Lorenzo Bini Smaghi vs Greece

By Felix Salmon
May 25, 2011
Aditya Chakrabortty has an enjoyable take-down today of Lorenzo Bini Smaghi:

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Aditya Chakrabortty has an enjoyable take-down today of Lorenzo Bini Smaghi:

Two weeks ago he warned the struggling Greeks: “Default or debt restructuring is a dramatic economic and social event for the country which experiences it – I would call it political ‘suicide’– which leads many into poverty.”

What’s wrong with this argument? Well, to use a technical term, it’s balls. More precisely, it’s the sort of everyone-says-it-so-it-must-be-true balls that’s been a hallmark of European policy-making ever since the banking crisis broke out.

When it comes to spouting conventional nonsense, Bini Smaghi has a fine pedigree. In 2007, he wrote: “The Irish example shows that it is possible to prosper in the monetary union while having a higher potential growth rate than the rest of the union.” It was the spectacular wrongness of this conclusion that prompted bloggers to award the eminent central banker a new name: BS.

Aditya is absolutely right that some kind of debt restructuring in Greece is necessary — it’s the failure to do one which would constitute a long and very painful suicide. On the other hand, while he’s right that the economic costs of default can be low, the political costs can be very high. As indeed Aditya’s favorite paper on the subject says: “The political consequences of a debt crisis, by contrast, seem to be particularly dire for incumbent governments and finance ministers”.

What’s more, in the specific case of Greece, the economic costs could be substantial too, if the restructuring isn’t done with international support. We’re talking about a country which is still running a substantial primary deficit, and which has no access to the international capital markets. A unilateral default, in that situation, cuts off all external funding sources, forcing extreme austerity overnight in order to bring the budget back to primary balance. It’s worse, economically and fiscally, than the status quo — even though the status quo is not sustainable.

So the reason to do a “soft restructuring” is just that the EU will play along and continue to fund Greece’s deficits. It won’t solve the insolvency problem, but it will reduce Greece’s debt-service payments and allow the country’s creditors to continue to hold Greece’s debt on their books at or near par. What’s more, it’s politically survivable for the current government, where a full-on default would probably (but not certainly) see them kicked out quite dramatically.

Why is Bini Smaghi so opposed to such a deal? It’s not some high principle that if you’re going to go to the trouble of restructuring your debts, you should do so in a once-and-for-all fashion. Instead, it’s simply that the ECB is a major creditor of Greece, and Bini Smaghi is fighting in the ECB’s corner. Someone is going to have to talk him around, though. Because if the likes of Bini Smaghi and Jean-Claude Trichet don’t play ball now, the end-game in Greece could be very drastic and chaotic indeed.

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Comments
3 comments so far

If the EU were to “play along”, and “continue to fund Greece’s deficits” indefinitely, then in what way would this fail to “solve the insolvency problem”? What is the advantage gained by default which isn’t the same thing “reduce Greece’s debt-service payments”?

Posted by dsquared | Report as abusive

OK, @dsquared, I’ll bite. I know that you know the difference between a liquidity problem and a solvency problem. The advantage gained by default is that it would end up reducing Greece’s debts to a sustainable level — sustainable not only if and when the EU is in a mind to play along, but in the sense that the country actually can borrow money elsewhere, and isn’t completely at the mercy of Euro politics, a ward of the Euro state. No?

Posted by FelixSalmon | Report as abusive

So the purpose of defaulting on the debt would be to improve Greece’s access to credit? And by putting its deficit funding at the caprice of international capital markets rather than other EU governments, Greece gains political independence? I suppose it is the land of the Pyrrhic victory, but even so; I am unconvinced that gaining the sort of freedom to set its own fiscal policy enjoyed by, say, Ecuador is really worth all that much.

btw, I don’t really know what the difference is between a liquidity problem and a solvency problem in this context, and I don’t believe anyone else does either.

Posted by dsquared | Report as abusive
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