Greece has a bad reputation. In default on its debts for half of the modern era. A dysfunctional economy, with a leaky tax system and retirement for the young. The reputation is somewhat deserved. In my view however, the blame for the ongoing fiasco that is Greece lies squarely with the European Union and IMF, and the pain for Greeks will not end unless they give up on those institutions and properly default, as well as repairing their economy.
The world’s first default was in… Greece
In the 5th Century BC the Greek city states borrowed from the Greek Treasury, then located on the island of Delos. The first sovereign default in history occurred in 454 BC when some of those city states started to skip payments.
In the modern era Greece has the record for the longest period in default of its loans. In 1824 Greece began borrowing to finance the costs of independence from the Turks, and subsequently to finance civil war. A debt of initially half a million pounds, and added to by further borrowings from England, France and Russia accrued to more than ten million pounds by 1878.
During the period between 1824 and 1878 the Greeks were permanently in default on these borrowings. However, in this period I would argue that the blame for the default was at least as much with the lenders, for funding Greek misadventures and expecting payment in full in return – a theme to which I’ll return.
In more recent years the problems in Greece began well before the financial crisis. In 1992 the Maastricht Treaty established the European Union. The Treaty laid out the roadmap for monetary union and the Euro, but also required countries to have a public debt to GDP ratio below 60% of GDP, deficits below 3% of GDP and inflation below 1.5%.
If countries did not meet these targets they would not be admitted to the Euro. The rules are a very sensible way of ensuring that countries that have problems with public debt do not get into difficulties financing those debts in the absence of independent monetary policy. The problem is that in Europe rules relating to economic management are routinely violated. And so the Greeks were admitted to the Eurozone in 2001 even when their deficits and debts were well in excess of the Maastricht requirements.
The decision to admit Greece was based on the belief that Greek public debt and deficits were falling. As it turns out the current CEO of Goldman Sachs, Lloyd Blankfein, helped the Greek government hide some of its public debt through a complicated debt swap, and so the belief that public debt was falling was very misguided.
The Athens Olympics saw further problems with rising Greek debts, and by the time the global financial crisis hit, Greek deficits and debts were well and truly out of control. When the PASOK government took office in October 2009, it revised upwards its estimates of the budget deficit that year to 12% of GDP. It turned out that the actual deficit was 15.4% of GDP and its total public debt was revised upwards to €300 billion, or 130% of GDP.
What Greece needed and what Greece got
It was clear at this point that the Greek situation was unsustainable. Greece needed economic restructuring and a write-down of their debt in order to move forward. This is not what they got.
The problem was that €134 billion of the Greek debt was owed to banks in Europe, and in particular German and French banks. The first Greek bailout in 2010 was not a bailout of Greece, but a bailout of French and German Banks, engineered by the ‘Troika’ – the IMF, EU and European Central Bank. This bailout saw the Troika gradually buy Greek debt from mostly French and German banks. Four years after this bailout European banks outside of Greece had sold their Greek government bonds, with these bonds now being held by EU governments, the ECB and IMF.
Germany’s exposure to Greek bonds increased, but the exposure shifted from the banks to the German government. Total French exposure to Greece fell over this period, with increases in the French government’s bond holdings being more than offset by €50 billion of sales of Greek debt by French banks. All of these deals shift the exposure of European banks, but do nothing for Greece. With the leadership of the EU and ECB dominated by French and Germans, and a French IMF Managing Director it is not surprising that the first Greek bailout was really a bailout of French and German Banks, and did very little in terms of putting the Greek economy and finances onto a more stable footing.
Philippe Legrain, in his book European Spring has described the Eurozone as a glorified debtors prison, and the monstrous undemocratic creditors racket – sentiments that I entirely agree with.
One year after this first bailout it was clear that the first bailout was not working, and negotiations for a second bailout began. What Greece got out of these first two bailouts was very little in the way of realistic debt relief, very little from the Greek side in terms of proper economic reform, and austerity programs that would only further destroy the Greek economy and demoralise the population.
Sensible austerity can work
Sensible austerity in conjunction with a credible economic reform program and debt restructuring can work. This is not at all what Greece got. A private debt swap was supposed to reduce Greece’s public debt ratio to 120.5% by 2020. The estimates of this debt level relied on completely unrealistic forecasts of Greek economic growth. Given the austerity which accompanied these first two bailouts, Greek debt today stands at a not surprising 180% of GDP.
So why did the Greek population vote a resounding no to the most recent EU bailout offer? The choice before the Greeks was 20 more years of austerity and economic misery, or exit from the Eurozone and the chaos that that would create – bank failures, high inflation, and economic chaos. Their banks would fail. They would have to revert to their own currency, and Greece has previously had a history of inflation problems – in 1944 they issued a 100 billion drachma note! But it comes down to the fact that countries can pick themselves up from that kind of chaos. South East Asian countries faced some similar issues and problems after the Asian crisis, but bank and economic restructuring saw those countries survive and thrive within 5 to 10 years.
Having seen what an exit might look like in the past two weeks, with the banks closed and economic activity at a standstill, the government decided to opt for continuation in the Eurozone, austerity and economic misery.
I think this is the wrong decision. If Greeks exited the Eurozone they would face several years of economic chaos. But they would be masters of their own destiny. The current EU offer will further destroy the Greek economy, and will lead to another bailout in three years time.
Bring in Paul Keating
Greece needs two things. They need a Paul Keating to run their economy. Greece does need tough economic reforms to labour markets, taxation, competition policy and competitiveness and more. Their leaders have avoided reform, but they are not the only European country to do so.
They also need Rafael Correa to manage their debt. The Ecuadoran President has continually told international creditors to “get stuffed” and piled haircut onto haircut on Ecuador’s public debt. It is time for Greece to tell the troika to do the same. Sovereigns should be sovereign, and should manage in the best interests of the citizens of their country, not in the interests of foreign banks or institutions. And lenders should be wary for precisely this reason.