Beware of Germans bearing Gifts

The Greek tragedy drags on, with subplots and anguish worthy of Euripides.

Having taken extreme measures to reign in government spending and raise revenues, the Greek government expects to be rewarded with 130 billion Euros in aid.  Yet now the Dutch Parliament (currently in recess) says it must agree to any new disbursements.  Germany has suggested that the disbursement should be contingent on postponing Spring elections in Greece and instead installing a technocratic government that pledged to implement the unpopular measures adopted by the current Greek leadership (who are rapidly losing popular support).

Yet the measures being forced on Greece are so extreme, they remind me more of the punishments imposed on a debtor, who is sent to debtors prison as punishment for the sin of excess debt, than of the modern bankrupty process designed to cancel old loans and give people a fresh start.  Unemployment is already 20%, yet the government is being asked to axe 150,000 state jobs.  The economy has shrunk 7% in 2011 and may shrink by a similar amount this year; yet the government is being told to raise taxes sharply.  Private businesses are going bankrupt by the tens of thousands, so privatization can hardly bring in attractive bids in an economy in a downward death spiral.

It is hoped that by meeting conditions to gain the 130 billion Euros on offer today, Greece will inspire confidence that will jump-start the economy, and persuade its private creditors to accept huge losses on Greek bonds.

But this seems like wishful thinking.  Austerity of the magnitude being imposed on Greece simply cannot work — if acted on they will drive the economy down so much that the debt/GDP ratio will rise again, thus forcing Greece to miss its targets for future cash infusions.  If not acted on they will leave Greece open to blame and with-holding of the future cash infusions.  In sum, I don’t see how this works.

The logical thing to do would be for the European Union to say — we let Greece screw up, but we want to keep it in the EU and Eurozone.  So we will fund the ECB to pay all of Greece’s debts at 30 cents on the dollar, recapitalize Greek’s banks, and THEN insist that balanced budgets be attained within five years.  But with Germany, the Netherlands, Belgium, and the UK all facing shrinking economies in the last quarter, and Italy in recession, it’s just not appealing and perhaps not even feasible for the populations of these countries to do this.  So they hope to squeeze enough blood out of Greek stones to keep the debt dogs at bay, hoping that European growth returns and bails everyone out.

The problem is that growth is not returning anywhere in the EU, anytime soon, precisely because of the harsh austerity policies that Germany, the UK, and other countries believe are the right medicine to coax recovery from the Great Recession (and the sicker the economy, the greater the austerity being sought).

I am frighteningly reminded of the run-up to Lehman Brothers’ collapse.  Back then, despite the fact that Lehman’s impending bankruptcy was obvious, the markets remained calm, secure in the belief that Lehman was too big to fail and that the authorities would bail them out and prevent a default.  But at the end of the day, Lehman’s debts were too big, its assets performing too poorly, and the authorities decided to let Lehman fail, believing that it was just one firm, it would be a salutary example, and the consequences could be contained.  The result, of course, was global financial meltdown.

Today, the markets are on a tear, believing that a Greek default will be avoided by the intercession of the wise authorities, or that even if a default occurs the consequences can now be contained.  But in reality, Greece’s debts are just to big, its economy peforming too poorly, to believe it can ever meet the required conditions to avoid a default.    The only questions are when the default will occur, and how will the consequences spread?

Leaked documents suggest plans are afoot for a formal, limited default on March 23, after Greece’s next major bond refinancings are due.  Frankly, a default is probably a good idea for Greece — better a painful end than an endless pain, as my father used to say.  But the anxiety is whether a Greek default can be managed without creating a panic that will spread all across Europe and the world.

Here it seems the authorities want to build a bigger firewall, requesting up to 750 billion Euros for the European Financial Stability Fund, which is a wise idea.  But making debt less dangerous is a weak and temporary substitute for returning to growth policies (or inflation) that will actually shrink nations’ debts as a fraction of GDP.  That is the only way out for Italy, Spain, the UK and even the U.S.   Fortunately, the US seems to be on track to return to modest growth; but the austerity policies in Europe look to prevent the growth they so badly need.

So more drama tonight — will the Germans and other Europeans give Greece the money?  At what economic and political price?  Or will this drag on for another week or more?  Meanwhile, the real drama lies in the shrinking economies all across Europe.  When will growth return?  If that question is not answered, only more pain and economic hardship awaits all of Europe.

About jackgoldstone

Hazel Professor of Public Policy at George Mason University
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