Home >> Europe >> The Balkans

     Email   Print 

Greece Should Restructure Debt and Abandon the Euro: German Engineering and Greece’s Debt Crisis

Prof. Peter Morici - 5/26/2011

Greece is in crisis again. Athens should restructure its debt and abandon the euro to reassert control over its finances and economy.

Just one year after wealthier EU governments and International Monetary Fund extended €110 billion in emergency financing, Greece is unable to meet the aid plan’s deficit reduction targets and grow fast enough to make its debt payments more manageable.

The European Central Bank and IMF insist that Athens can meet these targets, but raising taxes or cutting spending further would only slow growth even more, and likely cast Greece into a deep recession from which it could not recover.

Now, Greece is slipping from a liquidity crisis into downright insolvency. Bond investors are demanding yields 20 percentage points higher on Greek debt than on comparable German debt. Rolling over existing bonds, as those come due, will be prohibitively expensive, and the collapse of Athens’ finances seems inevitable.

Unless Greece gets significant concessions and loans at preferential rates from the EU and IMF, it will be impelled to ask private creditors to accept bonds with longer maturities and paying lower interest rates than the bonds they currently hold. As the market value of those securities would be much lower than the face value of Greece’s current outstanding debt, such a restructuring would constitute a “soft default.”

Exacerbating the crisis, the ECB has threatened to cut off support for Greece’s private banks if Athens restructures its debt. The ECB reasons that the banks’ holdings of Greek debt would make them a bad risk, but it does not extend such thinking to German and other European banks holding Greek government paper.

The European Central Bank and IMF remain firm that no such restructuring is necessary, but cutting government spending or raising taxes enough to pay higher interest rates as debt rolls over would be self defeating. The recession that would result would reduce debt servicing capacity, not improve it, and endanger political stability as social services were slashed and unemployment skyrocketed in tandem.

The alpha and the omega of Greece’s debt crisis—and those that could follow in Portugal, Ireland and other distressed states—are the anomalies in EU institutions that make difficult financing pensions and other social benefits in Greece and other poorer EU economies.

The 1992 Maastricht Treaty significantly harmonized product and safety standards and methods of taxation across the continent and was supposed to remove untold barriers to growth. It didn’t, because European strict labor laws and business regulations discourage individual initiative and investment, and the EU’s much advertised single market raised expectations among voters in poorer countries that pension and social benefits would be on a par with Germany and other rich states.

The single currency, the euro, introduced in 1999, was heralded the next great elixir but it too failed to rev up growth, because it addressed a problem that didn’t exist and created a new major barrier to the effective management of macroeconomic policy.

Prior to the euro, the European Currency Unit linked at fixed rates the national currencies of many of today’s euro zone countries. The ECU was accepted as payment in international commercial transactions—the primary void the euro was supposed to fill.

However, each country could print its domestic currency and occasionally devalue against the group as its circumstances might require. With the euro that flexibility was taken away from poorer countries like Portugal, Spain, Greece, and Ireland.

Germany, like New York, greatly prospers by participating in a huge single continental market, but Brussels cannot tax Germany to subsidize Greece’s welfare state in the same way Washington taxes New York to subsidize Mississippi’s Medicaid.

With all that wealth to itself, Germany provides generous pensions, gold plated employment security and jobless benefits, short work weeks, and the like. Meanwhile governments in Greece and other poorer EU states struggle to keep up, pile up lots of debt and can’t scale back too much without risking political upheaval, because their populations won’t accept they cannot enjoy the same perks as the Germans.

If Greece still had its own currency, it would still have had to cut spending and increase taxes—but not by nearly as much as the EU aid pact requires—because Greece could also devalue its currency against those of richer EU economies to make exports more competitive, accelerate growth, and increase debt servicing capacity.

Now things have gone too far. Greece’s debts are too large and are denominated in euro, not the Greek drachma.

The only real solutions are for Greece to restructure its debt—both sovereign and private creditors should take haircuts; abandon the euro and reinstate the drachma; and rethink its welfare state. Like Americans, the Greeks will have to work longer to retire and accept other less generous social benefits, but they could reassert control over their economy.

