Introduction

Things “sound” better for Greece: The government just sold $3.53 billion of 5-year bonds with a 4.6% coupon. Prime Minister Alexis Tsipras said that the debt sale signaled Greece was on the path to a definitive end to its crisis. He said it was “the most important message and the most significant step in order to finish this unpleasant adventure….”

But What is The Reality?

So far, the IMF, the European Central Bank (ECB) and the European Commission (EC) have together provided Greece with $383 billion in bailout monies. That amounts to 180% of Greece’s annual GDP! This assistance started in 2010. Since then, Greek income per capita has fallen by 34% in real terms.

In retrospect, I think it is fair to say that all the major players in the Greek tragedy share some blame for what happened:

• The Greek authorities for approving far more generous pensions and other benefits than the country could afford;
• The European bank regulators for allowing banks to treat sovereign debt like cash in calculating their reserves;
• The European banks for purchasing so much Greek debt in light of the country’s deteriorating economic situation;
• Other Eurozone members, led by Germany, insisting that even today, austerity is the answer and no further debt forgiveness will be given.

The Fund’s position is somewhat more nuanced. It started by agreeing with its European partners that severe austerity was the answer. But it backed off this when it saw Greek unemployment jump from 9.6% in 2010 to 27.5% in 2013.  It then switched to insisting on a huge and unrealistic set of structural reforms and further debt forgiveness. In reality, the structural reforms the IMF were insisting on would have been just as deflationary if implemented as the earlier austerity measure were.

Who Bought Greek Debt and Why?

Back in 2007, it was patently clear that Greece was on an unsustainable economic path: it was already running a government deficit of 2.2%, with government debt already at 103% of GDP and a current account deficit at 15% of GDP. And yet, there were still plenty of buyers for Greek debt. Table 1 gives interest rates on Greece’s 10 year debt for the years in question. Note how low they were until really spiking in 2012. Who were the buyers and why?

Table 1. – Interest Rates on 10 Year Greek Debt

Source: investing.com

Banks attract deposits (liabilities) and use them to earn income. These income earning vehicles and cash constitute bank assets. Regulators insist that banks maintain certain minimum liquid assets (such as cash) to cover fluctuations in other deposits. The Basel II rules governing Eurozone banks allow them to include government debt as part of their reserves. In short, the rules allowed banks to treat Greek government debt in the same manner as cash!

This explains the demand for Greek debt. The banks say why hold cash when we can buy Greek debt and get a healthy return? You might wonder why the banks’ “risk officers” did not point out just how risky Greek debt was. They probably did but were overruled. They were ignored until the market for these securities vanished overnight. And the regulators – where were they?

The Guardian recently did a piece breaking down how the Greek bailout money has been used. It found:

• Only a small fraction of the $282 billion Greece received in 2010 and 2012 found its way into the government’s coffers. Most of the money went to the banks that lent Greece funds before the crash.
• Two years later, the IMF, EU and ECB came up with a second bailout that centered on a $118 billion debt write-off by private sector lenders. This eliminated about $118 billion of debt.
• But $40 billion was used to pay for various “sweeteners” to get the deal accepted. That $40 billion was added to the Greek debt.
• Greek pension funds, which were major private lenders, also suffered terrible losses.
• Then $57 billion was used to bail out Greek banks.
• Lastly, $165 billion has been spent on paying the original debts and interest.
• Overall, that means less than 10% of the bailout money was left to be used by the government for reforming its economy and safeguarding weaker members of society.

 The Current IMF Position

 The EU and ECB don’t want further Greek debt reduction because of the write-downs banks would have to take. The IMF insists further debt reduction is needed. It will not disburse more funds until a further debt reduction plan has been worked out. I quote from the IMF’s recent Greek Request for Stand-By Arrangement:

“Greece’s debt remains unsustainable. While differences of view between staff and Greece’s European partners have narrowed, staff believes that a debt-reduction strategy that is based on maintaining unprecedentedly high primary surpluses or output growth rates for extended periods is not credible, even with full implementation of planned policies.”

The Fund point out that the only thing keeping Greece afloat is the ECB’s support for Greek debt. It notes that at some point, these supports will have to be removed and Greece will have to support its debt at commercial rates. Details in the Fund projections:

“Baseline projections suggest that Greek government debt will decline to 160 percent of GDP by 2022. Gross financing needs cross the 15 percent-of-GDP threshold already by 2028 and the 20 percent threshold by 2033, reaching around 45 percent of GDP by 2060. Debt is projected to decline gradually to around 150 percent by 2030, but rises thereafter, reaching around 195 percent of GDP by 2060, as the cost of debt, which rises over time as market financing replaces highly subsidized official sector financing, more than offsets the debt-reducing effects of growth and the primary balance surplus.” The Fund concludes that without further debt reduction, Greek’s gross financing needs become explosive after 2030.

But there is more to the IMF’s concerns. Its baseline projections assume all the reforms that Greece has agreed to for the bailout money it is receiving will be implemented. I quote from the IMF’s concerns:

• “Permanently raising growth would require a period of reform implementation that exceeds in both ambition and duration what Greece has achieved so far.
• In conclusion, achieving staff’s assumption of 1 percent growth in the face of adverse demographics and historically weak productivity growth will require that the Greek authorities and people commit to an extended period of profound structural reform.”

My translation: The IMF does not believe Greece will make the reforms it has agreed to make. So everyone continues to plod along with “heads in sand.”

Back in 2011, I wrote an open letter to the then President of Greece. I quote from that letter:

“This is not the time for you to be sitting on your hands trying to be Euro team players in hopes the leaders of the Eurozone will solve your problems. They will not. They only care about saving the banks that foolishly bought far too much of your debt. Were you partially to blame for the Eurozone mess? Of course. But you are not actors in a morality play. Your job is to do what is best for your citizens, and that means getting out of the Eurozone and defaulting on your debt.

Rest assured, it will be a messy process, an open invitation for corruption on a grand scale, and other unexpected surprises. But you should still do it. If you don’t, your unemployment rates will go even higher and your trade deficits will exhaust your already-depleted international reserves. In essence, your costs are too high and getting out of the Eurozone and defaulting on your debt is the only way to get them down.”

For more on this, see the Appendix.

Conclusions

The Greek economic crisis is not over. The key players are sticking to their positions:

• The Greek government will promise to implement reforms but fail to do so;
• The EU and ECB will insist on austerity and no further debt relief and
• The IMF will continue to insist on more debt relief.

The future is uncertain.

Appendix

Many do not understand how a currency union limits a country’s economic flexibility. A simplified explanation follows.

1. Assume Germany is more productive than Greece and that the productivity gap is growing.
2. That means Germany can produce good more cheaply than Greece. So people, including Greeks, buy goods from Germany.
3. This means the Greek trade deficit will widen and at some point, they will run out of Euros.
4. So Greece borrows Euros from banks who are foolish enough to make them loans.
5. Ipso facto, the Greek debt crisis.

Compare that with a case where countries have their own currency. In this latter case, the exchange rate of the country running up the deficit weakens to compensate for the cost differences. A good example of how this works is the US and Japanese experience. In 1970, there were ¥350 to the dollar. Now, there are only ¥100 to the dollar. The depreciation in the dollar made up for the higher productivity of Japan.

Greece has no such “adjustment mechanism” as long as it remains in the Eurozone.