Greece: Default is in the air

Contagion dangers

by
Michael Roberts

In this blog, I have advocated that part of the way out for the Greek people in Europe’s so-called sovereign debt crisis is for their government to negotiate a ‘restructuring’ or default on their government debt (The end game for the euro? 18 August 2011; Greece proof?, 23 July 2011; and Greece:heading for default, 16 June 2011)).  This would be similar to the move that the Argentine government carried out in 2001 when they made an offer to holders of their bonds: take 40% of their value in a deal or forget it.  There was a lot of moaning and groaning but in the end the bondholders did just that.   Argentina cuts it debt burden to foreign banks and others in one stroke.

Instead of that, the ministers in the so-called socialist PASOK government in Greece are running around like the proverbial headless chickens trying to come up with yet more money to satisfy the dreaded Troika of the EU, the ECB and the IMF.  In their daily video conference calls with Brussels, Frankfurt and Washington, they try to think of ways to hit their people again with yet more taxes and cuts in public spending and services.  They planned a €2bn property tax to be paid through the electricity bill on each home.  But the Troika said it was not enough and the wrong measure.  They wanted ‘structural reforms’ to reduce ‘the size of the state’, namely another 20,000 public sector workers to be sacked on top of the 80,000 going already.  All this is in order to pay back the banks that bought Greek government bonds because if they don’t, the banks will go bust too.  And these are very same banks that triggered the global financial crisis and slump in the first place.  This Gordian knot can be cut if the Greeks organise a default.

And the irony is that while the Greek socialist leaders rush to meet the demands of the Troika, now many pro-capitalist commentators are raising the idea of an ‘orderly default’ as a way out of the crisis.  Citibank economist Willem Buiter says a default cannot be avoided, so it would be better to get it over with along with suitable funding of other weak EMU states so the default can be restricted to just Greece.

Joining the default chorus is Nouriel Roubini.  In an article in the FT (http://blogs.ft.com/the-a-list/2011/09/19/greece-should-default-and-abandon-the-euro/), he argues that: “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.  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 which abandoned their currency pegs.”

Roubini raised the probability of a Greek default over a year ago, but now he sees it not as a calamity but as a way out: “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 firms would surge. Yet these problems can be overcome. …  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.”

Roubini correctly points out that defaulting would free the Greeks from the burden of servicing a ludicrously large debt stock. But can an ‘orderly’ default be achieved without the contagion of default spreading to other weak Eurozone capitalist states and generating a new economic slump in Europe and beyond?

Greece is not Argentina in 2001.  Argentina could default and devalue its currency with no risk of contagion for capitalist Brazil or Uruguay or Chile.  But this time is different.  If Greece defaults, the people of Portugal and Ireland are going to ask why should they go on paying back huge debts to the banks when Greece has negotiated a write-off.  They would want the burden lifted too.  Also the people of Spain and Italy, now subject to new draconian taxes and cuts in order to keep bond markets happier about their own sovereign debts, may ask the same.  And that is what really worries the bond holders: the banks , pension funds, insurance companies and hedge funds.  The pressure will move to Italy and Spain and bond investors will demand even higher rates of interest to lend more money.  Record rates will make it impossible for these governments to control and service their debt too and the issue of default will then emerge again.  Contagion will not be contained.

Banks across the region will be going bust if a Greek default is followed by others.  That is why the ECB is so opposed to any default, even an ‘orderly’ one.  They would be faced with printing money to keep the banks going and printing money (as they have started to do) to bail out the governments too.  But printing money does not mean everybody gets paid with no pain.  It will eventually mean a massive rise in inflation at a time when real economic growth is low and may even start to contract.  Dreaded stagflation would reappear in Europe.

And if the British and American ruling classes think they can sit back and smirk at the Continentals, they would be wrong.  Their banks too would be caught up in the impact of the default.  Also, if Europe slips into a new slump, it would drag down their already weak capitalist economies too.  Indeed, they are well aware of this – which is why US treasury secretary Tim Geithner made a special visit to the EU finance ministers’ meeting in Poland last weekend to suggest that the ECB do just what it does not want to do – print money to bail out everybody!

Roubini argues not only for an orderly default as the way out for the Greeks and European capitalism.  He also reckons that Greeks should leave the euro so they can devalue their currency to become ‘competitive’ in world markets.  In other words, by reverting to the New Drachma at a much lower value relative to the euro, the Greek capitalists can steal a march on their former EMU friends and sell their goods cheaper.

Now I’m sure that there is no sympathy among readers of this blog or among most observers for German or Dutch or Finnish capitalists who might be undercut in the few sectors that Greek capitalists might have an advantage over them.  So in that sense, leaving the euro and devaluing a new currency might be popular.  But it also might be popular with Portuguese or Irish capitalists too.  Before long, leaving the euro may lose its advantage for Greece.

At the same time, devaluing means that all the debts that Greek households have in euros would have to be devalued too or people would be destitute.  And Greek businesses that have borrowed in euros would face bankruptcy because now revenues would be in cheap drachmas.  There would be a run on the banks to get euros out and send them abroad, if the rich have their way.  So the banks would have to be nationalised, deposits guaranteed and capital controls put on to stop the rich and Greek big businesses taking their euros abroad.  In other words, an alternative policy could not stop at default and devaluation; it would have to move onto deeper measures of public control and planning if it were to work for the Greek people.

Costas Lapavitsas, a socialist economist, has joined the call for default and devaluation in the Guardian newspaper (http://www.guardian.co.uk/commentisfree/2011/sep/19/greece-must-default-and-quit-euro).  Lapavitsas recognises that default and devaluation is not enough but he argues that it is the best way out.  “A progressive government would take several decisive steps: switch to a new drachma quickly; nationalise the banks; and impose capital controls. There would need to be administrative measures to ensure supplies of oil, food and medicine, along with income and wealth redistribution to support the poorest. Recovery should start in a few months, spurred by devaluation that would allow industry to increase exports and recapture the domestic market. If progressive forces showed sufficient will, it would then be possible to transform the economy deeply, changing the balance of power in favour of working people.

But even he seems to emphasise devaluation as a cure more than public control and planning. This blog has outlined in more detail what policies need to be adopted by Eurozone governments to resolve this crisis and restore living standards to those that are suffering under the heel of the Troika (see An alternative programme for Europe, 11 September 2011).  The answer is not so much devaluation which is a Keynesian way of putting the burden of the crisis onto the people of other countries,  Such ‘beggar thy neighbour’ policies will soon to lead to copycats.  The need is for more investment and employment to grow the Greek economy.  That means state-owned banks and investment in a social plan.  Maybe such policies would lead to the Greeks being thrown out of the euro anyway.  But then it would not be seen as a policy of nationalism, but an act of punishment by the ruling groups and governments of the Eurozone.