Greece’s “Meaningless” Debt

The Debt-to-GDP ratio in Greece is now at 175% and rising. Recall Troika statements said anything over 120% was unsustainable.

Yet each quarter debt and debt service ratios rise. Now, a new argument has arisen: Greece does not need debt relief because its maturities and payback time are large.

Charles Wyplosz, a professor of economics at the Graduate Institute of International and Development Studies in Geneva, takes issue with that belief in a Bloomberg article The Anti-Debt-Relief Crowd Is Wrong on Greece.

Since Chancellor Angela Merkel’s impressive victory at the polls, however, a push-back has begun, most recently from Klaus Regling, the managing director of Europe’s bailout fund, the European Stability Mechanism. He argued in an interview last week that by now the maturities on Greek debt are so long and the interest rate it pays so low that the scale of the debt pile itself has become “meaningless.”

This is a new and more sophisticated twist to the usual argument against debt relief, which is that forgiveness risks encouraging chronically undisciplined countries to again run up their budget deficits, safe in the knowledge that whenever debts get out of control they won’t have to pay. Both the old and the new arguments are wrong and fraught with risk.
Greek Depression

The expectation that debt relief should follow the German elections was based on a number of immovable facts. The first is that Greece is in the grip of an economic depression that has lasted six years, wiping out 30 percent of its gross domestic product — the same contraction the U.S. suffered during the Great Depression. Greece is bleeding profusely. The second fact is that after four years of austerity measures designed to reduce Greece’s public debt, it has instead continued to grow to 175 percent of GDP. This is despite the 2012 restructuring of bonds held by the private investors, which shaved 30 percent of GDP worth of debt from what Greece owes.

Regling said in his interview that Greece already enjoys concessional interest rates and long maturities on its debt that amount to a form of relief — and this is true. Last year, the average maturity of Greek debt was extended from about six years to 16 years, as a combined result of the private sector restructuring and new loans from the ESM. The annual interest rate that Greece has to pay on these new loans is low, about 3 percent.

Yet whether Greece can pay the interest on its loans for now is not the issue. Until Greece’s nominal GDP growth, currently sharply negative, rises above the interest rate it pays on its debts, these will go on increasing as a proportion of the economy. This is simple arithmetic: Debt service costs add to the debt, the numerator, faster than GDP, the denominator, rises.

It is true that debt relief could prove contagious, but the answer to this objection is: “Yes, and so it should.” Greece is not the only euro area economy saddled by an unsustainable public debt.

Greece needs a debt relief package soon or its only option will be inflation, which means leaving the euro area. Even if this is a pessimistic view, it is a very real risk. Merkel must now weigh that risk against the political cost of reversing herself.

Puppies Beg for Treats

Like a puppy begging for a treat, Greek PM Samaras expected to seek debt relief from Merkel.

During scheduled talks with German Chancellor Angela Merkel in Berlin on Friday, Prime Minister Antonis Samaras is expected to ask for a lightening of his country’s huge debt, according to a report in Germany’s Sueddeutsche Zeitung.

According to the report, Samaras is to point to economic indicators suggesting that Greece will post a primary surplus both this year and in 2014 in a bid to convince Merkel that Greece should be given some debt relief.

Germany has repeatedly ruled out a second debt haircut for Greece. But Samaras is not expected to a seek another writedown on Greek debt, according to German reports. Rather, he is expected to ask for a reduction in the interest rates on Greece’s foreign loans and an extension on the maturities.

Still Merkel, is not expected to give in so easily, according to Sueddeutsche Zeitung which reported that the German Chancellor will concede that some economic reforms have been achieved but that much remains to be done. It is expected that Merkel will avoid taking a stance on slow-moving negotiations between Athens and the troika, sources said.

Euro Debate Greece Isn’t Having

Begging for treats from an unsympathetic master will not produce any results. Nor will the ostrich approach of sticking one’s head in the sand. It’s time for an honest discussion about Greece.

