Yves here. Readers will notice that the author assumes that Greece, even if it goes to the drachma, must maintain balanced budgets because it will need to borrow. In fact, one of the big point of voluntarily going to drachma would be to be able to run fiscal deficits to stimulate the economy.
The New York Times this morning also has an informative op ed on Argentina’s default in the early 2000s. Key section:
By 2001, the nation was caught in a painful crucible of recession and inflation. To Mr. Rodríguez Saá, reneging on a seemingly insurmountable foreign debt seemed a much better idea than cutting workers’ wages and benefits. It also appealed to Argentines as a rebellious cry of independence from the conditions imposed by foreign lenders.
The sense of triumph was short-lived. A week after announcing the default, Mr. Rodríguez Saá resigned. Soon, Argentina lurched into nightmarish chaos.
Economic activity was paralyzed, supermarket prices soared and pharmaceutical companies withdrew their products as the peso lost three-quarters of its value against the dollar. With private medical insurance firms virtually bankrupt and the public health system on the brink of collapse, badly needed drugs for cancer, H.I.V. and heart conditions soon became scarce. Insulin for the country’s estimated 300,000 diabetics disappeared from drugstore shelves.
With the economy in free fall, about half the country’s population was below the poverty line. The country’s middle class took to the streets by the tens of thousands with pots and pans held high, clanging them in what became the echoing beat to Argentina’s 2002 social collapse. “From now on, I sleep with my casserole beneath my bed,” said one woman, proudly proclaiming her commitment to the protest movement.
A run on the banks had already forced the resource-starved government to enact the most draconian economic measures in Argentina’s history. Savings accounts totaling $66 billion were frozen across the country.
Depositors started protesting inside banks. One man went into a bank with a stick of dynamite, demanding his savings to pay for a medical operation for his seriously ill wife. Soon, most of Argentina’s banks were boarded up with thick wooden panels, on which depositors angrily banged their pots and pans.
Well-off Argentines could get around the restrictions. In back rooms, large account holders were able to unofficially withdraw thousands of dollars at a time, or even wire their savings abroad through a growing black market.
For the rest, hundreds of barter clubs popped up around the country. Some were the size of shopping malls, set up in the abandoned hulks of closed factories. Thousands of cashless and hopeless Argentines flocked to them. One opened across the road from Alto Palermo, one of the showiest shopping malls built during the free-market ’90s.
At makeshift stalls, haircuts were traded for psychoanalysis sessions, apple cakes for clothes. By early 2002, the network of clubs was enrolling tens of thousands of glum-faced members every week. When the supply of pesos dried up because of the bank freeze, some of the biggest of the barter clubs began printing their own currency, the crédito.
Charles Wyplosz, Professor of International Economics, Graduate Institute, Geneva; Director, International Centre for Money and Banking Studies; CEPR Research Fellow. Originally published at VoxEU.
When thinking about Greece’s dilemma, two facts from Reinhart and Rogoff (2009) research are highly relevant:
- Defaults on public debts are pretty mundane events; and
- Greece is historically the world’s leading serious defaulter.
What makes the coming event interesting is that it will be the first time that a default occurs within a monetary union.
The crucial observation is that there is no automatic link between a default and monetary-union membership. As we know from previous experiments of government default within the dollar monetary union – the defaults of Orange County in California and Detroit in Michigan – a sub-central government can default and keep the currency. The unique characteristics of such events are that: 1) an exchange-rate depreciation cannot help shift expenditure to the defaulting region’s production; and 2) there is no local central bank to provide liquidity to both the government and commercial banks during the hard phase of the default.
The Greek government might be tempted to recover its own currency but the short-run costs are likely to far exceed the short-run benefits, as explained by Eichengreen (2010). An idea of what would await Greece is provided by Levy Yeyati (2011) in his description of how Argentina gave up its currency board link to the US dollar, an easier case given that the national currency was already in place. The Argentinian example should warn the Greek authorities of the political turmoil that could follow a default.
In the longer run, however, a much-depreciated drachma could lift the Greek economy and, of course, the country might appreciate monetary independence following its wrenching experience inside the Eurozone.
Basically, the trade-off is a major shock and one more year of misery versus the removal of Eurozone membership shackles forever. The balance of benefits is difficult to evaluate since it depends very much on institutional issues that are not clear now. The key questions are:
- Will Greece be able to finally establish on its own fiscal discipline and will its central bank deliver high-quality monetary policy?
