Greece’s debt: the horror story has only one ending
Originally published Telegraph Online 14 Apr 2010
Solving the crisis in Greece will involve an enormous amount of pain, which Britain will share, says Edmund Conway.
EVEN IF YOU DON’T OWN A HOLIDAY HOME IN EUROPE, I suggest you take a long, hard look at what’s happening in Greece. Athens’s latest wheeze to fill the gaping hole in its public finances is to levy a tax of up to 20 per cent on people who have had extensions built on their holiday villas. And it is hardly a coincidence that the foreigners most likely to suffer – aside from the British – will be the Germans.
Of all the European nations, it is Germany that has been by far the most resistant to bailing out the continent’s perennial profligates. Despite the insistence of EU officials that they have finally clinched a deal to “rescue” Greece, the bail-out is still stuck in what Hollywood producers call “development hell”: the documents are not signed, the money is not yet delivered, and there are even fears that the whole plan may be struck down by the German courts as unconstitutional.
The Greeks complain that to follow the Germans’ advice of solving the problem by slashing their deficit would be foolhardy, and they have a point. While in the long run everyone agrees that Greece should live within its means, if this means shutting down vast parts of its economy in the short run, its tax revenues would implode so fast that even paying the interest on its debts could be beyond its ability. And yet that seems to be the course Germany and the International Monetary Fund are plotting. The proposed villa tax is the perfect rebuke, not merely because it will hit German second home-owners, but because the Greeks can claim they are merely following orders.
But this minor skirmish disguises the real problem, which is that Greece is facing the kind of crisis that invariably ends in default. You can choose the comparison yourself: some think things look all too similar to Argentina at the turn of the millennium; others prefer Russia a couple of years earlier. In both cases, the country, having lost the confidence of external investors, had to be bailed out by the IMF; in both cases, the boost to confidence lasted only a few weeks. Ultimately, the currency collapsed and they defaulted. Roland Nash, head of research at Renaissance Capital, the Moscow-based investment bank, suspects the only reason the “bond vigilantes” haven’t yet attacked is because European governments are slightly less “fair game” than was post-Communist Russia.
The constant in these examples is a country that, for a period, is allowed to live well beyond its means – in most cases by yoking its currency to another, and borrowing like there’s no tomorrow. When tomorrow eventually arrives, investors wise up, realise their money is at risk, and get the hell out of there. Greece is on that precipice: its central bank has reported a rush of cash out of the country as domestic savers move their accounts to other EU nations – and who can blame them, given that they can do so almost for free? The government’s already drastic austerity plans hinge on it being able to borrow at under 5 per cent, but investors are demanding more than 7 per cent. In short, it cannot go on alone much longer. Set against the scale of the problem, the 30 billion euro loan from the EU and IMF is a mere sticking plaster.
One option would be to follow the example of Britain, which managed to erode much of its debt by allowing the pound to fall by a quarter. If the powers-that-be in Frankfurt were persuaded to allow the entire euro to fall enough, thus driving up inflation in Germany, they could avoid both Greek default and the break-up of the currency. This would right the balance between the two countries (in Germany prices are too low, in Greece they are too high, and producers too uncompetitive). The problem, again, is the scale: the euro would have to more than halve in value and Germans would have to accept inflation of around 14 per cent for five years to make the adjustment. Not something politically feasible given the country’s history of hyperinflation.
That this is the least bad option underlines the scale of the problems – which are so vast that any solution is deeply unpalatable. Though the EU’s technocrats deny it, it is quite feasible to imagine Greece defaulting, or – to use lawyer-friendly jargon – restructuring its debt, over the next few years.
Less predictable are the implications for the rest of us. What is certain is that there would be an instant Lehman-style hit to the banks, as those who held Greek sovereign bonds (mainly in Switzerland, Portugal and Ireland) would have to write off chunks of their investments. But the indirect contagion could be far more damaging. Just as the collapse of Lehman Brothers raised questions about the solvency of all banks, so a Greek collapse would turn the spotlight on any country with ugly public finances and an addiction to debt.
Which, inevitably, brings us back home. Everyone knows that, at some point, our Government must tackle the deficit and overhaul the welfare state, which is the largest drain on the public finances. But the speed with which the Greek crisis developed ought to remind our politicians that merely glossing over these issues – as, for the most part, they have in their manifestos – is not good enough. If the voters do not make that clear, the markets soon will.