June 25, 2011

The New Imperialism: EU Aid Package Will Destroy Greece and Enrich Germany

Global Politician

By Prof. Peter Morici
Greece is insolvent. No amount of new loans from rich EU governments and the IMF can save Athens from default on sovereign debt, and that poses a clear threat to the global financial stability. Moreover, the solutions being imposed will reduce Greeks into poverty to sustain German prosperity. Welcome to the New Imperialism!

Greece’s national debt exceeds 175 percent of GDP, and investors view its debt so risky that its bonds are deeply discounted in the resale market, pushing up yields to 20 percent and more. At those rates, Greece simply can’t refinance existing bonds as those come due.

Either bondholders accept new notes with longer maturities and paying much lower effective yields than the notes they currently hold, or Greece must default on bonds coming due. However, bonds with longer maturities and lower effective yields will be immediately worth less than their face value in the resale market—this makes such a rollover a soft restructuring or soft default. Bond rating agencies, if they apply established standards, must declare Greece in default in the face of such a maneuver.

This poses a twofold challenge for rich EU states. Their banks are extremely vulnerable and Greece has another way out if Athens has the sense to use it.

French and German banks hold $14 billion and $23 billion, respectively, in Greek sovereign debt, and even greater exposure to Greek private debt.

A soft restructuring on maturing debt should require those banks to recognize losses on their balance sheets, and if the bond rating agencies do their job—declare Greece in default. SWAP contracts guaranteeing the entire Greek sovereign debt, which exceeds $500 billion, will trigger. In addition, contracts on the debt of some European banks could trigger, and U.S. banks have considerable exposure to EU banks.

The global economy could easily replay the tragedy that followed the 2008 failure of Lehman Brothers and then AIG, which wrote SWAP contracts it could not honor, and threw the global financial system into chaos.

The French-German solution--Greek austerity measures and sale of public assets, and $157 billion in EU and IMF loans over several years—coupled with either a voluntary soft restructuring by French, German and other banks is bogus.

German and French politicians expect to persuade private banks to lie to their stockholders and domestic regulators, by not writing down Greek bonds on their books, and to persuade bond rating agencies and SWAP contract holders to ignore what is a default. A sort of grand fairy tale without a handsome prince to kiss and transform the Greek frog into something it is not—solvent.

Of course, the EU is demanding and will obtain more than $40 billion in budget cuts from Greece, but those will surely slow GDP growth and reduce the ability of the Greek government to collect taxes to pay its foreign creditors in future years.

Austerity will also drive down prices and wages, but leave private debt unchanged. Ultimately, many Greeks will default on their mortgages and lose their homes to foreign investors.

Even if the bond rating agencies choose to turn a blind eye and the SWAP contracts don’t trigger, Greece will face another crisis next year or the year after, when the cost of cleaning up the mess will be even greater.

The whole scheme is irresponsible and incomprehensible, except when you consider who is selling it—French and German politicians. To understand why, consider plan B.

Greece could abandon the euro and resurrect the drachma, unilaterally remark public and private debt into drachma, and let the drachma float to a value on currency markets that balances Greece’s export revenues against its imports and debt servicing obligations.

Abandoning the euro for the drachma would cause Greek GDP and debt servicing capacity to grow more rapidly. Whatever the losses imposed by remarking on EU banks, other private creditors, richer EU governments and Greek citizens, those would be smaller than the total losses that will be imposed through the annual ritual of crises, aid packages and debt rollovers—conditioned on ever more draconian austerity—and the ultimate absolute default when the final charade ends.

The rub is Portugal, Spain and several other poor EU states might follow Greece out of the euro, and Germany and France don’t want a downsized euro zone consisting of just the rich exporters.

The euro is undervalued for strong economies like Germany and France, boosting their exports and growth, and overvalued for poorer debt laden countries like Greece and Portugal. This permits Germans, for example, to enjoy a huge trade surplus, work only 32.5 hours a week in factories, and have single earner households, while the Greeks and Portuguese suffer under the yoke of then new imperialism—EU imposed austerity and deflation

Surely, the poorer countries are in need of fiscal reform, but they can’t accomplish that without selling off all their national assets and being banged down into poverty if they continue doing business in the euro.

Peter Morici is a professor at the Smith School of Business, University of
Maryland School, and former Chief Economist at the U.S. International Trade