debt crisis

I haven’t written about the Greek debt crisis largely because my focus here is the US economy, but it bears at least a mention. Especially in view of the violence of the opposition to the austerity programs the Greek government is having to implement in order to qualify for foreign aid.

This is quite simple.

The Greek economy has never matured to ‘modern’ status. It is still, in many ways, an emerging economy. This assertion is based upon my reading of the great Reinhart/Rogoff book on financial history. They make the point, based upon their unrivaled database, that it often takes a full 75 years for a national economy to make the complete transition from emerging to modern status. The last Greek default was back in the 1960’s, and the transition to democratic government was only in the 1970’s, so in many respects the population is still learning how to trust its elected officials. And those officials are still learning how to make tough choices.

Which is what is now needed.

Some of you have asked why the Greeks simply don’t default.

Well … I think they will. The most likely outcome of this crisis is some form of ‘re-negotiated’ debt. That is default by another name. The Greeks will try to impose a debt reduction on its debt holders. This means that Greek access to future debt will be limited and very high cost, or non-existent.

Think that through for a moment.

If the Greeks default they will get rid of the debt burden they currently have, but they will also eliminate or curtail their ability to raise new debt. This means that they will have to absorb the deficits on their national budget internally. They won’t be able to borrow to pay for them. This merely gets them back to where they started.

Defaulting in order to avoid austerity doesn’t work. All it does is to eliminate the external funding of the debt. By implication, it also forces all the focus back on the budget problems. Without resort to debt, the budget will have to be balanced internally. This means the introduction of austerity measures.

So, one way or another, the Greeks have to face the music.

Of course there is another route they could take.

They could leave the Euro zone, re-adopt their old currency – the Drachma – and allow it to collapse. They could also introduce their own internal monetary policy because they would be free of the Euro zone central bank. This would enable them to allow inflation to rise above the Euro limits. Both these measures would impose a default on the external creditors because it would debase the debt. In effect, Greece could admit that it is an emerging economy, and use the traditional tools those economies have traditionally used in order to wriggle free of their external obligations.

The problem with this ‘plan B’ is that it also allows the Greeks to avoid reality: they can pretend that their economy is just fine with a ludicrous retirement age, rampant tax cheating, and a bloated bureaucracy.

If they go with Plan B, look for repeated crises.

If they go with the austerity program, look for a lot of miserable Greek faces, and lots of moaning and wailing. The recovery will take the best part of a decade, but at least the Greek economy now has a chance to clean out the culture that led to the crisis.

Beware: Mad Greeks everywhere.

Addendum:

The Dow traded down over 300 points today. The most often quoted reason? The Greek turmoil. I don’t buy it. The Greek’s adopted the austerity package. So for these fears to have traction we have to assume that the Greeks will not come through, even after they have signed up for the medicine. Plus we have to assume that the interest rate tremors that the Euro zone crisis is churning up will flow through and hammer the US Treasury bond market. That, in turn, will drive up rates here and kill the recovery.

Or we can posit an alternative reason for the Dow’s ignominious collapse: it had run up way too far anyway. The levels the Dow had reached priced in quite a surge in corporate profits over the near term. The chances of realizing those profits were slim to none. The run up was more an overshooting reaction from the low levels reached during the recession than one grounded in fiscal reality.

So it was bound to fall at some point. Reality had to set in.

Blaming the Greeks for the Dow’s stupidity is going a bit far. They may have screwed up their economy, but they didn’t screw up the Dow. That was self-inflicted.