The alternatives are endless EU bailouts—something the German and French voters are doubtful to allow—loss of Greek sovereignty, and economic collapse.

German Engineering and Greece’s Debt Crisis


In all their piety, the barons of Europe—German politicians and the European Central Bank—are pressuring Greece to sell off assets, raise taxes and curb spending to resolve its debt crisis. After all irresponsible southern EU states are in need of rehabilitation and some lessons in Teutonic thrift.

Sadly, selling assets won’t lower Greece’s debt enough to make it manageable. Further, cutting spending and increasing taxes further will thrust Greece into a deep and prolonged recession and severe deflation. That might raise Greek exports enough to service its euro denominated debt but not without turning much of Greece into a Great Depression era Appalachia.

And, Greece’s problems are hardly all its own doing. The 1992 Maastricht Treaty widened and deepened the EU’s single market, and raised expectations in poorer EU states for retirement, health care and other social benefits on a par with rich states like Germany and France. However, the treaty did not provide Brussels with the taxing powers Washington enjoys to equalize Social Security, Medicare and Medicaid, and other benefits across the 50 states.

With Maastricht, German manufactures and technology became more valuable in a single integrated European market. However, Greece, Portugal and others were not able to use their lower labor costs to capture assembly plants to the degree that the post-World War II American South captured northern textiles and furniture factories, and now attracts automobiles and high-end electronics manufacturing. Germany and other rich states enjoy subtle forms of protection that discourage sufficient outsourcing even to other EU member states, and this frustrates the EU single market promise to more effectively equalize prosperity among the prosperous core and southern Europe.

Germany grew richer, while Portugal, Greece and others fell behind northern Europe. In such circumstances, the currencies of poorer states would be expected to fall in value, lifting exports and providing a new elixir for Mediterranean growth, but the advent of the euro in 1998 put the kibosh on that most vital tool of macroeconomic policy.

Prosperous Germany, unburdened by an obligation to share significant enough tax revenues with poorer EU states, used the wealth it obtained exploiting a single market to provide generous pensions, gold plated employment security and jobless benefits, and the shortest workweek on the planet. Meanwhile, governments in Greece and other poorer EU states struggled to keep up, piled up lots of debt and couldn’t scale back spending too much without risking political upheaval. Their voters don’t understand why the much touted single EU market imposes equal responsibilities without ensuring more equal benefits.

If Greece still had its own currency, it would still have had to cut spending and increase taxes—but not by nearly as much as richer EU states and the ECB now demand—because Greece could also devalue its currency against those of richer EU economies to make exports more competitive, accelerate growth, and increase debt servicing capacity.

But like an American homeowner with a mortgage too large relative to his income, Greece is too far in debt for any kind of refinancing that does not cut principal owed to succeed.

Selling off Greece’s prized assets, like the Piraeus Port Authority or the Thessaloniki Water and Sewage Company, will only finance interest payments for a period without addressing Greece’s fundamental insolvency problem.

In the end, the only viable option is to restructure its debt—ask bondholders to accept long maturity and lower interest rates, or a more explicit write down of amounts owed. The ECB has threatened to abandon Greece’s private banks if Athens restructures.

That would force Greece’s banks into failure and surely thrust Greece into a depression. And it begs the question: if the ECB won’t support the only reasonable solution for Greece, why should Greece remain in the euro?

Thanks to German and ECB intransigence on restructuring, Greece has no choice but to require sovereign and private creditors to take haircuts; abandon the euro and reinstate the drachma; and rethink its welfare state.

Like Americans, the Greeks will have to work longer to retire, accept other less generous social benefits, and accept that the European dream of a single market is a very pleasant reality for the Germany and other rich states but a nightmare of constant austerity, or worse, for the poor Mediterranean nations.

In the bargain, Greece can let its currency adjust to a value that fairly values its exports and regain control economy. The alternative is endless EU bailouts—something the German, Dutch and French voters are doubtful to allow—loss of Greek sovereignty, and economic collapse.