- Will the Eurozone draw all the lessons from a Grexit and amend its policies and governance?
In the short run, after a first default, even a partial one, the Greek government will have to balance its books because no one will lend anything any more. ‘Balancing the books’ can mean different things, however.
- One option is to run an overall balanced budget, thus continuing to service the debt after the initial wave of defaults.
The latest European Commission forecasts for 2015 are for a surplus of 1.1% of GDP, after a deficit of 2.5% last year. This might be optimistic as tax receipts seem to have slowed down.
- Another option is to balance the primary budget, which means no servicing of the debt.
The primary budget was just about balanced in 2014. With growth returning to the Eurozone in 2015 and with the end of the fiscal contraction of recent years, this is within reach if the government refrains from many of its electoral promises.
A balanced primary budget would shield the government from external pressure but the size of defaults will grow. It is argued that various debt restructurings have lengthened the average maturity to more than 15 years and provide a ten-year grace period on capital repayment, and even interest service to the European Financial Stability Facility (Darvas 2015). Yet, debt service remains non-negligible, especially for the rest of the year, with a debt service estimated at some $20 billion (8.5% of GDP). It will decline somewhat over the next few years, but not significantly.
Somehow, a debt restructuring, long overdue, will have to follow. There is nothing new here.1 More novel is how a sovereign default can be handled within the Eurozone.
Sovereign Default Within the Eurozone?
Under normal conditions, a country whose government is in default but needs no financing, can remain within the monetary union. Current account deficits, if they exist, represent private borrowing. They are entirely financed, otherwise they would not occur. In the case of Greece, a number of things must happen for it to prosper in the longer run, but there is no immediate macroeconomic pressure that would jeopardise Eurozone membership.
Conditions are not normal, however, and a default would aggravate an already dicey situation.
Many people seem to equate default and Grexit. This is an instance of a self-fulfilling prophecy. If the Greek citizens believe that this is indeed the case, they will not want to keep their savings in Greek financial institutions. In fact, they are already moving them. Since December 2014, when the coming election outcome became obvious, according to various estimates, they have withdrawn about a fifth of their bank account balances. A default would likely trigger a full-blown run on already enfeebled Greek banks.
There is not much debate on how to deal with a bank run.
- First, short of declaring a crippling long-lasting bank holiday, bank withdrawals must be limited, which may, or may not, require controls on capital outflows.
- Second, the authorities must move to urgently stabilise the banking system.
This may involve urgent large-scale lending to solvent banks, and the takeover of insolvent banks.
In such a situation, determining bank solvency is more art than science, so value judgement is unavoidable. But who are the authorities? The defaulting government and the central bank. Either the government receives emergency funding, which is likely to be ruled out, or the central bank must foot the bill entirely on its own. That effectively means the ECB. As De Grauwe (2011) convincingly argued, the sovereign debt crisis only occurred because the euro was a foreign currency to Eurozone member countries.
- If, in the face of a bank run, the ECB does not act as lender of last resort, the Greek government will have no choice but to leave the euro under the most unfavourable of all circumstances.
Since the onset of the slow-motion bank run, the ECB has dithered. Its instrument, the Emergency Liquidity Assistance facility, leaves quite some discretion in the hands of the central bank. It has a ceiling, which it has raised repeatedly. It must list what is acceptable collateral, and the list has been repeatedly expanded. Since much of the collateral of Greek banks is soon-to-be-defaulted-upon Greek government debt, it is understandable that the ECB proceeds with caution.
- Once, following a default, a bank run is under way, in principle Greek bonds will not be acceptable to ECB; with no central bank able to act as lender of last resort, the Grexit prophecy will have become reality.
What this all means is that, if the aim is to avoid a Grexit, it is not possible to wait for a default to happen.
Avoiding Grexit Means Avoiding Default or Lining Up a Lender-Of-Last-Resort
The vicious cycle that underpins the self-fulfilling prophecy must be broken now. That means ruling out either the first or the last step of the cycle.
- The way to avoid the first step, default, is to announce an agreement in principle to reduce the public debt of the Greek government.
- The way to avoid the last step, Grexit, is to announce that resources to thwart a bank run are available.
These announcements must be unconditional – independent of an agreement on the assistance programme – because it seems that such an agreement is beyond reach.
Concluding Remarks
The problem is that European authorities are bound to find it politically impossible to give in, ditch the pre-existing agreement and abandon conditionality. Economically, they also face a conflict of interest. About 80% of the Greek debt is now owed to officials, the European authorities and the IMF. The official rhetoric is that “we have done enough for Greece”.
