Why Greece Should Default
Government debt as a percentage of GDP
|3||Saint Kitts and Nevis||185.00|
|7||Antigua and Barbuda||130.00|
|67||Bosnia and Herzegovina||44.00|
|68||United Arab Emirates||43.90|
|96||Trinidad and Tobago||31.70|
|108||Papua New Guinea||22.30|
|131||Wallis and Futuna||5.60|
CIA World Factbook
(updated to 2011)
More than a year ago, I wrote about the economic problems facing Europe and the rest of the world. It's time for an update -- but this time concentrating on Greece. The numbers in the column on the right are from 2011 rather than the previous 2009.
Tomorrow (February 6, 1012) is the deadline for Greece to agree to terms with the European Union on a debt restructuring plan. They may nor may not come to an agreement with the EU tomorrow, but whether they do or not, they will be facing several more debt negotiations before they are done.
Most of the EU members are in the same kind of boat Greece is in, but they aren't taking on as much water -- yet. The heart of the problem for the debtor nations of the EU is the euro. In the old days, when Greece got too far into debt, they could inflate the drachma (their prior currency), let the drachma go way down versus the rest of the world and pay off the debt with much cheaper drachmas. The fact that the world charged Greece extremely high interest rates to subject themselves to this shell game tended to keep Greece from borrowing more than they needed.
When the euro came along, Greece was able to get cheap loans as did the other weaker members of the EU. Greece lowered the retirement age, made awful agreements with the public employee unions and paid for it with cheap euros. They never considered that they couldn't devalue the euro to pay off their excesses.
The current rescue plan allows Greece to cut their debt in half. The banks would write-down the portion forgiven. In return, Greece must drastically cut social programs, reduce benefits to retirees and public employees and cut the size of the government. The rescue plan isn't as generous as it sounds, either, because the majority of the bonds are held by Greek banks and retirement plans. Most of the pain will be domestic, not European.
If Greece agrees to the restructuring plan, here's what will happen: (1) Unemployment will go way up as a result of the budget cuts and government layoffs. (2) Unemployment obligations will cause Greece to need even more money than is currently budgeted, causing them to fail to meet the debt benchmarks and forcing another round of renegotiations. (3) Because they cannot devalue their currency and the EU agreement prohibits them from invoking duties on imports from other EU nations, Germany and the rest of the EU will continue to flood Greece with cheap imports that Greece's shattered economy will not be able to compete with. This will cause even more layoffs and yet more rounds of renegotiations into budget concessions.
This cycle of belt-tightening causing weaker economy, causing more expenditures, requiring more belt-tightening will continue for quite a while. As I discussed in my previous article, Japan's economy peaked in 1990 and 20 years later their stock market was a quarter of what it had been and their outlook wasn't rosy. This was for a nation that still had a good economic reputation, had not defaulted, had control of their currency and could impose import tariffs on everyone. Certainly the earthquake/tsunami has worsened Japan's position, but they are still miles ahead of Greece, even thogh their debt in comparison to the size of their economy is considerably worse.
If Greece stays in the EU none of us will be alive when they crawl out of the abyss.
If Greece were to leave the EU they could repudiate all euro debts, not just a portion; revert to the drachma, or whatever they chose to call it; pump inflatable drachmas into their own banking system, without having to give the Europeans anything; erect barriers to imports, giving Greek industry breathing room; and begin to restructure their social agreements with retireed and unions at a much slower pace.
Amazingly, they probably wouldn't have any trouble getting loans. They'd owe nothing. Just like consumers who go through bankrupcy have better credit than they did when they were debt-strapped, Greece would be free to start over with a clean slate.
This path is not without cost, however. It would be humiliating. Domestic inflation would be awful as the supply of cheap imports dwindled. Traveling outside Greece would be hideously expensive because of the cheap drachma. They would still have to negotiate with their retirees and unions -- and the elected leaders could no longer blame outsiders for the austerity.
But despite the costs, Greece will have an easier time leaving the EU now rather than later. The current rounds of demands will not resolve Greece's problems. It only buys them time. The structural issues (fixed value of the euro, inability to impose tariffs on imports and domestic social contracts) will cause them to need to negotiate again and again as they reach the bottom of each cycle. This could easily go on for 50 years, assuming the rest of the EU lasts that long.
The EU is essentially a rigged game. It gives those member nations who produce goods cheaply easy access to the markets in the economies where the competition simply cannot compete. Most modern industries require massive amounts of capital to become efficient. This makes it virtually impossible for an industry to bootstrap itself into a competitive position. This is why, for example, almost all the automobile manufacturers in the EU have consolidated into just a handful in Germany, France and Italy, with a few, like Volvo being purchased by Asian interests mainly to acquire technology so they can enter the game.