Greek Tragedy or Dashing Western? The Future of Greece

As economic leaders meet at the G-7 conclave in France, everyone is asking:  will Greece fade in the last act and fall in tragic fashion?  Or will western powers dash in guns blazing with additional credit and save the day?

Jeffrey Sachs is all for the western version.  Writing in the Financial Times, he calls for Europe to patiently extend more credit to Greece, so that its courageous and painful austerity measures have time to produce positive results.  For Sachs, Germany is to blame — Greece has been bold and only Germany and the rest of Europe’s continued public reluctance to keep credit flowing freely has produced a credit-crunch for Greece that is preventing its own good actions from yielding solid benefits.

Doug McWilliams, writing for CNN (former Chief Economist for IBM), gives Europe a month before the curtain rings down on the tragedy, with the markets forcing a break-up of the Euro and possibly worse.

Indeed, BOTH Sachs and McWilliams predict an epic crisis for the global economy, worse than in 2008, if Europe cannot figure out a way to prevent a Greek default.

So what will happen?  What can happen?

We need to start with some simple arithmetic.  If a country has debt that is 100% or more of its GDP (in Greece it is way more, Italy a bit more), then if it is paying interest rates higher than its national growth rate, all the growth in its income cannot keep up with the interest it owes, and its debts will grow larger and larger over time.  The only way to avoid a default is to turn over all current growth and more to paying down debts, so that interest owed is brought below the rate of growth.   Then the country’s economy can start to grow faster than its debt, and the debt burden be reduced.

The time until default depends on the differences — the higher a country’s debt above 100% of GDP, and the bigger the gap between its interest rates and growth rates, the sooner its debt will explode.  Greece is off the map on all of these — its public debts are about 160% of GDP and rising.  Its growth has been negative since 2009, and increasingly so — lastest estimates for the 2nd quarter of 2011 are for a decline of 6.9% at an annual rate, after declines of 8 percent (annual rate) in the prior two quarters.  Meanwhile, the interest rate that the markets want Greece to pay for any further credit, given the mess it is in and the low likelihood of repayment, are around 20%.

To be sure, overall Greek debt (public and private) is not too bad.  It is the government that is in trouble, first because it borrowed a great deal of money, second because it has a very hard time collecting taxes from Greek businesses and taxpayers.  So to even begin paying down its debts, the Greek government would have to extract far more tax revenues from the population at a time when the economy is already in steep decline, without driving the population into revolt or the economy into a further downward spiral.

If it sounds impossible to you, it does to me too!  I just don’t see how it can be done, which is why the markets estimate the chances of a major restructuring or default at nearly 100%.  The only real question is when and how.  Sachs thinks that if Europe will guarantee Greece low-interest loans for 5 years, then Greece can gets its economy growing again, and collect the taxes needed to start reducing its debts without default.  Gotta love the optimism!  But really — “Greek GDP is at 2004 levels, and it will take about a decade to reach pre-crisis levels.  Greece’s GDP has been declining since Q4 2008, and is now just above  2004 levels.  A greater than anticipated recession means it could  take past 2020 for Greece to recover to the income level it had coming into this crisis.” (Greek Default Watch).   The “Growth Gods” are not going to come down from Olympus and ignite the Greek economy (see my previous post “Ten Reasons why Growth is Dead”.  Tourism is down due to the austerity riots; trade is down due to the European and US economic slump, and Greece does not export to developing countries anything that would boost it into turbo-growth.  So the idea that Europe will lend to Greece until its growth allows it to pay down its debts is farcical; I fear it is not only delaying the inevitable but making it worse by throwing more good credit after bad.

It is time to do what Iceland did — let the Banks take a huge but orderly haircut; give Greece a 10 year ‘temporary withdrawal’ from the Euro with promises to readmission if it gets its finances in order; let Greece’s own new currency float down, and give the country a chance to start moving forward without being weighted down by the government’s misguided accumulation of debts.

Trying to keep Greece from defaulting is like Sisyphus’s efforts to role a giant stone up a steep hill.  It will never work, and for us mere mortals, if the boulder starts rushing downhill out of control it will crush a lot of us in its wake.

About jackgoldstone

Hazel Professor of Public Policy at George Mason University
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