Europe's Hard Choice

Greece, Euro, IMF, ECB, European Union

ECB, Greece, Euro, European Union, IMFIn Monday's Financial Times, columnist Gideon Rachman presented a grim outlook for Greece and the European Union.  He argues there are no good outcomes.  There are three options.  First, the EU can make concessions to Greece.  Second, the EU can stand firm and allow Greece to leave the Euro.  Third, the Greek government can accept the EU's terms.

The first option represents a near-term victory for the Greek government.  It also creates moral hazard within the broader EU.  Governments in other countries implementing austerity measures would come under pressure.  Populist parties would make further electoral gains across Europe. Consensus rule within the EU would become impossible.

It is feared the second route would put pressure on other countries, e.g., Spain and Italy, viewed as being vulnerable to the economic woes besetting the Greeks.  That is an argument for “contagion.”

The third outcome may offer no long-term solution.  Even were the Greek government largely to accept what the EU, the ECB and the IMF want to impose on it, that would likely not solve the Greek problem in the long run.  Greece’s debt level would still likely be unsustainable.  It is not clear that any government can implement the far-reaching economic reforms needed to put the Greek economy on a sustainable growth trajectory.

Rachman’s analysis is cogent, if bleak.

The IMF, and its partners in the troika, first proposed its standard nostrum for a highly indebted sovereign: incur more debt.  Existing debt may be restructured, and payment terms extended, but always new loans are made.  The cure for drinking is more drinking, the cure for over-eating is more food, and the cure for excessive debt is more debt.  It all makes sense in the Alice-in-Wonderland world of the IMF.

True, later some debt-relief was offered to Greece when the utter unsustainability of its existing debt could not be overlooked.  But the relief was too little, too late.  More recently, in a rare moment of humility for the organization, the IMF appears to have accepted that still more debt relief is needed.

Unsustainable debt cannot be repaid.

The unstated reason for policy intransigence in the face of reality is that much of the Greek sovereign debt was owed to important financial institutions, including major banks.  Other global banks were also exposed because of interbank lending.  The rational thing for individual governments to have done was to bail out their own banks and write down the Greek debt.  That was politically unpalatable, however, because it would have involved acknowledging the shaky finances of European banks.  Politicians would have had to acknowledge the bad practices of its banks.  That would have been messy and unpleasant.  Far better to offload the problem on the Greeks.

I will close by offering one possible optimistic scenario.  Contrary to received wisdom, Greece may be better off out of the Euro.  Left to their own devices, including the need to finance sovereign debt, the Greek people and their political leaders might be forced to make the needed economic reforms and to implement fiscal discipline.  The good outcome is not guaranteed, but Grexit from the Euro may be the only feasible way of achieving it.

Alas, it is more likely that the EU and Greek government will muddle through until the next crisis. Perhaps, the next crisis will break out first in another EU country.  Take your pick.