There's no way out for Greece

By Mike Whitney

May 24, 2011
"Information Clearing House" -- Stocks plunged on Monday as Europe's sovereign-debt crisis deepened and bond yields across the EU periphery headed sharply higher. The euro fell hard against the dollar ($1.40) while the Greek 10-year bond spiked to 17 percent before mounting a modest comeback. The situation is getting desperate. Most economists now believe that Greece will have to restructure its debt. But bondholders are doing everything they can to make sure that doesn't happen because they stand to lose billions on their investments. So, they've thrown their weight behind ECB chief Jean-Claude Trichet, EU policymakers, and the IMF, all of which are trying to pressure Greece to accept harsher austerity measures in order to avoid default. But the plan isn't working. Greece's finances are getting worse by the day. Something will have to be done soon or Greece's troubles will send markets into a nosedive.

The problem is simple; the current belt-tightening policy has failed, so it's time to move on to Plan B. But the folks in charge don't want to change policies because then the banks (who own a large share of the bonds) would take a hit on their investments. So, the fiasco drags on while the debts pile up and while peaceful street demonstrations turn into violent conflagrations. The bigwigs at the EU and ECB would rather see cities across the continent descend into a bloody free-for-all than lose one euro on their original investment. Here's how economist Mark Weisbrot sums it up:

"The peripheral European countries are stuck in a currency union where their monetary policy is dictated by the European Central Bank (ECB), which is far to the right of the U.S. Federal Reserve and has little interest in helping them. Since they have adopted the Euro, they also do not control their exchange rate, and their fiscal policy is going in the wrong direction...

This does not make any economic sense, except from the point of view of creditors that want to make sure that these countries are punished for their “excesses” – although for the most part, it was not over-borrowing but the collapse of bubble growth and the world financial crisis and recession that brought them to this situation. Unfortunately, the view of the creditors is that which prevails among the European authorities....

When will it end? So long as these governments are committed to policies that shrink their economies, their only hope is that the global economy will pick up steam and pull them out with demand for their exports. This does not look likely in foreseeable future – the rest of Europe is not growing that rapidly and the U.S. economy is still weak." ("Eurozone’s Periphery Needs to Challenge Right-Wing European Authorities", Mark Weisbrot, CEPR)

What Greece needs is a way to dig out, which means debt forgiveness and a hefty fiscal stimulus package to rev up activity and put people back to work. Unfortunately, the EU doesn't have a mechanism for delivering fiscal aid to the weaker states. All they can do is extend loans to the struggling members and encourage them to slash domestic spending as much as possible. But that just increases unemployment, decreases revenues and makes and even bigger hole. The whole process just fuels public outrage which further exacerbates the economic troubles. The best thing to do is nip the problem in the bud; figure out what needs to be done and then do it. By dragging their feet, the ECB and IMF have only increased the chances of another meltdown.

So, what would happen if Greece defaulted on its debt? Would it be as bad as Lehman Brothers? Here's an excerpt from The Guardian:

"If Athens reneged on its debts it would shatter the markets' confidence in the eurozone project... Given the structure of modern financial markets, with their chains of derivative trades and their pyramids of debt, there is only one answer. Greece could certainly be the next Lehmans. The likelihood that a Greek default would pose a threat to the future of the eurozone as well as to the health of the world economy means it has the potential to be worse than Lehmans. Much worse...." ("Could Greece be the next Lehman Brothers? Yes – and potentially even worse", The Guardian)

If Greece goes under, then it could take Portugal, Ireland and (perhaps) Spain along with it. So why is ECB chief Jean-Claude Trichet dilly-dallying? Does he really think the problem is just going to go away? And why did French Finance Minster Christine Lagarde (who is the leading candidate to replace ex-IMF chief Dominique Strauss-Kahn) announce that "that a rescheduling or reprofiling of Greek debt is NOT an option (and that) executing the planned austerity program, proper implementation of privatization, and commitments across the political spectrum in Greece are the key for a solution in Greece" ("France's Lagarde: Option Of Rescheduling Greek Debt Not On Table", Wall Street Journal)

Talk about throwing gas on a fire?!? Does Lagarde want to kick off her appointment by sending the markets into freefall? Is that what she's up to?

Things are looking bleaker and bleaker for Greece. Bond yields are widening, the red ink is rising and the ECB is as inflexible as ever. There's a good chance that policymakers will push this austerity-thing too far and bring the whole EU crashing down around them.