Greece's Deal with the Devil

So far the EU elite refuse to discuss successful restructuring techniques in past emerging market crises. The markets presently see 80% prospects of a Greek default. Their emotional outbursts against default or debt restructuring are directly related to their exposure to sovereign toxic debt and weak balance sheets. After their own meltdown in 2008, the U.S. authorities want to keep this mess under the rug as long as possible, basically turning over the IMF to them as a European bad bank.

As it stands presently, there are basically two trends of thought. The EU elite seem intent on the EU public sector picking up an ever-increasing share of Greek sovereign debt. In a few years’ time, there will be one sole public creditor with the private creditors paid off and Greece will have a very high debt to GDP ratio, likely in excess of 200%. There is no clear plan thereafter what to do about this mountain of debt. There is a vague hope that somehow Greece will grow its way out of the debt. Structural reforms have been discussed for the last 20 years in Greece, but the many stakeholders in the present system create substantial resistance to change. Locked into a hard euro and compulsory wage and price deflation, it is hard to see from where this growth will come.

The other school of thought comes mainly from American economists like Simon Johnson, Nouriel Roubini, and Paul Krugman, heavily influenced by the disorderly Argentine debt default and emerging market debt restructuring. They have support from German economists concerned about Greek debt sustainability and capacity to repay. They call for orderly and coercive debt restructuring as soon as possible to remove the default risk and provide relief from the huge debt overhang.  Such action may make the structural reforms more palatable, gaining the good will of the Greek public with burden sharing and allowing more gradual adjustment. Both structural reforms and debt renegotiation are necessary conditions to resolve the Greek debt crisis.

Unless the EU elite realize that they must meet periphery needs, the divergence between the core and periphery will grow so large that it may lead to a breakup of the currency zone. It may take generations to restore the credibility of EU institutions after such an aftermath. Moody's in the latest downgrade of Portugal cited poor EU crisis management as a major risk factor, angering many EU politicians. The truth frequently hurts.