Please consider The euro debate Greece is not having

There is no dispute that Greece’s current account, from a staggering deficit of close to 35 billion euros in 2008, is nearing balance. But the majority of the correction of the trade deficit is covered by a collapse in imports due to domestic demand almost evaporating after three years of austerity and disposable incomes plummeting by almost a third.

The “internal devaluation” rationale is that, in the absence of the currency devaluation which automatically makes everything produced domestically cheaper to the outside world, you suppress domestic demand with the aim of reducing imports and correcting the trade balance. You also implement cuts in costs which are variable, such as wages, unlike other input factors that further feed the effort to push down domestic demand. This naturally leads to higher unemployment and more people without disposable income further suppressing domestic demand.

Overall, it creates a perfect feedback loop and a concerted effort to sink an economy.

You might think all this is worth it if there is light at the end of tunnel but that is not true in Greece’s case. After three years of brutal austerity policies, Greece remains in a heavily overpriced currency for its economic standards.

A research paper by Morgan Stanley published in September puts the fair value of the euro against the dollar for the Greek economy at just over 1 dollar. The same figure for Germany is 1.53 – the currency currently trades against the dollar at 1.35.

A paper by Deutsche Bank (DB) on foreign exchange pain thresholds puts Germany’s at 1.79 against the dollar. Simply put, Germany is in a situation where the euro has to appreciate from its current levels by circa 33 percent before it starts feeling any strain on its competitiveness while Greece is already in this position with the euro at its current trading levels.

It is a debate on these plain macro facts that is missing in Greece. Any discussion around the currency has been stigmatized and leads to political labelling. The real question we need to answer is how much of the economy and society are we willing to sacrifice to stay in the euro. And if Greece’s conscious decision as a nation is to remain in the euro, is there an actual national plan or we will find ourselves in a perpetual deflationary vicious cycle of low wages, subdued demand and high unemployment because we will remain a services economy with low value added and labour intensive industries?

Questioning the benefits of a currency whose flaws and institutional weaknesses have been so blatantly exposed over the last three years should not earn one a place in the ‘drachma lobby’. These questions should be used as the fulcrum for a much needed debate on how Greece will be able to respond to the euro challenges. It is about time we have a debate that extends our horizon beyond the next troika review and loan tranche, above accounting primary surpluses and superficial success stories.

So far, neither the government, nor the opposition are making any contribution towards these pressing issues. If this does not change, Greece’s task ahead will remain Sisyphean.

Sisyphean Tasks

The adults are still unwilling to hold a discussion. Germany insists Greece become more German-like but the math says it’s impossible.

Prime Minister Antonis Samaras doesn’t want another restructuring (for the simple reason he knows Germany will not allow one). Instead he begs for treats, from a master whose only concern is the electorate of another nation.

The fewer treats Merkel dispenses, the more praise she receives at home. Meanwhile the policies destroy Greece.

Mathematical Irrelevance

It’s mathematically irrelevant whether the problem started in Greece, or Germany or who is to blame. And regardless of one’s stance on bailouts, something has to give. This situation will be resolved in one of three ways.

Three Possible Resolutions

  1. Greece gets substantial debt relief from Germany and Northern Europe
  2. Greece puts up with financial repression for the rest of the decade (or longer)
  3. Greece defaults on the debt and exits the Euro

Germany has ruled out number one.
I highly doubt the people of Greece will put up with economic depression forever

Neither option one, nor option two, solves any structural flaws with the euro itself.

The needed discussion regards resolution three.

Greece should hold this discussion, in a meaningful way or at least tell the people they have selected option number 2. Instead, all we see and hear is how Greece has turned the corner.

Greece hasn’t and won’t turn the corner until it exits the euro, or the structural problems of the euro are addressed AND Greece gets debt relief.

Violent Hyperinflationary End

Years of economic depression has given rise to the Golden Dawn neo-Nazi party. And the absence of a meaningful discussion about the realities of the situation, coupled with blatant lies about how well Greece is doing, all but ensures a violent hyperinflationary end to this sad saga.

Ironically, the Greek debt writeoff that Germany would not allow, will happen anyway, with Greece, Germany, and Europe all worse off because of the manner in which it happen.

Mike “Mish” Shedlock