Column: Can’t pay or won’t pay – The Greek gamble

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Updated: February 24, 2015 11:29 AM

Syriza must choose between the extreme but short-lived pain of Grexit and the near-eternal suffering of austerity

Much as expected, Syriza has won the Greek election and formed a government in partnership with an ideologically opposite right-wing party. Syriza won because the Greek people are fed up with their austerity and accepted Syriza’s promise that the austerity will end. Syriza also promised not to accept the bail-out conditions of the troika—EU, IMF and ECB.

Since being sworn-in, apart from a difference of style—no ties and no priests present at the swearing-in, Syriza has not done much more. They have rehired the cleaning staff of the government offices who were sacked as an economy measure and reversed a privatisation planned by the previous government. The prime minister, Alexis Tsipras, and the finance minister, Yanis Varoufakis, have toured European capitals in the hope of renegotiating their debts. They are proposing that a part of the debt be converted into another set of bonds tied to the growth of nominal GDP and for the rest postponed to a farther date. It is unlikely that the creditors will concede. For one thing, some EU governments such as Germany cannot legally accept a downgrading of debt which may result in a nominal loss. Nor can the ECB accept any loss on its assets. Only the IMF may be able if its board agrees to take on the entire debt from all creditors and swap them for the sort of bonds the Greek government would like. It is unlikely, however. While the IMF is not prohibited from such action, any loss will fall on its members some of whom are much poorer than Greece, not to say, also have conducted their financial affairs more responsibly.

There is also the problem that if Greece is let off its obligations, other Eurozone countries who have taken their share of pain and recovered—Ireland, Portugal and Spain—may feel betrayed. Spain has an election coming where the left-wing party, Podemos, is campaigning on an anti-austerity platform, just like the Syriza. The Spanish government can hardly afford to concede to the Greek demands or approve of IMF indulging the Greeks.

If the IMF does not oblige, Syriza faces the unpleasant choice of going back on their campaign promises, (which, though not unusual, may cause a widespread and violent revolt in Greece) or they exit the euro. Grexit, as it is called, is uncharted territory. It would mean that Greece would renege on all its debts. It would exit the euro. It would have then to print its own currency—call it the New Drachma. This would be heavily depreciated. There would be rampant inflation and indeed the population would endure another sort of austerity which would be disguised by a money illusion.

The problem comes with the banks. As of now, the Greek banks and its central bank are all part of the Eurozone and depend upon the ECB for liquidity. If Grexit comes near, depositors would withdraw their euro deposits and send them abroad while Greece is still technically in the euro. Indeed, capital flight has already begun. The ECB has just refused to advance liquidity against Greek junk bonds. It may very soon stop emergency liquidity assistance (ELA) which it can provide to the banks. This is what happened when Cyprus had a banking collapse.

Greece would then be in uncharted territoy. Iceland recently had excessive debts incurred by their private banks, which, after a referendum, the government refused to honour. For a few years, Iceland could not access international bond markets. But soon it recovered and is now a healthy economy. Iceland was however printing its own currency and did not belong to the euro. Greece was a surprise member of the euro zone. It had a notoriously corrupt government and an oligarchy of the rich who never paid any tax. The first decade of the euro was marked by easy credit conditions around the world, and Greece was borrowing at the same rate as Germany. Once the Lehman Brothers crash came, markets began to examine the true risks and the bond yield on Greek debt shot up. Since 2010, Greece has been struggling with its problems. It has yet to reform its fiscal administration and improve its government efficiency. Syriza may be able to do that better than the older establishment parties. If it cuts loose, it will have to raise resources somehow or other. It may just resort to a capital levy or some other confiscatory taxes. There are many wealthy Greeks who have not suffered any austerity.

Such a policy of exit—hardship for five years—has to be compared to 20-30 years austerity which faces Greece now. It is a choice of extreme pain for a short while against almost eternal suffering. If the Syriza government can rely on a feeling of solidarity such as is seen in war times, then the short sharp pain option may yet be grasped. It will annoy the euro zone, but not wreck it.

The author is a prominent economist and Labour peer

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