Greece Sovereign Crisis Resolved?

Martin Wolf's essay in today's FT (http://www.ft.com/cms/s/0/de21becc-57af-11df-855b-00144feab49a.html) is excellent. This discusses the cost benefits of the agreed $143bn multilateral loan to the Greek Government, much of which is really required to help secure the balance sheet solvency of Greek banks.
The data provided is also interesting. Note the table showing the difference between gross and net national debt, showing what is typically the case that one fifth to one third of national debts are internal to governments and should not really be considered when assessing national debts. In the UK's case, for example, when gross National Debt has reached 80% ratio to GDP, its net debt is only half this, and one wonders if that also includes another quarter of the debt currently owned by the Bank of England as a result of quantitative easing - probably so.A GREEK TRAGEDY
The definition of Greek Tragedy is a form of art based on human suffering that paradoxically offers its audiences pleasure. There is a large audience for the sovereign debt crisis of Greece that is taking perverse pleasure in holier than thou statements as if Greece may be classed in the same basket of felon's heads as Lehman Brothers! Righteous commentators blame Greece for being irresponsibly spendthrift and to link the state of public finances of UK to Greece etc. They are both right and wrong, but more wrong than right. Greece alongside Ireland were praised during its years of high economic growth for contributing positively to EU and Euro Area growth, punching much above their weight etc. Greece, under the assumed protection of the single currency and EU membership was merely operating a credit-led growth policy based on banks growing their mortgage business fast and lending to property developers, similar to the USA, UK, Ireland and Spain. Greece did so perhaps too enthusiastically and ran the highest trade deficit in the OECD financed by selling securitised loans to foreign investors and borrowing from foreign banks plus diaspora and tourist receipts.
Greek banks also invested massively on growing bank networks in nearby emerging countries to the benefit of developing those countries. The Central Bank of Greece tried to order the Greek banks to cut back on property exposure and lend more to productive industry and help reduce the trade deficit. But, as in UK, USA and elsewhere this is like asking addicts to volunteer for rehab. The advice was ignored when the same advice in Spain was responded to by the banks there, if somewhat late.
Arguably, the problems derive from Greece believing there is security is doing what much bigger countries were doing like USA and UK such discounting the risks of historically high trade deficits so long as these could be financed (the so-called "new paradigm for economic growth' overcoming boom & bust). It is hypocritical to blame Greece alone for its problems. When the Credit Crunch erupted it seemed for nearly 2 years that the fragility of Greece could remain below the radar of the bond markets. Greek bankers told each other that the Credit Crunch would probably by-pass them so long as Greece was counted among emerging countries when those were viewed positively. This was, of course, a massive self-delusion.
Credit-boom growth was hugely positive in transforming the living standards and quality of life in Greece, allowing it to catch-up fast, like Ireland, with EU per capita GDP average. Ireland operated an extreme credit-boom catch-up growth too with banks lending too much to mortgages and property, even more than UK banks that lent 70% of domestic loans to mortgages and property. The differences were that Ireland ran the highest trade surplus in the EU while extremely paradoxically also the highest payments deficit, and the UK generated a large financial services external surplus to off-set its more trade deficit. Greece was hoping to emulate the UK by how its banks were investing in cross-border retail banking but failed abysmally to get its banks to support export industries, while its main competitive advantage, its huge shipping fleet increasingly operated in tax, borrowing and GDP terms off-shore. Greece's enormous trade deficit is as much a long term failure caused by the choices of banks of who and what to lend to as by government, but also very much an outcome of false assurances from the EU and the models they followed of the USA, UK, Spain and Ireland. Germany's position in the whole matter is self-serving and hypocritical too insofar as its trade surpluses require there to be countries running deficits. It's excessive lending to business borrowers instead of mortgage and consumer borrowers leaves its banks vulnerable to funding costs so that the worse the sovereign risk costs of deficit countries are the lower are the borrowing costs of its banks and corporates. Greece is a mere pawn in a bigger global game. The main points of Wolf’s article are:
After months of costly delay, the eurozone has come up with an enormous package of support for Greece. By bringing in the IMF, at Germany’s behest, it has obtained some additional resources and a better programme. But is it going to work?
