Saturday, November 1, 2014

The Greek Tragedy, Act II

CHICAGO – A Greek tragedy is typically composed of three acts. The first sets the scene. It is only with the second that the plot reaches its climax. For current-day Greece, the imposition of “voluntary” losses on the country’s private creditors represents just the end of the beginning. The real tragedy has still to unfold.

On the face of it, the “voluntary” arrangement with creditors might appear to have been a big success. The volume of Greece’s foreign debt has been reduced by more than €100 billion ($130 billion). Greece’s European partners have provided €130 billion in new loans. As a result, Greece has avoided generalized bank failures, and it has been able to continue paying its public employees.

But, despite these trumpeted results, the reality is much harsher. Even with the latest deal, Greece’s debt ratio remains at 120% of last year’s GDP. With a projected drop in GDP of 7% this year and a sustained deficit, the debt ratio would exceed 130% before stabilizing at 120% in 2020.

But even this reduced level is not sustainable. With its population set to contract by 0.5% annually over the next 30 years, even if per capita income in Greece were to rise at the German rate of 1.5% per year, the debt would be difficult to service. Assuming that Greece could borrow at a real interest rate of only 3% (the current level is 17%), the government would need to run an annual 2.6%-of-GDP primary budget surplus (the fiscal balance minus debt-service costs) for the next 30 years just to keep the debt burden stable.

To put that task in perspective, in the last 25 years, Greece ran an average primary deficit of 2% per year. To reduce the debt-to-GDP ratio to 70%, Greece would have to maintain an average primary surplus of 4% for the next 30 years, a level that it has temporarily achieved in only four of the last 25 years. 

If the situation is so dramatic, why are the European Union and the International Monetary Fund celebrating the recent agreement? Simply put, these institutions’ primary objective was to minimize the repercussions that a Greek default would have on the international financial system. Greece, frankly, was not their priority.

Given the reaction in financial markets, they have succeeded. The delay in reaching an agreement enabled most private creditors to escape the consequences of their reckless lending to Greece. Roughly half of Greece’s external debt migrated from the private sector to official institutions.

But the group of lenders that the EU and the IMF wanted to help the most – the banks – only partly reduced their exposure. Between May 2010 and September 2011, the value of Greek sovereign debt held by French banks dropped by €4.6 billion (39%), while German banks reduced their holdings by €2.9 billion (31%) and Italian banks by €530 million (30%). In part, this drop reflects the reduction in market value of the existing liabilities. Thus, on average, banks have sold very little.

But, while private-sector losses have been minimized, at what price? Had Greece defaulted on its debt in 2010, imposing the same “haircut” on private creditors as it has imposed now, it would have reduced the debt-to-GDP ratio to a more manageable 80%. That would have been painful, but it could have spared the Greeks from a 7% decline in GDP and a rise in unemployment to 22% (including an increase in youth unemployment to a whopping 48%).

More importantly, a default in 2010 would have left some room for adjustments. Under the current plan, there is none: if the economy does not turn around quickly, Greece will need more help. But where can it go now to find it? Most of the sovereign debt is now held by the official sector, which traditionally does not allow any haircut. The remainder has been reissued under English, not Greek, law, putting it outside of the control of the Greek government and its new collective-action clause, which facilities partial defaults.

In other words, Greece has exhausted its ability to share part of the burden with the private sector. Next time, Europe’s taxpayers will be on the hook.

The second act of the Greek tragedy will cast desperate Greeks against angry and disenchanted Europeans elsewhere. Only at the climax will we know whether the effort to delay the inevitable contributed to undermining the idea of Europe for the current generation. 

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  1. CommentedSarchis Dolmanian

    Untill reading this I still nurtured the hope that someday somebody will open 'their' eyes about what is needed to be done.
    Now I realize that the necessary information was available for some time.
    Where do we find some political acumen?
    How much time do we have to spend really deep inside the 'danger zone'?

