Letter To A Greek Journalist

The Year Ahead 2018

The world’s leading thinkers and policymakers examine what’s come apart in the past year, and anticipate what will define the year ahead.

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The Greek banking system is and must be a ward and contingent liability of the state. At this point in the tragedy, the banks should be nationalized and probably merged. There is no real point in multiple banks if they are all going to be state-owned for the next decade. The more banks there are, the more potential bailouts and self-dealing by management.

The financial system and the sovereign are one, whether people like it or not. The idea of somehow separating the banks from the state and having them default in their own private ways is spectacularly ill-advised. Depositor protection must come before government bondholders and the troika. Deposits are sacred liabilities of the nation; they are not "investments", and depositors are not "investors".

Greece cannot repeat the Cyprus mistake of defaulting on or confiscating bank deposits. All other liabilities (including pensions and Target2 balances) must be subordinated to bank depositors. This is because bank deposits are the money supply, and without money an economy can't operate. MxV = PxT. As M declines, so will both P and T.

It is very disturbing to contemplate what appears to be the troika's plan for Greece. With Europe's new philosophy of self-financing bailouts, it would appear that the plan is for Greece to starve itself, the way that Romania did in the 1980s, and Cyprus will going forward. Starvation is not a viable economic program.

The government should do what it can to hold things together while it prepares for the inevitable redenomination. There is nothing more important to the future of the Greek people than using this time to secretly build up international reserves in foreign currencies that are beyond the reach of the ECB.

In the end, Greece will have to default on everything denominated in euros, and she will be cut off from credit from the ECB and the IMF. She will be, at least for a while, a pariah state like Argentina. That is when FX reserves will be absolutely crucial to pay for vital imports.

There is considerable discussion in the financial media at present concerning the looming necessity of a Greek exit, weighing the costs and the benefits. I don't wish to make light of the costs. But in the end, it has to happen, so the costs will have to be borne. And those costs will ultimately be ameliorated by effective debt repudiation.

Some of the Club Med countries will have to leave not only the eurozone but the EU itself. That is, unless the words "European solidarity" can be construed to include compassion for the destitute, which I doubt. The North won't like it when the South defaults on its bonds and Target2 liabilities. Before this is over, Southern Europe will become a humanitarian problem for the world. I do not envy the nasty choices that will be facing the Greek, Cypriot and Portuguese governments.

All countries have survived macro shocks; Germany lost two awful wars, and is prosperous today. The world went off the gold standard in the early thirties, with great commotion, and things got better. But no country has submitted itself to perpetual depression, and that is what staying in the eurozone means for Greece. The peripherals will ultimately have to go off the euro, and things will get better. It will take about five years. Staying in will only prolong the pain of exit. Even the Bank of England went off gold, which is like the Vatican going off the papacy.

I don't see any reason to put off what will have to happen eventually. The peripherals will exit according to their own schedules, which will be driven by bond spreads and bank solvency. As long as the troika persist in their deflation policies, there is no hope for growth for Southern Europe.

Why have a prolonged depression prior to D-Day, if D-Day is inevitable? Right now the most important question is whether there is any hope of negotiating an orderly exit with the troika, including transitional financial assistance. That would be helpful, except that the troika is unlikely to agree to a deal that involves massive debt forgiveness and a write-off of Target2 balances.

This is why I recommend that the Bank of Greece stockpile foreign exchange in advance of a unilateral exit. Given the risk that the troika initially blacklists Greece, she will need FX to pay for vital imports until her exports revive. An important point is that the shock of exit would be cushioned by default and/or redenomination of all external debt. Greece can start over with a clean balance sheet (but with no access to external finance). For a period of time, Greece would have to live with a balanced current account.

Any plan to redenominate will require exchange controls in advance to preclude capital flight. If the government chooses to pursue exit, it should retain the services of a world-class adviser such as Stanley Fischer, formerly of the Bank of Israel, or Joseph Yam, formerly of the HKMA.

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  6. The Year Ahead 2018

    The world’s leading thinkers and policymakers examine what’s come apart in the past year, and anticipate what will define the year ahead.

    Order now