Daily Archives: September 19, 2011

Greece is stuck in a vicious cycle of insolvency, low competitiveness and ever-deepening depression. Exacerbated by a draconian fiscal austerity, its public debt is heading towards 200 per cent of gross domestic product. To escape, Greece must now begin an orderly default, voluntarily exit the eurozone and return to the drachma.

The recent debt exchange deal Europe offered Greece was a rip-off, providing much less debt relief than the country needed. If you pick apart the figures, and take into account the large sweeteners the plan gave to creditors, the true debt relief is actually close to zero. The country’s best current option would be to reject this agreement and, under threat of default, renegotiate a better one.

Yet even if Greece were soon to be given real and significant relief on its public debt, it cannot return to growth unless competitiveness is rapidly restored. And without a return to growth, its debts will stay unsustainable. Problematically, however, all of the options that might restore competitiveness require real currency depreciation.

The first of these options, a sharp weakening of the euro, is unlikely while the US is economically weak and Germany über-competitive. A rapid reduction in unit labour costs, through structural reforms that increased productivity growth in excess of wages, is just as unlikely. Germany took 10 years to restore its competitiveness this way; Greece cannot wait in depression for a decade.

The third option is a rapid deflation in prices and wages, known as an “internal devaluation”. But this would lead to five years of ever-deepening depression, while making public debts more unsustainable.

Logically, therefore, if those three options are not possible, the only path left is to leave the eurozone. A return to a national currency and a sharp depreciation would quickly restore competitiveness and growth, as it did in Argentina and many other emerging markets that abandoned their currency pegs.

Of course, this process will be traumatic. The most significant problem would be capital losses for core eurozone financial institutions. Overnight, the foreign euro liabilities of Greece’s government, banks and companies would surge. Yet these problems can be overcome. Argentina did so in 2001, when it “pesified” its dollar debts. America actually did something similar too, in 1933 when it depreciated the dollar by 69 per cent and repealed the gold clause. A similar unilateral “drachmatisation” of euro debts would be necessary and unavoidable.

Major eurozone banks and investors would also suffer large losses in this process, but they would be manageable too – if these institutions are properly and aggressively recapitalised. Avoiding a post-exit implosion of the Greek banking system, however, may unfortunately require the imposition of Argentine-style measures – such as bank holidays and capital controls – to prevent a disorderly fallout.

Realistically, collateral damage will occur, but this could be limited if the exit process is orderly, and if international support was provided to recapitalise Greek banks and finance the difficult fiscal and external balance transition. Some argue that Greece’s real GDP will be much lower in an exit scenario than in the hard slog of deflation. But this is logically flawed: even with deflation the real purchasing power of the Greek economy and of its wealth will fall as the real depreciation occurs. Via nominal and real depreciation, the exit path will restore growth right away, avoiding a decade-long depressionary deflation.

Those who claim contagion will drag others into the crisis are also in denial too. Other peripheral countries have Greek-style debt sustainability and competitiveness problems too; Portugal, for example, may eventually have to restructure its debt and exit the euro too.

Illiquid but potentially solvent economies, such as Italy and Spain, will need support from Europe regardless of whether Greece exits; indeed, a self-fulfilling run on Italy and Spain’s public debt at this point is almost certain, if this liquidity support is not provided. The substantial official resources currently being wasted bailing out Greece’s private creditors could also then be used to ringfence these countries, and banks elsewhere in the periphery.

A Greek exit may have secondary benefits. Other crisis-stricken eurozone economies will then have a chance to decide for themselves whether they want to follow suit, or remain in the euro, with all the costs that come with that choice. Regardless of what Greece does, eurozone banks now need to be rapidly recapitalised. For this a new European Union-wide programme is needed, and one not reliant on fudged estimates and phoney stress tests. A Greek exit could be the catalyst for this approach.

The recent experiences of Iceland, along with many emerging markets in the past 20 years, show that the orderly restructuring and reduction of foreign debts can restore debt sustainability, competitiveness and growth. Just as in these cases, the collateral damage to Greece of a euro exit will be significant, but it can be contained.

Like a broken marriage that requires a break-up, it is better to have rules that make separation less costly to both sides. Breaking up and divorcing is painful and costly, even when such rules exist. Make no mistake: an orderly euro exit will be hard. But watching the slow disorderly implosion of the Greek economy and society will be much worse.

Nouriel Roubini is Chairman of Roubini Global Economics, professor at the Stern School, New York University and co-author of ‘Crisis Economics’. A longer version of this article can be found on the RGE website

This article is part of the A-List series: Can the euro be saved?

Response to Lawrence Summers

There is a big difference between the Vietnam War and the euro battle: it is hard to think that the former could have been won whatever the means deployed. But as regards the latter Lawrence Summers is right to point out that instead of acting promptly with overwhelming force, Europe has consistently been one day late and one euro short. The Greek crisis was after all a very small problem when it emerged. Denial, procrastination and parsimony have now led to contagion to the core.

Bygones are bygones, however, and the only question that matters is, what to do now? Mr Summers advocates a bold view of the future, a swift recapitalisation of banks and a reversal of the macroeconomic policy stance. All three are necessary, with the important caveat that most eurozone countries cannot afford a fiscal stimulus. Among the significant players only Germany has the possibility of changing course, and it will not do it. It may, at most, slow down consolidation, and this only will not change the landscape.

The proposed recipe is furthermore incomplete. The two immediate urgencies are to extinguish the Greek fire and to contain the widening of spreads on Italian and Spanish sovreign debt. To achieve the former, a debt relief for Greece should be organised, over and above the voluntary and limited private sector involvement initiative agreed upon in July. Ensuring that Greece remains solvent over a wide range of macroeconomic and financial scenarios would help address lingering market concerns. Obviously, such an initiative would require to be accompanied by bank recapitalisation. As soon as ratification authorises it, the European financial facility should be used to this end – especially in Greece itself.

To stabilise Italy and Spain, the euro area should make clear that it will do whatever it takes to quell self-fulfilling debt crises. At present this is the task of the European Central Bank, but it has no explicit mandate for it and central bankers are divided about bond purchases. This leads markets to doubt its resolve. In a few weeks, hopefully, the baton will be passed to the EFSF, which will have a mandate. But it lacks significant firepower. The solution is to leverage the EFSF by giving it a credit line from the ECB and the possibility to repo sovereign bonds purchased on the secondary market. A scheme of this sort would give it at least €2,000bn in firepower, perhaps significantly more. Secretary Geithner alluded to the idea in Wroclaw last week. The Europeans should seriously consider it.

The writer is a French economist and director of Bruegel, a Brussels-based think-tank focusing on global economic policy-making.

This article is part of the A-List series: Can the euro be saved?

The A-List

About this blog Blog guide
Welcome. This blog is available to subscribers only.

The A-List from the Financial Times provides timely, insightful comment on the topics that matter, from globally renowned leaders, policymakers and commentators.

Read the A-List author biographies

Subscribe to the RSS feed

To comment, please register for free with FT.com and read our policy on submitting comments.

All posts are published in UK time.

See the full list of FT blogs.

What we’re writing about

Afghanistan Asia maritime tensions carbon central banks China climate change Crimea emerging markets energy EU European Central Bank George Osborne global economy inflation Japan Pakistan quantitative easing Russia Rwanda security surveillance Syria technology terrorism UK Budget UK economy Ukraine unemployment US US Federal Reserve US jobs Vladimir Putin


Africa America Asia Britain Business China Davos Europe Finance Foreign Policy Global Economy Latin America Markets Middle East Syria World


« Jul Oct »September 2011