  2. CommentedJonathan Lam

    Gamesmith94134: Two model for Europe 12-29-2011

    I think what Mr. Hans-Werner Sinn meant was the outflow were the collateral damage attributed by the Rogue Trader who bidden on the 1.6 instead of 1.3 to a dollar; the hedge fund managers like FM and Goldman Sacks and the fall of Dexia bank and others. Furthermore, the outflow to the Dow Jones was not accidental either at the slow down on the American economy, the stock boomed for sake of the monopoly or ‘get me out of Eurobonds’ made it obvious is upon everyone else guesses, or its disposition is part of the deleverage that Euro is pegged to dollar to promote another delusion of growth scenario. The recent sale on the Italian and Spanish bond held at 7%; and inflation rate edged higher from 2% to 3.4% in America; so, I suspect the Europe is not any lower on the account of the deleverage, rather than the shortage of resources and the questionable status in the Strait of Hermuz. Besides, the next four months in rolling over of the $900 billion Euro bonds may not be sold again at 7%, even with the direct periphery of the loans from Fed, even at the 500 basis points to exchange or 0.25% loan available to the local banks.

    “MUNICH – Interest rates for public debt within the eurozone have spread once again, just as they did before the introduction of the euro. Balance-of-payment disparities are steadily increasing. The sovereign-debt crisis is eating its way from the periphery to the core, and the exodus of capital is accelerating.”

    So, the question is clear for the safety net could be for the $650 net foreign wealth, if the interest rate is being sacrificed to sustain the unity of the Eurobonds? Or, how much is American banker is willing to abstain to bankruptcy if the present 8-15% for the Euros will escalate in the coming three-year-term of the Eurobonds and the exchange rate must sustain at a profitable level after being deleverage?

    Far as the data indicated the unemployment and housing are merely improved the sentiment to the holiday seasons, or Fed is playing with the exchange rate again. And, the yuan went 4% over the year and inflation rate held at 6.5%, China must made its domestic growth program to ease the tension on the manufacturing slowdown. I am not sure how the debtor nations can use its austerity program to sustain the level of certainty for repayment on the next coming restructuring of the debts.

    Shuffling of the 2.7 trillion with lesser growth is hard to do, even if, the investors and banker would turn into rogue trader to hold the line on the exchange rate. However, the inflation rate would certainly change one’s mind quickly if the change of status quo to commodities goods or outbreak of war in Middle East is eminent.

    Perhaps, it is time to choose how the next round for the global finance and the sovereignty debts if Euro stands even it is contagious. There is no escape for most financials if Euro collapses; but EU must sustain a firewall like to create its EU zone policy as well to stop further spread of inequity and insecurity if the Bael II is not working with its banks, or breakup of the north and south under the pressure of the fiscal unity. Then we may consider the financials are separated by the disgusted investors as each develops their doors in shutting of trades by its partners by continents other than EU; if the exchange rate or interest rate becomes irrelevant. So, sovereignty debts must be traded under the scrutiny of sovereignties not bankers since they, the citizens of sovereignty, must repay them. And, capital financing should not be the part of the sovereignty debt that shared with the lower rate; it demands its proof of performance and consequence and not just politicians for promoting propagandas like ClubMed or Green industries, that they plays double jeopardy on WTO.

    Personally, I refer the multi-speed, multi-currencies approaches in various zones that each enjoy their own responsibility for building up their equities; and shared retirement with their assets they earned by leaving the exchange rate and interest rate to the achievement and performance of the states, and not to bankers even for Central banks. Finally, there is no right choice of the model as available, but each must accept the alternatives in changing the model we definitely needed to meet globalization of the finance.

    May the Buddha bless you?

  3. CommentedRik Rijs

    Very interesting. And alarming. Only strange to read how a professor makes a 30-year forecast about the population evolution in Greece. There he's on a par with African wizzards. To blame the banks for not selling their Greek paper is .... there simply was nobody in the market willing to buy that rubbish! The author forgets one possible solution to the Greek tragedy: the Greek orthodox church owns land and real estate worth some 700 billion euros and still remains a tax exempt entity. Its influence is incredible (the Greek constitution defines the country as orthodox rather than as a democracy). There's enough money. The problem is Greece's medieval taboo on taxing the church.