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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.
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.
Choice 1: True Fiscal Austerity – 10% of GDP, with further measures soon
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
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.
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.
full post By Peter Boone and Simon Johnson
Thanks again The Baseline Scenario!
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