So far, however, the Europeans have not made any present to Greece,2 only loans, initially on harsh financial conditions, then sweetened. A default would turn the loans into presents. Making it possible for Greece to comfortably default does not seem appealing at all.
National governments are elected by their citizens so they are most unlikely to act to prevent a Grexit. One more time, we have to turn to the ECB, whose essential mandate is to uphold the Eurozone.
It may be unfair, but the ECB’s duty is to announce very soon that it will do whatever it takes to keep the Eurozone whole.
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Wyplosz’s article did cover this point (in the sections around “This may involve urgent large-scale lending to solvent banks, and the takeover of insolvent banks.” …) but I’ll expand an important point which didn’t jump out at you from the way the piece worded it (I think it was trying to not be overly complicated or labour particular points but this is really important).
EVEN NATIONALISED FAILED BANKS NEED NEW CAPITAL ! (sorry for shouting — but it is amazing how few people outside of the banking industry appreciate how and why this is the case.)
So if a) Greece is to remain in the Eurozone and b) takes the essential step* of cleaning up its insolvent banks and quasi-banks then it will need new euro denominated funding to recapitalise the “bad banks” even if it puts them in wind-up or run-off mode. If it has just defaulted, as Wyplosz implies, this must come from the ECB. It is just me that is struggling to figure out why the ECB should do that ?
I’m not skilled enough to try to figure out in a thought-experiment what would have to happen if Greece both exited the Eurozone and wanted to resolve insolvent financial institutions. I’m guessing that it would have to crystallise its euro-denominated losses then attempt to assess what the remaining debts represented in new-Drachmas and what the resultant credit quality was in the portion which wasn’t written off initially. We’re really in uncharted territory on that one.
* Okay, Greece could play extend-and-pretend with its banking system but see Japan for what happens when you fail to hose down your banking system (and Greece is in a much, much worse position than Japan ever was).
“So far, however, the Europeans have not made any present to Greece, only loans”
A very important sentiment to remember. In neoliberal homo-economicus terms, the idea of a gift is a silly one. When countries make loans with the expectation of repayment plus interest, isn’t the benefit accruing to them? I’m asking facetiously here, we all know the answer is yes, and that the purpose of loans like this is to exert dominance.
I know it seems like an alien concept, but you’d figure countries who are ostensibly allies and within a monetary union would behave like friends, and give one another gifts, rather than behave like adversaries and try to extract advantage over one another. Then again, the EU never was a real union of friends, now was it?
As one last note, one might be amused when they see that Syriza are treating the EU as though it was a union of friends and are being shut down. Kind of explains how there’s no overlap between their bargaining positions, doesn’t it?
The idea that the Eurozone is a union of “friends” is as nonsensical as the idea that Yugoslavia was a union of “friends”. The Holy Roman Empire made more sense than the Eurozone.
The idea behind a gift to Greece would be that if you avoid default/ Grexit through such a gift you keep the currency union alive, you keep the game going, and you’re allowed to continue to operate within an economic context which so far has allowed you to behave like the predator you currently are, in neoliberal homo-economicus terms.
The thing to recognize, at this point, is that the “neoliberal homo-economicus terms” do not make a recipe for humanistic survival, or for that matter survival at all. Too bad they’re universally accepted.
I know. After the Jacobin article yesterday the trajectory looks to have been something like this: Idiotic credit bubble to pay for WW1 creates 1929, no way out because factories could produce a surplus at less than half capacity; so WW2; then US hegemony wherein we deficit spent to make the world free for capitalism (aaargh); US goes seriously bankrupt in the 50s, extends its insanity thru the 60s and folds in the 70s with Nixon proclaiming that the USA isn’t afraid to compete with anybody (not even god); this coincides with the New Left becoming radicalized and the emergence of the Neoconservatives in defense of liberal values (which are?) and this is followed in the 90s by the neoliberals seeking to make the economy work for all (it’s the economy stupid) which fails everywhere and all at once for various reasons. Mostly existential lack of a reason for being; the environment and global warming, and pollution, plus an overstimulated overpopulation. Good god. Can’t we do better than this?
It’s worth remembering that the whole idea of “lending and borrowing” developed (one hesitates to say evolved) from “gift” economies wherein gifts were reciprocated, and could be counted on to be thus, by dint of the fact that people had to assume a future dependency on the surrounding “folk” i.e. society, and reciprocal gifting was thus transacted in a space of necessary and reliable “good faith” .
