Monday, February 8, 2010

Coulda Seen This One Coming

. Monday, February 8, 2010


But the problem is not only the numbers; it is one of credibility. Thanks to decades of low investment in statistical capacity, no one trusts the Greek government’s figures. Nor does Greece’s default history inspire confidence.

As demonstrated in my recent book with Carmen Reinhart This Time is Different: Eight Centuries of Financial Folly, Greece has been in default roughly one out of every two years since it first gained independence in the nineteenth century.

It's bad:

Most Greeks are taking whatever action they can to avoid the government’s likely insatiable thirst for higher tax revenues, with wealthy individuals shifting money abroad and ordinary people migrating to the underground economy. Greece’s underground economy, estimated to be as large as 30% of GDP, is already one of Europe’s biggest, and it is growing by the day.

In the case of Argentina, a pair of massive IMF loans in 2000 and 2001 ultimately only delayed the inevitable harsh adjustment, and made the country’s ultimate default even more traumatic. Like Argentina, Greece has a fixed exchange rate, a long history of fiscal deficits, and an even longer history of sovereign defaults. Nevertheless, Greece can avoid an Argentine-style meltdown, but it needs to engage in far more determined adjustment.

One might think that the socialist government would not have the political will to make the necessary adjustments. And they might not. But there is some literature showing that left parties are more able to push through adjustment programs than right parties, precisely because it runs against their ideology: it's a costly signal with a high degree of credibility behind it.

To me the most interesting thing is not the potential for default; as Rogoff says, this is common even in Greece. What interests me is to see the interplay between the Greek government, the EU, and the IMF. The IMF seems ready and willing to jump in, but the EU wants to maintain credibility. At the same time, the EU doesn't want to create moral hazard, so they favor internal adjustment over a bailout, and are pressuring the Greek government to enact those policies. As Edward Hugh says, the EU is acting like a "local 'mini-IMF'" towards Greece after not having done the same with Hungary, Latvia, and Romania.

The roles of supranational and international institutions may be changing in important ways. This is worth keeping an eye on.


CrisisMaven said...

In and of itself a Greek bankruptcy or bond default should -in theory- not affect the Euro as such very much, Greece being maybe 3% of the total. However, just as a Californian bankruptcy (probably inevitable, large US cities at least are already contemplating insolvency, ten idividual states may well follow) would reflect badly on the "state of the Union" as a whole so would the default of on EU country, coupled with the rising interest rates and thus further destabilisation of the remaining over-leveraged member states, make investors wonder when sovereign default across the board is likely. Thus they wouldn't commit themseves to bonds of longer maturity and that's the beginning of the end.

Coulda Seen This One Coming
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