Time for common sense on Greece

The question is, would a default be enough to return the economy to health?

Albert Einstein is reported to have said that insanity consists of doing the same thing over and over again and expecting different results. By those standards, the deal with Greece that is about to be agreed looks insane. The only justification, as I argued in a column on May 10, is that it is needed to play for time. This is a bad strategy. Something more radical is required.

The question about the prospects for Greece is not whether the country will default. That is, in my view, as near to a certainty as any such thing can be. The question is whether a default would be enough to return the economy to reasonable health. I strongly doubt it. The country seems too uncompetitive for that. A default is a necessary, but not a sufficient, condition for a return to economic health.

Greek performance under the programme agreed with the International Monetary Fund in May 2010 has been quite impressive. But it has also failed to return the country to solvency. The spread between Greek and German 10-year bonds has gone from 460 basis points (4.6 percentage points) after the programme was announced to 1,460 basis points. Much the same has happened to Ireland and Portugal. More dangerously still, even Spanish spreads have reached 270 basis points (see chart). Greece, Ireland and Portugal have no chance of being able to borrow in the markets at rates they can afford in the foreseeable future.

What has to be quite depressing for those involved is that these jumps in spreads have occurred despite reasonable performance. In the original programme, Greek gross domestic product was forecast to fall by 4 per cent in 2010 followed by 2.6 per cent in 2011. In the March 2011 review, this had turned out to be only a little worse, at 4.5 per cent and 3 per cent, respectively. The general government deficit was initially forecast at 8.1 per cent of GDP for 2010 and 7.6 per cent for 2011. This had only risen to 9.6 per cent and 7.5 per cent, respectively, in the March 2011 review. Even on the current account deficit, the March review’s 10.5 per cent for 2010 and 8.2 per cent for 2011 was little worse than the initial forecasts of 8.4 per cent and 7.1 per cent, respectively.

Unfortunately, this does not begin to be enough, for four reasons. First, the debt profile has moved from horrible to still worse: in the initial programme the ratio of gross debt to GDP was forecast to peak at 149 per cent of GDP in 2012. In the March review this had already jumped to 159 per cent. Second, the economy looks extraordinarily uncompetitive. The most telling indicator is the combination of the still huge current account deficit with a deep recession (see charts). This external deficit cannot now be financed in the market. Third, prospects for the current account deficit are seen to be deteriorating sharply: initially, the IMF forecast the current account deficit at 2.8 per cent of GDP in 2014; in the March review, it forecasts this at 5.5 per cent of GDP. Fourth, without a surge in exports, it will be impossible to return to sustainable growth. But such a surge will require a big reduction in nominal costs. If this is feasible at all, which I doubt, this will raise the ratio of debt to GDP still more.

The market’s scepticism about the ability of Greece to become creditworthy is warranted. It rests on awareness of two facts: the massive indebtedness and the lack of competitiveness. The fact that the Greek people are unwilling to bear the pain merely makes the already implausible quite inconceivable. If this was the state of, say, Finland, one might just believe it. Rightly or wrongly, few believe that today’s Greece is another Finland.

What is the case for persisting with lending ever more and, in the process, taking a larger proportion of the liabilities of the Greek government on to public sector balance sheets? I see four arguments.

The first is that the strategy conceals the state of private lenders. It is far less embarrassing to state that one is helping Greece when one is in fact helping one’s own banks. If private lenders have enough time, they can sell their loans to the public sector or write them off without capital infusions from states.

The second argument is that the strategy of delay allows other countries to get their houses in order before a Greek default and perhaps a disorderly exit from the euro. Should those events occur now, it is feared, there will be runs from sovereign debt and the banks in fragile countries, with devastating results.

The third argument is that it is possible that Greece will come good. Giving the country the maximum support makes that at least feasible.

The fourth argument is that Greece is forecast to run a primary fiscal deficit (before interest payments) of 0.9 per cent of GDP this year, by the IMF. Thus, the net transfer of resources is into the Greek public sector. So long as this is the case a default makes no sense.

These arguments are persuasive roughly in ascending order. The first argument was used to justify the policies of denial that gave Latin America its “lost decade” in the 1980s. It seemed immoral then and seems equally immoral now. Losses should be recognised and banks recapitalised. The second argument assumes that the Greek position is still a mystery. It is clear, however, that flight is already under way from other fragile jurisdictions. The third argument is not ridiculous, but such a happy outcome seems implausible, given the situation in which Greece finds itself. The last argument is right. But it is one for a brief delay, not for struggling forever.

When an outcome is inevitable, it is necessary to plan for it. In this case, that outcome seems to most informed observers inevitable. I can see little merit in having Greece default to the public sector years of agony hence rather than to the private sector soon. The best policy is to act pre-emptively. One aspect of such pre-emption would consist of acting to shore up other fragile eurozone members and financial systems more strongly than now. In at least one case, Ireland, that might require debt restructuring. This will also surely require a further move toward a eurozone-wide financial system, with matching fiscal support.

Yet the principal requirement now is to recognise unpleasant reality. One cannot make the incredible credible by endless delay. One can only make the recognition of reality more painful when it finally comes. The time has surely come to recognise the reality of the Greek predicament and act at once on the wider ramifications for its partners.


More columns at www.ft.com/martinwolf

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