The raw math of who owes who what weren’t as important or tyrannical as today’s consensus assumptions about balancing ledgers and rule based stability (if one can talk of stability with a straight face)
What’s missing in other words is “comity” and sincere commitment to good faith negotiations based on mutual need to get along, without which capitalism is unworkable for all but the few (and that few is a revolving door over time).
The notion of debt jubilee and “odious debt” is lost in the rush to prove one’s math matches the moral good. Which it might, but only by accident, not by inherent virtue.
“So far, however, the Europeans have not made any present to Greece, only loans”
Has there been any acknowledgement by ECB or the Eurogroup of finance ministers that most of the loans “to Greece” were to prop up German & French banks? The Troika/ECB/IMF/Eurogroup didn’t help Greece at all–they just protected the most powerful EU countries’ own powerful vested interests, and increased Greek debt at the same time.
Why are there no press conferences with the ECB, Troika et al where they are called to account for this? Is it that mainstream journalists feel it would be career-shortening to delve into such questions, as their editors would not be pleased? Is it that events are choreographed in a way that question-asking at public events does not occur, or that only certain questions are allowed?
On spot. No one either want´s to talk about how the EU-elite behind the curtain tries to “manage” the union towards a fully fiscal federation. Completely without electorial debate. And the press have no clue at all. It is just unbelievable. Here´s the secret(schhhhss…). Europe´s households are full of debt still betting up housing and NOONE want´s anything tinkering with this unstable stability. People are literally debt-slaves today(more so then ever before)and extrem-low-rates is a must. People of the press are not really interested in longer term questions and consequences. Central banks are seen as omnipotent gods.
From a short historical perspective, especially in regard to The Eruo in general, does anyone think their entire banking system is a mess? We know The Fed was sending a liquidity lifeline for years (thanks to the late Mark Pittman), is there any reason to believe things are better now? The Euro is being run out of Brussels, by a lot of unelected Kleptocrats, it’s pretty clear (at least to me) Greece was never being served with any well intent.
Won’t the holders of that bad debt from sovereigns that are already broke to begin with matter?
I agree with this conclusion “the ECB’s duty is to announce very soon that it will do whatever it takes to keep the Eurozone whole.”
If you take the position that much of the global banking system is ‘papered over’ or insolvent then it makes no sense to single out Greek banks.
There has to be some underlying productivity based on employment. State banks seem to be a good way to provide this as they don’t have the financial overhead of large executive compensation or private stockholders. Central banks should act to back this sort of activity rather than protecting creditors.
The best way for the ECB to come out of this is with a European Investment Bank. Syriza still seems to be on track with developing a fiscal program and has a good depth of economists well versed in employment. They have a number of alternate currency options to put them on a better track.
Hudson was also interesting yesterday. In the long history of money both interest and usury were the same word until well into the middle ages. Now, of course, finance lives on interest. In the case of Greece it is nothing short of usury. But usury, the basis of our modern economy, is almost a nonexistent concept. Likewise odious debt. In pre-historical times in order to convince laborers to build big projects they had to be paid plus given lots of meat and beer. Because they could refuse to work. And debt was a tenuous confrontation because debtors could just pack up and move away. Now it has all come down to a lender of last resort.
Not all “finance” lives on interest and BIG INTEREST (usury) and fraud — http://www.theguardian.com/money/islamic-finance
Better not let that “Sharia Evil Law” sneak its Evil Nose under the skirts of the tent…
All this complicated talk about somehow placing the deck chairs on the Titanic with the assumption that if only enough complexity and chimaerical “order” can be worked into the arrangement, nobody will notice that the captain, crew and upper-deck passengers have filled the lifeboats and are pulling away from the settling ship of state. Not so far away, of course, as to not be able to row back in and strip the wedding bands and earrings and wallets ans purses off the corpses, before they get waterlogged and sink or are eaten by the sharks who are ever circling, circling…
This is a machine filled with positive-feedback loops, constantly being added to and tinkered with by “fiscalmonetary technicians” with no understanding of how or why it functions at all, and no governors built into the design to keep it from trashing itself and smashing anyone or anything anywhere in the area.
Will the Kyiv part of what’s called Ukraine get the “relief” that the Brussels kleptocrats, the “traders” who are placing leveraged bets on the collapse of the ‘bund’ market, and others claiming some neo-exalted risk-free status as “creditors” are all hot to deny to the people in Greece? Because the first eats borschch and potatoes, instead of agvolemono and spanakopita?
