2010
- “The Painful Arithmetic of a Greek Debt Default”, Charles Calomiris, E21: Economic Policies for the 21st Century, March 2010
- Interactive graphic: “Debt Rising in Europe“, New York Times, 6 April 2010 — “Greece is not the only country in Europe with problems with credit and debt.”
- “Why Greece will default“, Wolfgang Münchau, Eurointelligence, 1 April 2010
On the FM website:
- Can the European Monetary Union survive the next recession?, 11 July 2008
- The periphery of Europe – a flashpoint to the global economy, 8 February 2010
- Would a default by the US government help America?, 21 February 2010
- We might default on our governments’ debt in the future. Do you know how often we’ve done so in the past?, 5 March 2010
- Our government’s finances are broken. How do we compare with our peers?, 8 April 2010
- Governments cannot go bankrupt, 2 April 2010
Afterword
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