Has Greece already defaulted?

The answer is ‘yes’—ostensibly, Greece has defaulted. This de facto debt repudiation follows from several factors: first, the Greek austerity measures are clearly not working given that its GDP contracted 5.5% in 2011Q1 and the debt/GDP ratio rose to 140%; secondly, last Monday the S&P cut Greece’s credit rating to zilch which in effect ends ECB lending; and thirdly, eurozone ministers failed to reach agreement on a new bailout plan and it is unlikely they will do so next Monday. Most importantly, Mr Papandreou’s government is now on its last legs as political protest in Greece escalates.

In consequence, the financial markets have now decided that the country will default. Yesterday (the 15th), the Greek 2-year bond yield jumped to 28%, while (CDS) insurance on Greek debt jumped to the highest level ever recorded. Mr Papandreou’s new government, even if it does not collapse overnight, has little legitimacy and will in all likelihood fail to secure better terms for next month’s 12 billion euro loan. As Heather Stewart tweeted today, every option on the table for Greek ‘restructuring’ looks and quacks like a default – but without the upside of a major write-down. Meanwhile, Irish and Portuguese two-year yields and five-year bond insurance has also jumped to record highs while Spanish and Italian bond markets have been hit too, with Spanish bond yields closing in on highs last seen in 2000.[1] Contagion stalks the eurozone once again, precisely the outcome most feared by all concerned.

What is the likely outcome? There are three possibilities: one is ‘more of the same’ with an uncontrolled financial crisis leading ultimately to the collapse of the eurozone. The second is that Greece, Ireland and Portugal (though not Spain and Italy) will leave the euro while the Germans finally accept that a federal political and economic structure is necessary if the core eurozone is to survive. Finally—the most desirable but (for the moment) least likely outcome—is that the weaker member-states are not forced out while retributive ‘fiscal austerity’ is renounced and the debt is everywhere restructured at the cost of borrowing.

The first alternative at present seems the most likely. The downgrading of Greek bonds to CCC status means that the ECB will no longer accept these as collateral for its lending, in effect cutting off ECB funds to Greece and possibly leading to the collapse of the entire Greek financial system. Equally, some German and French banks (which hold large numbers of Greek bonds) will find that their non-performing Greek assets exceed their equity, and thus will face insolvency. Under these circumstances, contagion and bankruptcy would almost certainly spread to Spain and Italy resulting in a ‘Lehman moment’ which would bring down the euro.

The second alternative is that of a controlled default, meaning that the weakest members would default and leave the eurozone by common consent, while in consequence the strongest would recognise the need for a radical overhaul of its current structure. The central pillar of a new economic architecture would be the creation of an embryonic Eurozone Treasury (Ministry of Finance). This idea was floated earlier in June by Monsieur Trichet himself who added that such a Ministry would also carry out “all the typical responsibilities of the executive branches as regards the union’s integrated financial sector, so as to accompany the full integration of financial services, and third, the representation of the union confederation in international financial institutions.”.[3] The key point, of course, is that a Eurozone Treasury could emit E-bonds jointly guaranteed by all members.

But there is an even better solution—retaining the existing eurozone and changing its architecture. My friend Andrew Watt at the European Trade Union Institute has an excellent piece explaining what the latter would entail.[2] As he argues, the ‘progressive’ view that Greece should default and banks be made to pay—however appealing—misses the point. The real alternative is between forcing retributive fiscal austerity on the peripheral economies or promoting growth. Without growth, their debts will never be brought under control. At present, the EU/IMF loans to the periphery carry a punitive 6% interest rate compounded by a suicidal programme of budgetary cuts. But since the strong eurozone states can borrow cheaply at around 3%, there is no reason why the money cannot be then be lent on the same terms to the periphery at zero cost to the lenders. Indeed, because Greece, Portugal and Ireland between them account for only 6% of Eurozone GDP, it would be preferable for the eurozone countries to pay off the entire debt at a stroke rather than to risk default, contagion and financial crisis (for which we would all pay).

At the end of the day, the reasons for the harsh conditionality and usurious interest rates being imposed on the periphery are purely political, the result of growing populist pressure on the extreme right and the failure of centre-right governments, particularly in Germany, to explain the potential cost of a sovereign debt crisis to their electorates and to take timely avoiding action. A properly designed bailout can be costless. Austerity policies kill growth and jobs in the periphery—and ultimately in the core countries as well.

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[1] See David Oakley ‘Investors bet on prospect of Greek accident’ Financial Times, June 15 2011
[2] See http://www.social-europe.eu/2011/06/eurozone-economics-are-simple-it’s-the-politics-stupid/

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