The Few profit from keeping the enormous fraud going — but all it’s doing, all this sturm-und-Draghi-ing and DieselSchauble-ing, this Heyward-Cameron-ing, is to make the quantum of pain when the inevitable forced recognition of the bankruptcy and terminal cancer of the whole thing finally becomes undeniable.
Well, well, at last we have to confront our demons. I´m thinking of D Bowie´s lyrics Five Years when looking back at what the Troika did to Greece(etc) when they decided to save principally bankrupted German&French banks. We have to acknowledge that the Euro-system is a political construction. Not an economic or monetary entety as it should be as follows;
1. A common currency-zon consists of one centralbank with full cb-capacity(i.e LoLR) that works with ONE sovereign debt, NOT nineteen.
2. If i.e financing-problems occurs that monetary-policy can´t solve then there must be fiscal mechanisms to rebalance(give from the rich to the poor etc). Parlamentary proceedings.
None of the above is (fully) implemented in the Euro-system. Still I can read daily about ECB lending as the last resort. That is impossible when reading the ECB-statutes and Maastricht-law. Not to speak how often this was publicly stated by the EU-elites during the Euro-launch back in the 90´s. The ECB was different and could not buy it´s members debt. Instead part of the system-integrety was based on the Maastricht-criteria(GSP). The responsibility among members to manage inflation, budgetdeficit´s and public debts. Greece did not make the entry-levels but were let in anyway. But before the GFC Greece economy were in relatively good order. Germany and France were the biggest thieves in this respect and for years.
The Euro-system was from start a broken part of a half-designed political union which the elitist knew they could make whole in an expected and forthcoming crises. At a time when the people could be black-mailed into a full federation. A classic case of politicians always running ahead of their constituency more or less in an undemocratic way.
It is very high time to help Greece. There is a big responsibility for EU to acknowledge leadership-failure. Greece in or out of the EMU should be promised financial assistance on good survival-terms. No Argentina!
A sovereign default by Greece would trigger sovereign guarantee obligations by other states; that is, a default by Greece would impose substantial costs on the creditors side of the agreement, costs that the Troika and other parties would rationally want to avoid. It would also impose horrific costs on Greece. That is why Greece forswore default going in to these negotiations. Both sides have rational incentives to reach an agreement that avoids these costs. Rational bargaining would focus on how to divide the savings of these avoided costs.
The Troika has an incentive to delay a final agreement for so long as Greece is able to continue making payments under the existing agreements, and then compromise and settle the existing agreements at the last moment, just in time to avoid default. and the avoidable costs that go with it. The Troika has this incentive because the terms of any settlement agreement must necessarily be less favorable to the Troika than the terms of the existing agreements, so the Troika will want to wring out every bit of performance that it can under the old agreements before extinguishing them. Greece will want to protract the negotiations as well, because it knows that the terms of Troika’s best-and-final offer will be hard to sell to the Greek electorate, and so it will want to delay the day of reckoning as long as it can.
A sovereign default by Greece would trigger sovereign guarantee obligations by other states; that is, a default by Greece would impose substantial costs on the creditors side of the agreement, costs that the Troika and other EU parties must rationally want to avoid.
Default would also impose horrific costs on Greece.–and problems that would spill over the borders of its EU neighbors. That is why Greece forswore default going in to these negotiations. Both sides have rational incentives to reach an agreement that avoids these costs. Rational bargaining would focus on how to divide the savings of these avoided costs.
The Troika has an incentive to delay a final agreement for so long as Greece is able to continue making payments under the existing agreements, and then compromise and settle the existing agreements at the last moment, just in time to avoid default. and the avoidable costs that go with it. The Troika has this incentive because the terms of any settlement agreement must necessarily be less favorable to the Troika than the terms of the existing agreements, so the Troika will want to wring out every bit of performance that it can under the old agreements before extinguishing them.
Greece will want to protract the negotiations as well, because it knows that the terms of Troika’s best-and-final offer will be hard to sell to the Greek electorate, and so it will want to delay the day of reckoning as long as it can. But as long as the Troika’s terms of settlement are not as disadvantageous to Greece as the consequences of default would be, Greece will accept them.
The Greeks do not want to default, and the Troika does not want to force them to. The threat of default was hollow from the start, and never was a source of leverage to the Greeks.
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