Crossroads: Greece, the IMF and the financial systemMay 24th, 2011 | By Daan Wijnants | Tags: DSK, ECB, Economy, EU, Finance, Greece, IMF
There is a sentence these days that European leaders are struggling to avoid, as if it where He Who Must Not Be Named: the restructuring of Greek debt. It is something of a euphemism for Greek bankruptcy. Even though I am not an economic expert, I am beginning to feel that a ‘restructuring’ or bankruptcy is not only in the long term inevitable, but also the best way for Greece and Europe to escape the present situation of financial uncertainty.
The Greek economy
Let us begin with a few numbers to illustrate how dramatic the situation in Greece truly is. Greece has agreed to lend 110 billion euro from the IMF and the EU, in exchange for drastic measures to reduce the budget deficit. The goal to reduce the deficit to 8,1% in 2010 was not reached, eventually stopping at a figure of 10,5%. Greece’s credit rating has sunk to the same level as the African nation of Burkina Faso, according to Standard & Poor’s. The country is forced to pay a 20% interest rate over its ten year bonds. So it seems to be fairly obvious that Greece will be unable to pay off its debtors by itself, without help from other nations.
Now there are really two ways out of the present crisis. The first is to lend more money to Greece to give them more time to implement the necessary reforms. The second method is for Greece to acknowledge that it cannot pay all its debtors, which means that they will only be able to return a portion of the 330 billion euro public debt, say 30-50%. This will lead to a depreciation of Greek debt by creditors and they will be forced to take their losses. Both methods have serious downsides. Lending more money means that if Greece will still turn out to be unable to pay all its debt, the pain will not be felt by those who have speculatively invested their money in Greece, but mostly by the European taxpayers. Declaring Greece bankrupt will lead to losses by creditors, mostly banks, who might then be in need of a new capital injection by their governments.
There is no easy solution for the Greek financial problem. Perhaps the best or the least troubling way will be to let creditors take their losses. European banks have invested something close to 136 billion euro in the Greece economy. Should Greece be declared bankrupt, banks will suffer great losses. Greece’s banks will tumble like dominos. French and German banks will have a large share in the pain. But it seems that the problem is manageable. Most governments will be able to provide their banks with a capital injection to ease the pain. Greece will be able to start again, but it will still be punished for its irresponsible financial policy of the past. For me, the most important aspect is that those who have taken risks in the past by investing, will not be rescued with taxpayer’s money. If you gamble, you can lose. This is the healthy, but painful system of market capitalism.
Europe’s problems do not end with Greece however. If Greece continues to be in need of financial support and the stability of the euro remains uncertain, there are fears that other countries will get in even bigger trouble. Ireland and Portugal have already received loans from the IMF and the EU. If Spain were to follow, the EU is in serious trouble, considering that the Spanish economy is way too large for the EU to save. In such a situation, it is extremely unhelpful that the director of the IMF, Dominique Strauss-Kahn (DSK), has been arrested on charges of sexual abuse. Whether or not DSK is guilty of the crime he allegedly committed, history has shown that the sudden absence of an important leader can lead to a worsening of a crisis. Just before the great crash of 1929, the then –leader of the Fed, Benjamin Strong, passed away. His successors at the Fed were unable to deal with the problems that faced them. The respected economic expert Milton Friedman later claimed that the death of Strong might well have caused or at least worsened the Great Depression of the 1930’s.
Furthermore, this Fall Mario Draghi will be installed as the successor of Jean-Claude Trichet as president of the European Central Bank (ECB). Draghi is Italian, which has made his candidature somewhat controversial. The main cause for this is that the ECB board, when Draghi is appointed, will consist of a majority of Mediterranean members. The vice-president of the ECB is Portuguese citizen Vitor Constancio, while there are also a Spaniard and another Italian on the board, giving the southern European countries a majority. I believe that a Mediterranean majority is undesirable because the way southern European countries run their economies differs from how this is done in the northern part of Europe. The latter traditionally emphasize low public debt and reduced governmental spending. Furthermore, some economists have argued that Draghi, as president of the Italian Central Bank, failed to tackle inflation, which is one of his tasks as ECB president, perhaps even the most important one.
It seems that Europe will be facing turbulent times ahead. With the financial crisis far from over, with Greece not out but increasingly in trouble, with uncertainty around the IMF leadership and with a Mediterranean majority on the ECB board, we will have to see what the future has in store for Europe’s financial system.
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