It is a package of €110bn ($143bn) (over a third of Greece’s outstanding debt), €30bn of which will come from the IMF (far more than normally permitted) and the rest from the eurozone, enough to take Greece out of the (borrowing) market for more than two years.
Greece promises to reduce government borrowing by 11%/GDP over 3 years, on top of cuts already taken earlier, with the aim of to reach 3%/GDP deficit by 2014 (13.6%/GDP in 2009). Cuts are 5¼%/GDP annually for 3 years. Pensions and wages will be cut then frozen for 3 years. Seasonal bonuses abolished. Tax rises = 4%/GDP. Gross national debt will peak at 150%/GDP.
This is far less unrealistic than the first deal. The fantasy of a mild contraction this year followed by steady growth is gone. There will be cumulative decline in GDP of 8% (rough forecast). The new plan sets 2014 as the target year instead of 2012.
There is to be no debt restructuring; and the ECB will suspend the minimum credit rating required for the Greek government-backed assets in its liquidity operations, thereby offering a liquidity window to Greek banks.
The alternative was default in paying debt interest, but it would have to narrow its primary budget deficit (before interest payments), by 9-10%/GDP immediately, far more brutal than Greece has now agreed. With default, the Greek banking system would collapse. It can instead gain the time to eliminate its primary deficit more smoothly.
It is likely that Greece will however have to run a primary budget surplus of 4.5%/ GDP, with revenue of 7.5%/GDP devoted to interest payments. Will the Greek public bear that burden year on year? With huge fiscal retrenchment without exchange rate or monetary policy offsets, Greece is likely to experience a prolonged slump. Would structural reform work e.g. huge fall in labour costs to gain a prolonged surge in exports to offset the fiscal tightening, or a hugely higher financial deficit of the private sector? That seems inconceivable. If nominal wages fall steeply, the debt burden would worsen.
Greece is being asked to do what Latin America did in the 1980s, which led to a lost decade, the beneficiaries being foreign creditors. As creditors are now paid to escape, who will replace them? This package will surely fail to return Greece to the market, on manageable terms, in a few years. More money will be needed if debt restructuring (forgiveness and or longer maturity and or lower rates) is ruled out.
For other eurozone members, the programme prevents an immediate shock to their fragile financial systems. It is overtly a rescue of Greece, but covertly a bail-out of banks – and unclear that it will help other member states now in the firing line.
Investors could well conclude that the scale of the package required for tiny Greece and the overwhelming difficulty of agreeing and ratifying it, particularly in Germany, suggest that further such packages are going to be elusive. Other eurozone members might well end up on their own. None is in as bad a condition as Greece. Several have unsustainable budget deficits and spiking debt ratios. In this, their situation does not differ from that of the UK and US. But they lack the same policy options.
This Greek Tragedy, in short, is not over nor confined to Greece. For the Eurozone, two lessons - first, it has a choice – either it allows sovereign defaults, however messy, or it creates a true fiscal union with strong discipline and funds sufficient to cushion adjustment in crushed economies – Mr Willem Buiter (Citigroup Chief economist) recommends a European Monetary Fund of €2,000bn; and, second, adjustment in the eurozone is not going to work without offsetting adjustments in core countries. If the eurozone is willing to live with close to stagnant overall demand, it will become an arena for beggar-my-neighbour competitive disinflation, with growing reliance on world markets as a vent for surplus. Few are going to like this outcome.
The crises now unfolding confirm the wisdom of those who saw the euro as a highly risky venture. These shocks are not that surprising. On the contrary, they could have been expected. The fear that yoking together such diverse countries would increase tension, rather than reduce it, also appears vindicated: look at the surge of anti-European sentiment inside Germany. Yet, now that the eurozone has been created, it must work. The attempted rescue of Greece is just the beginning of the story. Much more still needs to be done, in responding to the immediate crisis and in reforming the eurozone itself, in the not too distant future.