Greece Should Default
Contrary to consensus market opinion, I’m hoping Greece does fail to seal an 11th hour agreement with its creditors. If it does so, it won’t change any of Greece’s underlying problems and will only “kick the can down the road” a little further.
The International Monetary Fund and the European Commission would be wise not to drag on this saga any more. Both aren’t winning any friends in the process across the rest of Europe and certainly not in Greece.
Meanwhile, Greece cannot hope to pay back its debts. The economy is in depression, has an uncompetitive cost structure that prevents economic recovery and an unstable political system that prevents growth boosting structural reform.
The Greek population still see little the need for reform of their overly generous welfare system and bloated public sector. Avoiding tax is a national past-time.
As such, contrary to any promises that Greece might make during negotiations, the Greek Government will inevitably lack the will or authority to impose any further austerity on its people. After all, whatever tough new measures might be agreed to would need to pass a highly unstable parliament. And chances are some renegade politicians will baulk at the proposed changes, no doubt supported by an electorate that still feels the rest of Europe owes it a living. All that would happen is political breakdown and yet another round of fresh elections would need to be called.
The problem is that both sides know this already – yet are prepared to play out the pantomime just so they can save face at least in the short term and kick the can of problems down the road, hopefully for someone else to worry about later.
So what to do? Greece should simply default - perhaps a managed default in agreement with the IMF and the EU. It might be termed debt forgiveness. In one fell stroke, much of the debt servicing burden – which is at heart of Greece’s remaining fiscal problems – would be lifted. Indeed, excluding debt servicing costs Greece’s is already currently able to meet its most of its domestic spending from current taxes. In other words, it’s running a primary budget surplus.
Under this scenario, it’s not clear to me why Greece needs to leave the Euro zone if it does not want to. Indeed, there seems no legal means by which the rest of Europe can force Greece out even if it wanted to. By the same token, the current Greek Government can’t simply decide to leave the Euro even if it wanted to – a referendum would need to be held, and chances are that decision would be rejected by voters. Greeks still want to be part of the Euro.
Of course, it there’s capital flight and/or Greek banks can’t borrow from the European Central Bank to sustain their operations, capital controls and perhaps even temporary bank nationalisation might need to be considered (even the United States has nationalised some institutions at a time of crisis).
In exchange for debt forgiveness and not trying to force Greece out of the Eurozone (such as by bankrupting its banks), the EU might make one important proviso - it will never again bailout or guarantee repayment of Greek public debt. That should be legislated through the European parliament. It would mean should Greece ever decide to borrow in Euros again, it will have to do so on the open market and pay market rates – much as other countries do when they borrow in US dollars.
Greece will henceforth be required to pay its way. By debt forgiveness but no further official support, Greece will immediately find it has keep financing its general spending programs through its own tax system – or borrow at (likely quite high) interest rates on the open market. The realities of trying to live beyond its means will be quickly come to light and might hopefully creating the catalyst for long overdue reforms to make the economy more competitive.
Of course, this solution will not be pretty either. Greece will face some tough times ahead. But at least it’s a solution. The can will stop being kicked down the road.
David is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR). His has held former roles as senior commentator with The Australian Financial Review, Macquarie Bank interest rate strategist and Federal Treasury economist. He is also author of the online e-book, TheAustralian ETF Guide.