Greece is broken, and can’t be fixed

February 15, 2012
Mohamed El-Erian says, the broken dynamics surrounding Greece right now are extremely reminiscent of what was happening in Argentina in 2001.

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As Mohamed El-Erian says, the broken dynamics surrounding Greece right now are extremely reminiscent of what was happening in Argentina in 2001. New money is necessary, but it’s also insufficient; it all feels like some kind of Samuel Beckett-style existential paradox. You must go on, I can’t go on, I’ll go on.

To provide a bit of context here, look at the amount that the Greek economy has already shrunk: 16%. That compares to 20%, peak-to-trough, in Argentina, and 29% in the US in the Great Depression. But the big problem in Greece is that the worst economic effects of austerity haven’t even happened yet.

“On the current path – which is not sustainable in my view – we may very well see Greek GDP go down 25-30 percent, which would be historically unprecedented. It’s a disastrous crisis for them,” Dadush, a former senior World Bank official, said…

“They’re suffering. It’s nasty,” said Weisbrot, who has studied the lessons to be learned from economic crises in Latvia and Argentina. “If you could say with a reasonable probability that the worst was over, then that would be different. But you can’t say that. They’re in for a long nightmare.”

The point here is that both Europe and Greece need a light at the end of the tunnel. Without that, social unrest in Greece will only get worse, the credibility of its promises will continue to deteriorate, and the Europeans will be understandably reluctant to throw good money after bad. And right now that light does not exist. Greece probably can’t implement the austerity package it’s promising, and even if it does, GDP won’t start growing to the point at which its debt-to-GDP ratio will come down to a remotely sustainable level. Which brings me to El-Erian:

First, they should stop repeating the claim that there is no “Plan B.” Telling people that there is no alternative to a discredited policy merely pushes them either to resist an approach that does not work, or to opt for mayhem. Recent official remarks heard in Greece (“We must show that Greeks, when they are called on to choose between the bad and the worst, choose the bad to avoid the worst”) do little to engender hope.

The lesson of what happened in Argentina should be top of mind:

After the Argentine parliament approved yet another new austerity package, the IMF agreed to release its financing tranche. But it was too late to save a discredited approach, further undermining the Fund’s standing.

Indeed, rather than engendering confidence, Argentine citizens withdrew their bank deposits over the next few months. Capital flight accelerated. The government again failed to deliver on its policy commitments. Most important of all, social and political pressures mounted, reaching a tipping point.

One of the weirder aspects of the Greek crisis is the way in which deposits in Greek banks have not fled the country. Many have, but Greeks still have something in the region of €150 billion on deposit in Greek banks. (I’m pretty sure that non-Greek deposits in Greek banks are de minimis.) If history repeats itself — and there’s no reason to believe that it won’t — that’s going to change.

There will be some kind of muddle-through bailout deal which allows Greece to do a bond exchange before its €14 billion bond coupon comes due on March 20. But the new money coming into Greece from the Troika will be less than the amount of money flowing out of Greek banks, and the lack of credit and liquidity in the country will only exacerbate the current depression and increase the number and severity of riots. Eventually, Greece will tip, and will leave the euro in a chaotic manner. I’m thinking late summer.

That’s not a Plan B anybody really wants. Greece’s budget deficit doesn’t disappear when it exits the euro, which means that it will have no real choice but to print new drachmas to cover that deficit. (Certainly no one outside Greece is going to lend the government new money at that point.) As a result, there will be a spiral of devaluation and inflation in Greece. Nominal GDP growth never felt so bad.

Is there a Plan C? Is there a real alternative? I think that there probably isn’t. El-Erian talks in a vague way about “economic restructuring”, “institutional changes”, and “policy flexibility” — all of which is code for the kind of deep-seated economic reform that Germany went through under Gerhard Schroder. That involved a combination of falling real wages and popular unhappiness in the context of a fundamentally strong and growing economy running a large current-account surplus. It also took many years, without real guarantees that it was going to work.

Greece doesn’t have that kind of leadership, partly because its population has no good reason to believe that such reforms would work or be at all effective in increasing national competitiveness. On top of that, it’s trying to act from a position of weakness rather than strength, and in any case it simply doesn’t have the time to implement changes which involve a fundamental restructuring of the nation’s social compact, including the population’s willingness to pay taxes.

Which is why I feel that what we’re seeing right now is the playing-out of the endgame in Greece. It reminds me in a way of the fiscal debate within the Obama administration, where the Christy Romer faction wanted “naked stimulus” without worrying too much about cuts down the road, while the Peter Orszag faction wanted “coupled stimulus” where short-term spending was offset by long-term budget cuts and revenue hikes. Basically everybody in the administration wanted stimulus, of one form or another — but that’s exactly what they didn’t get.

Similarly, in Greece, if you look at the various players — bondholders, the European Commission, the Greek government, the Greek population — all of them want Greece to stay in the euro. I have a feeling they’re all going to be very, very disappointed.


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