Greek Default


Greece needs to default. The markets know it, most Greeks seem to know it. The EU of course knows it, but being dominated by French and German politicians do not want to see Greek default threaten French and German banks (ditto the ECB). But Greek politicians are responsible to their citizens, not the EU or ECB. …my piece from today’s Age on this follows …

On June 13 the ratings agency Standard and Poors downgraded Greek debt to CCC, meaning according to the ratings agency that Greece is “currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments.” Countries rated less vulnerable than Greece include Ecuador and Pakistan, both rated B-.

What does it mean to be rated less likely to pay than Ecuador? Well Ecuador has been in default on its foreign loans for 110 out of the last 185 years! Ecuador has been in arrears on its debts every year since 1987. In 1995 Ecuador was a part of the Brady Plan, when some emerging markets debts were marked down by 35%. Ecuador got a special deal and was allowed to write down its principal by 45%. However by 1999 a weakening economy forced Ecuador to default on its already written down loans. Bondholders were offered a further 40% haircut, with interest rate holidays for several years. [DDET Read more]

Despite these write-downs the government of Rafael Correa decided in 2008 to default on public external debts, claiming that debt was immoral. This was despite the fact that externally owed public debt was less than 20 percent of GDP, and interest payments were only 4 percent of government revenues.

At the same time as Ecuador defaulted on its sovereign debt it also introduced a new tax – at 99% of what we might call super profits in Australia. International oil and gas companies were to be reimbursed for their expenses, but the initial offer made was to tax profits at 99%. Alternatively these companies could sell to the national Ecuadoran oil and gas company, with the price paid related to exploration and other expenses to that time.

Eventually the government of Ecuador agreed to drop the super tax rate to 70%, but some oil and gas companies sensibly chose to exit. For those that stayed, there are very few avenues for international appeal against injustices. There are some international courts that hear cases against sovereigns, but governments can choose to simply snub their nose at courts such as the World Bank’s International Centre for Settlement of Investment Disputes.

The latest antic from Ecuador has been to demand US$100 million per year to not exploit the Yasuni biosphere reserve in the Amazon.  Surprisingly, Chile, Spain, Belgium and Italy have contributed US$37 million so far this year.

So what does all of this mean for Greece? Firstly, it should default! The ratings agencies are telling us what all economists already know. No matter how much of an austerity package Greece is able to implement, the burden of existing public debt is simply too great. It is far better to default now than to continue the pain of delayed restructuring.

Among the reasons that Greece has not defaulted so far is the fact that other European banks hold some Greek debt. Some banks have even issued insurance on Greek debt, called credit default swaps. Apparently we learnt during the financial crisis that banks are too big to fail, and now we have the argument that banks are too stupid to fail.

We don’t know who issued insurance on Greek debt, and nor should we care. If a Greek default leads to failures among banks responsible for issuing insurance on Greek debt then hooray. Why should Greek citizens continue to suffer at the hands of foolish European banks? Of course the EU and the European Central bank don’t see it this way, since many of those foolish banks are in France and Germany.

And what would happen if Greece defaults and that leads to further defaults in Europe? Well hooray again. It is not for the citizens of Ireland, Greece and Spain to bail out bankers in other parts of Europe. These governments are responsible to their citizens, and the best course of action is to negotiate a significant write-down of debts so as to put the public finances on a sound footing and allow these economies to recover.

What would I do if I were the Prime Minister of Greece? Default. Now. And while I’m at it take a leaf out of the Ecuadoran government’s book. Threaten to blow up the Acropolis unless the international community hands over US$100 million pronto![/DDET]

6 Responses to "Greek Default"
  1. The only other option I can see is deliberate unanticipated inflation of the euro, that inter alia amounts to a gradual writedown of all debt.  Not an option the Bundesbank  ECB would countenance, though I think it is actually the least painful one all around.

    Of course threatening to deliberately go broke and take their creditors with them is a traditional strategy of the indebted, and popular in many more circles than Ecuadoran government ones.  As KB notes, formal default requires them out of the Euro and that would not be pleasant at all – who would use their new drachma for anything other than toilet paper?  But the threat of it should be a good bargaining chip for a more gradual writedown.

  2. My view is that the problem lies in the very fundamentals of Eurozone. The centralization of the monetary policies yet allowing individual fiscal policies could not have done any good to begin with. It is just too difficult to develop sound fiscal discipline and yet honoring the sovereignty of the nations which are the part of the EU.

    The whole situation reminds me of California budget crisis of 2010, but the advantage CA has is that it is a state within a country and therefore, people are free to relocate to other states with better opportunities. wait.. thats true with EU as well.. OK, so EU is just like a giant supernation but still wants to retain some level of sovereignty of its member nations??

    So really, the moral of the story is that this is not Greece’s debt.. it is an EU debt. I have a feeling that Greece realizes that and would hope that EU Central banks are going to figure out this mess..

  3. It is not long ago that rating agencies such as Standard & Poors proved themselves as being worse than useless in assessing credit risk of CDOs.  The standard is poor, so to speak. Lets see what happens by 2 August 2011 in the USA.

  4. Ashish you’re right. That is why Europe had the Maastricht Treaty, which was supposed to ensure that countries did not have deficits greater than 3% of GDP or public debt > 60% of GDP. But once France and Germany violated those rules so did everyone else. The problem with the EU is that it is great at rhetoric, but hopeless at follow through. Read about the Lisbon Agenda at the EU website. Excellent principles re making the EU more competitive but zero follow through. The Euro is a great idea, but European governments are hopelessly weak.
    I’m not sure why default requires them out of the Euro. When the Euro was created national currencies were extinguished as legal tender. Debts are written in Euros. You are right, I don’t think Greece can ever cope with the Euro, but it seems likely that they’ll be pretty hopeless inside or outside the Euro.

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