In truth, Greece does have an alternative. Instead of submitting to the ferocious and pro-cyclical conditionality imposed by Germany and the IMF – cutting its budget deficit by 11% over three years in return for a €120bn (£104bn) loan – it could follow Argentina’s example in 2001-02, and default on the bulk of its sovereign debt. This would mean abandoning the euro, introducing a “new drachma” and probably devaluing by 50% or more.
Some weeks ago, I had a private exchange about this scenario with Mark Weisbrot of the Centre for Economic Policy Research in Washington. He favoured Argentinian-style default; I did not. But given Angela Merkel’s politically motivated foot-dragging, the failure of the European Central Bank to deal with the problem at an earlier stage and the strongly pro-cyclical nature of the cuts required, I am having second thoughts.
Eight years ago, Argentina defaulted on the major part of its sovereign debt and survived quite well. Many economists predicted that Argentina’s debt default would result in currency collapse, hyperinflation and even greater economic contraction than it had endured during its 1999-2002 recession. Instead, after the 2001-02 debt default and subsequent devaluation against the dollar (from 1:1 to 3:1), GDP grew at over 8% per annum over the period 2003-2007 and annual inflation fell from over 10% per month in early 2002 to less than 10% per annum. By 2005, Argentina had sufficient reserves to allow President Néstor Kirchner to pay off its remaining $9.8bn (£6.4bn) loan from the IMF in full and discontinue its programme with them.European leaders would do well to read up on the Asian, Russian and Latin American financial crises of 1997-2002. The Nobel laureate Joseph Stiglitz famously published an open letter citing his reasons for resigning from his post of chief economist at the World Bank. Among his criticisms of the bank and the IMF was the imposition of drastic deflationary measures on Thailand and Korea in 1997, and on Russia in 1998, mainly to protect the balance sheets of private western banks. The conditionality imposed was paid for dearly by cuts in economic and social expenditure thrust on ordinary citizens.
A central lesson of all this is that unless protective action is taken early, a country can rapidly be overpowered by the financial markets. Once traders start betting against a country’s bonds or its currency, the herd instinct takes over. Greece’s budget deficit is not particularly high by world standards – 13.6% versus 11% in the UK, and 12.3% in the US. But traders perceived its sovereign debt structure as too risky and prophecies of doom became self-fulfilling. There is a further problem. The spending cuts needed to meet the government’s deficit target will undermine Greek government revenues. As an economist at London-based Capital Economics put it: “The key risk to its target is that deeper recession will lead to lower tax revenues, offsetting some of the savings that the government expects to make as a result of its fiscal tightening.” In short, even though the bailout package has been agreed, the cuts may prove counterproductive and Greek recovery is far from assured.
The ECB could have nipped this crisis in the bud several months ago, both by continuing to accept Greek government bonds as collateral and by quantitative easing. Although the ECB had used quantitative easing to bailout the EU banking system, it refused to do so for Greece. There are clear signs that contagion is spreading to Portugal, and possibly to Spain and Italy. Can the ECB really be counted on in future to prevent the gradual unravelling of the euro?
As the French economist Jean-Paul Fitoussi argued in a recent interview in Libération, even if the Greek crisis is successfully contained for a time by an EU-IMF package, the financial markets will hope to profit by squeezing other European countries. Meanwhile, ordinary Greeks are taking to the streets to protest against further draconian austerity measures, while the EU’s political class continues to focus entirely on its narrow domestic interests. Here in Britain, a bemused electorate apparently has not yet woken up to the nature and magnitude of the cuts we will almost certainly suffer as a result of the 2008 bank bailout. Most important, we have not begun to question seriously whether placating the financial markets by means of such cuts is unavoidable. Perhaps it’s time to start thinking the unthinkable: namely, that financial markets should be our servants, not our masters.