One More Time

Greece will need 110 billion Euros, an amount nearly equal to its bailout package last year, to make it through this one.

The admission, after weeks of speculation over the size of the package, highlighted the parlous state of the country’s economy despite receiving regular cash injections from the €110bn rescue agreed last May, the biggest bailout in western history. Athens’s debt, which stood at €340bn in December, was estimated to have exceeded €355bn, the equivalent of 150% of GDP, in April. By comparison, the government’s annual income is almost one-tenth of that, at around €40bn. …

In an attempt to placate voters, who increasingly have come to identify Greece’s politicians with corruption, he pledged to call a referendum on changes to the “political system” later this year. Reforms would include an overhaul of the constitution and abolishing practices such as the immunity enjoyed by MPs, a source of the discontent that has prompted protestors to scream “thieves” outside parliament as the debt drama has unfolded. The conservative opposition leader, Antonis Samaras, called for Papandreou to step down to pave the way for elections and a renegotiation of the bailout. But Papandreou called for the opposition to “stop fighting in these critical times, stop sending the image that the country is being torn apart”.

The alternative to not lending Greece money might be “disorderly financial and sovereign defaults” according to IMF chief economist Olivier Blanchard. Germany has not closed the door on more taxpayer funded bailouts for Greece to prevent the “unraveling of the euro, which it still sees as the centerpiece of European unification”.

Germany would be a “massive loser” in a Greek default, but it is unclear whether the bailout package now being negotiated will be adequate to the purpose. A third bailout, perhaps in a year’s time may be further necessary in addition to some kind of political union, if the Euro is to be saved.

Irwin Stelzer says that short term European aid will mean that Athens will be liquid, but insolvent; that even if Greek bondholders accept a voluntary rollover of debt, that is a “de facto default” according to Standard & Poor’s. But the larger problem is that many economies are in equally dire straits. It is the fragile state of the world that magnifies the consequentiality of events in Athens. By itself it would be a match sputtering in an ashtray. In today’s world it is a match lit in a power magazine. Now the powder kegs must come to the rescue of the match without allowing the spark to jump. The sole credibility of its rescuers lies not in their relative strength, but because they are perceived as “too big to fail”.  They can’t fail not because they are safe but because their explosion would be too horrible to contemplate.

Outside of the zone both the U.K. and the U.S. have deficit:GDP ratios every bit as high as Greece’s. Britain’s plan to reduce its deficit is threatened by the slowdown in its economy induced by its spending cuts, while the U.S. has no plan at all.

Portugal and Ireland are only avoiding default because of a flow of bailout cash, but have no prospect of repaying their outstanding loans—and would not have even if Greece sovereign debt were triple-A rated: shrinking economies do not produce a robust flow of tax revenues.

Spain, the euro zone’s fourth largest economy, is struggling with an unemployment rate in excess of 20%, undercapitalized regional banks, and an economy that at best barely ekes out a tiny bit of growth. Italy, the zone’s third largest economy has already been warned by Moody’s that its no-growth economy, deficits, and political chaos might lead to a down-rating.

Throw in what appears to be an economic slowdown in America and in Europe, not to mention China, the end of QE2 in the U.S., and worst of all a sudden realization that “too big to fail” might be less of a problem than “too interconnected to fail”—Lehman Brothers was, after all, small potatoes as financial institutions go—and there is ample reason for worry.

The preference for taxpayer bailouts over taking the banks to the cleaners is the notion that in the last analysis, countries can print their own money. “The U.S. situation is most analogous to Japan 20 years ago,” David Wyss, former chief economist at Standard & Poors explained. “We downgraded Japan as well, but bond yields didn’t rise. As long as a country can issue debt in its own currency, the threat of default is remote because it is cheaper to print money than default.”

But there are limits to what even sovereign governments can do.  Zimbabwe and Hungary are two post-war examples of hyperinflation. In order to favor his political cronies, Robert Mugabe collapsed real economic production. At the same time, in order to pay his minions and conduct war abroad, Zimbabwe printed money with reckless abandon. While nobody expects such a thing to happen on an international scale, it does suggest that there is no such thing as “too big to fail.”

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