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Greece’s Catch-22

May 7th, 2011 · No Comments

The Spanish translation for ‘Catch-22’ is ‘situation without a way out’ Or is there…
Here a quick summary of the Greek quagmire:

  1. Their public finances are out of control as (forced) austerity is making things worse, not better. You know, as Krugman likes to put it, we recently rediscovered that contractionary policy is, well, contractionary (surprise, surprise!). By the way, this ‘new’ insight is the reason why EU/IMF conditions on the Portuguese bail-out were quite a bit more lenient. Apparently, this was mostly on the behest of the IMF, whose economist (in no small measure due to their excellent chief economist Blanchard) are more open than the guys in Frankfurt.
  2. Greece would be helped with growth (which austerity is destroying) and/or some inflation (which reduces the real value of outstanding debt) but the Teutonic anti-inflationary zealots in Frankfurt are talking about increasing interest rates and Greece doesn’t have it’s own monetary policy, thanks to the euro.
  3. However, even if there would be some inflating the real value of the debt away, it would worsen Greek competitiveness as they don’t have a currency to devalue.
  4. Restructuring the public debt (fast approaching 150% of GDP) would help, but since most of that debt is in the hands of Greek banks, or banks in the rest of Europe, nobody is too keen on this either. It could trigger a banking crisis.

As it stands, Greece has entered a long, dark economic winter and there is little light at the end of the tunnel, if any.

It certainly looks like a Catch-22, but as we wrote a year ago, there is the possibility of doing an ‘Argentina’, devaluing the currency. Problem here is that Greece shares its currency with most of the rest of Europe, it’s the euro. So they will have to leave the euro and reintroduce their own currency at, one can only assume, a rather heavily devalued value.

As the Argentinian experience has shown, this can jolt an economy out of depression. Re-introducing the Greek drachme comes with a good deal of practical problems though. It would trigger a bank-run, for starters. You don’t want to be like one of those Argentinians who thought his bank savings were in dollars, only to wake up one day and find out that they were in pesos one-quarter of their original value.

But it is a sign of how desperate things are in Greece now that it’s becoming clear (which comes as no surprise to us) that austerity has only made matters worse, that these kind of scenarios are now seriously considered.

This ain’t over, not by a long shot..

And then there is Portugal, Ireland, Spain..

The only very slight upside to all of this is that all this has jolted an increasingly overvalued euro downwards quite rapidly. The whole euro project needs all the help it can get right now as only economic growth and moderate inflation can help the European sovereign debt problem.

Tags: Sovereign debt crisis