On the Max Keiser show, I said that Greece has been sent to debtor’s prison. The goal is for creditors to Greece to get as much out of the Greek government as possible before they default. These brazen attempts to heap the lion’s share of the losses onto Greek taxpayers and citizens will eventually backfire and lead to a disorderly outcome.
Right now, the policy is enforce fiscal contraction (a.k.a. fiscal austerity) in the European periphery as a pre-condition for monetising periphery debt until market access is re-gained. I have indicated that the central bank’s buying government paper is about price not quantity. If the ECB committed to a specific spread to Bunds at which it would buy, then it could sustain its programme indefinitely. However, this is unlikely to happen. Instead the ECB is buying just enough bonds to send a message to the Spanish and Italians that they need to live up to their austerity quid pro quo or else the ECB will stop buying.
At a minimum, the ECB wants to prevent ‘free riders’, if they are to move into a quasi-fiscal role. That means the quid pro quo is austerity for purchases. Moreover, institutionally, there is no appetite for capital losses at the ECB and that means buying Greek bonds is something the ECB sees as fraught with peril for the ECB itself.
Ireland is seen as the model here. Nicolas Sarkozy is reported to have said: “Ireland is today a country which is out of the crisis, or on the way out of the crisis“. A leaked Troika document has admitted this policy has failed in Greece. Clearly, these policies were never meant to be expansionary any more than the same programmes in Asia during their debt crisis in the late 1990s. But fiscal consolidation was sold as the solution to Greece’s problems. And that presents the conundrum of deep economic contraction and stagnant or rising debt.
Given the incomplete institutional structure of the single currency area, I think it was always the case that this conundrum would have to be solved via default. The question is who defaults, how much of a haircut bondholders have to take, and whether the default occurs before or after contagion has made the situation considerably worse.
Everyone is still trying to act as if Greece is different and that even there, there should be as small a haircut as possible. You can’t have small haircuts if the debt levels are high, the primary deficit is high and the institutional structure makes the ECB a reluctant bond buyer. Under these pre-conditions, internal devaluation and austerity are the only policy remedies; and that’s an anti-growth outcome in which debt increases. That is a scenario in which yields stay elevated and contagion takes down the banking system. Right now, that’s where we are headed. The Europeans think they can move to a hard restructuring before contagion becomes systemic. I think contagion is already systemic, both in government debt and with banks.
Note, one new proposal developed by the German consulting company Roland Berger and dubbed the Eureka proposal, is really an asset strip; it is based on having the ECB seize Greek assets for sale to pay off creditors. I find these kinds of policy proposals completely counter productive because they will only awaken a justified sense of economic nationalism in Greece, making the likelihood of a nasty and disorderly default greater.
The Europeans need to get religion about bank recaps, bond buying, and growth strategies or it’s game over.
The video is below comparing and contrasting Greece, Ireland and Iceland.
P.S. – I also go on the warpath about the central bank setting interest rates. How on earth are they expected to succeed?
This post originally appeared at Credit Writedowns and is reproduced with permission.