Gianpaolo Rossini - 06/ 2011

The Greek emergency, like Argentina's in 2001, is the result of crippling levels of foreign debt and insufficient reserves for financing both private and public sectors. In Ireland, Portugal and Spain, too, the travails of Greece's public sector are a reflection of a sharp imbalance in respect of external debt and the unwillingness of the rest of the world to finance it. This triggers a hike in interest rates which undermines even healthy public accounts. Overall, Greece, as a sum of public and the private sectors, spends more than it produces, thereby accumulating foreign debt. The lack of liquidity resulting from the crisis in 2008 and 2009 put immense pressure on countries that relied upon foreign capital to finance their public and/or private deficits. Iceland collapsed in a matter of days in 2008 with a negligible public debt (15% of GDP), but an external debt that was three times the country's GDP. In Europe, the problem of Greece emerged after Iceland's in the Spring of 2010. This was due to the different timing of Europe's crisis compared to that of the USA, and the subsequent over appreciation of the euro. The illusion that Europe was a safe financial haven pushed the euro to the point of reaching, by the end of 2009, a value of $1.5. This paradox in our currency has often been highlighted in these pages. Its quotations are acceptable only when Europe is experiencing financial or other difficulties. When Europe's economy is going well, it tends to appreciate in a manner which many Eurozone countries, excluding Germany, the Netherlands, Finland and Austria, find it hard to sustain. Even in these weeks of tension on the currency and financial markets deriving from the Greek crisis, quotations are difficult to sustain and require increasingly stringent adjustments, not only for weak economies with foreign debt, but also for countries with a more solid economic structure whose public accounts are nevertheless exposed, largely because of the measures that are required for economies that find themselves having to deal with an over appreciated exchange rate. In Europe, thanks partly to Germany, which remains unaffected by the over appreciation of exchange rates, public accounts continue to be held responsible. But why do we have written restrictions for the public accounts of one country, and not only in Europe, but complete silence on foreign accounts? The answer is disarming. An ideological approach to economic policy has viewed public debt as Mammon and private debt as innocuous, if not even a vehicle for growth. A less extreme approach says that each foreign debt (for example in Greece) corresponds to a surplus elsewhere (Germany), and that in order for the deficit to be reduced the country with the surplus must be persuaded to spend more because it saves too much. If we focus solely upon the country with the deficit, which is unfortunately customary, it will fall into recession and will end up damaging the one with the surplus too. It matters little whether a country has an external surplus because it is highly competitive and produces the world's most beautiful cars (Germany) or goods for the lower end of the market at cut-throat prices (China). In both cases the country's expenditure is too low and there is too much saving, meaning that there is lower demand in the rest of world, which is forced to pay with bonds, industrial assets or real estate. If, on the other hand, a country's only problem is its public accounts, it means that it has an inefficient public sector or a generous welfare system, which, coupled with low levels of growth, has a detrimental effect on public accounts. This is the case of Japan and Italy, which are weak in terms of public accounts, but healthy on the foreign front. If a country has ongoing problems with its foreign accounts and low unemployment, it spends too much. High foreign debt and unemployment mean that it is not competitive. Greece's problem is double: excessive demand needing to be reduced with public spending and a lack of competitiveness. But how can the latter issue be addressed without abandoning the euro? Certainly with a measure of deflation through a reduction in public spending. But this is not sufficient, as Argentina proved a decade ago, also because deflation cannot be pushed beyond certain limits in democratic systems. How to resolve the stalemate? Some observers, especially Americans like Roubini, believe that the only way forward is to abandon the euro. A strong dose of devaluation would restore Greece's competitiveness, cut foreign and public debt and transform the old-new currency by means of an operation which is neither easy nor a sure-fire success. The cost could be massive for both Greece and Europe, which would be subject to an uncontrollable chain-effect. Greece's exit could signal the end of the euro and the demise of many European institutions, which appear to be excessively removed from the problems of the least wealthy nations. A shocking prospect, but there are those in America who are betting on it, albeit not within the Obama administration. After all, the fall of the euro would restore the dollar to a role of unquestioned primacy as a reserve currency, a privilege which Barry Eichengreen defines as “exorbitant”. There are alternatives to leaving the euro, despite the fact that it is late in the day and the situation is deteriorating badly. It needs to be clear that it is not enough just to pump aid into Greece's public accounts and finance its instability, at least not on the terms we have seen in these past weeks in June 2011. The delays and limitations of the actions taken by the ECB and Ecofin have pushed interest rates on Greek bonds beyond the level of Argentinian bonds in 2001, and the have carried Irish and Portuguese bonds wt them. A far greater financial effort is now required. But if there remains a lot to do on the financial front, other measures must also be thought of. Measures for the financial markets What has been done so far is not enough, as the turning screw of the Greek crisis shows. The first measure that could be introduced is for the auction of Greek government bonds (primary market) to be conducted at rates regulated by the ECB to avoid them reaching critical levels. This is already done in part, but the rates that Greece is paying must be lowered to bring the spread back to reasonable levels. Alternatively, a cheaper solution would be to cover all new Greek bonds with eurobonds, namely European bonds with European ratings, as a sort of securitisation of Greek debt. Intervening on the primary market, however, leaving the secondary market exposed, would be like building a new house without a roof. In order to face the problem seriously, however, a monitored and regulated secondary market of Greek bonds needs to be developed, with ECB assistance, from a pool of major European banks, which must become the market makers. The solution is akin to the big American and British banking consortia which worked on sovereign debt in Latin America in the 'Eighties, or saved the US LTCM fund in 1997. A regulated and monitored secondary market would address Germany's demand to allow private entities to participate in the rescue. The banks themselves would therefore give rise to the secondary market and which it would not be in their interests to attack. Real markets A financial answer is vital, but not sufficient. Real measures are still needed. How can Greece return to competitiveness without resorting to devaluation? There is one policy which would be equivalent to devaluation: to allow Greece for a period of a few years to levy a duty on imports and subsidise exports, which is in fact the textbook alternative to devaluation. Greece would temporarily leave the single market, but not the euro. Revenue from import taxes would go partly into the public accounts, partly into subsidising exports. And Greece's geographical location would make the operation all the easier to accomplish. After all, other EU members have resorted to the Schengen Treaty for far less, and some have never adopted it. Reintroducing border controls would be far less damaging than leaving the euro. Such a measure could be justifiable within the WTO because of its temporary nature and the seriousness of the financial situation which threatens the whole of Europe. Greece needs also to keep its domestic prices under control, and must no longer be conditioned by the higher cost of imports into diverging from the EU mean. A stringent fiscal policy aimed at reining in public debt would contribute to staving off this threat. Furthermore, Greece's main export revenues come from tourism and shipping tariffs, therefore more expensive imports would have a limited effect on the price of exports. But still it is not enough, because Europe cannot allow Germany to continue to build up a foreign surplus that is higher than China's. It is good that Germany is competitive. But if it spends too little while accumulating a surplus, the outcome for the rest of Europe will be disastrous. The Eurozone needs to devise and implement credible plan Bs for ailing economies. Purely financial solutions are not enough for reducing the external imbalances of the Eurozone countries, which are a genuine Achilles' heel for the single currency.

Gianpaolo Rossini (Università di Bologna)