Greece-- And The Thrifty Dutch... And The Shifty Romney

Wednesday night I had dinner-- at Uncle Nick's on 8th Avenue, a low end Greek restaurant that deserves none of the accolades bestowed on it by a food press desperate for faux-authenticity-- with my old friend Bart and his grandson, Nicky, who are visiting from Amsterdam. Last time I saw Bart, or even heard from him, he didn't have any children, let alone grandchildren. We both worked at a youth center in Amsterdam, de Kosmos. I ran the macrobiotic restaurant. He was the financial controller of the whole institution. So who better to ask about how the Euro crisis that is rapidly coming down the pike in the guise of a Greek (+ Spanish/Portuguese/Italian) default would impact the industrious, thrifty Dutch? Bart said no one knows. That doesn't sound good. The next morning I found someone who does-- Nouriel Roubini ("Dr. Doom," the first guy to warn about the impending mortgage crisis here in the U.S.)-- and his prognosis... lives up to his charming nickname.

Actually, he's being very realistic in his prognosis-- Greece has to leave the Eurozone and default. (I still have a jarful of old drachmas, lira, pesetas, etc. I wonder if they'll ever be accepted as currency again.) He says it's either this year or next for an orderly Greek default. Hard to imagine it would take that long.

Greece is stuck in a vicious cycle of insolvency, lost competitiveness, external deficits, and ever-deepening depression. The only way to stop it is to begin an orderly default and exit, coordinated and financed by the European Central Bank, the European Union, and the International Monetary Fund (the “Troika”), that minimizes collateral damage to Greece and the rest of the eurozone.

Greece’s recent financing package, overseen by the Troika, gave the country much less debt relief than it needed. But, even with significantly more public-debt relief, Greece could not return to growth without rapidly restoring competitiveness. And, without a return to growth, its debt burden will remain unsustainable. But all of the options that might restore competitiveness require real currency depreciation.

The first option, a sharp weakening of the euro, is unlikely, as Germany is strong and the ECB is not aggressively easing monetary policy. A rapid reduction in unit labor costs, through structural reforms that increased productivity growth in excess of wages, is just as unlikely. It took Germany ten years to restore its competitiveness this way; Greece cannot remain in a depression for a decade. Likewise, a rapid deflation in prices and wages, known as an “internal devaluation,” would lead to five years of ever-deepening depression.

If none of those three options is feasible, the only path left is to leave the eurozone. A return to a national currency and a sharp depreciation would quickly restore competitiveness and growth.

Of course, the process would be traumatic-- and not just for Greece. The most significant problem would be capital losses for core eurozone financial institutions. Overnight, the foreign euro liabilities of Greece’s government, banks, and companies would surge. Yet these problems can be overcome. Argentina did so in 2001, when it “pesofied” its dollar debts. The United States did something similar in 1933, when it depreciated the dollar by 69% and abandoned the gold standard. A similar “drachmatization” of euro debts would be necessary and unavoidable.

Losses that eurozone banks would suffer would be manageable if the banks were properly and aggressively recapitalized. Avoiding a post-exit implosion of the Greek banking system, however, might require temporary measures, such as bank holidays and capital controls, to prevent a disorderly run on deposits. The European Financial Stability Facility/European Stability Mechanism (EFSF/ESM) should carry out the necessary recapitalization of the Greek banks via direct capital injections. European taxpayers would effectively take over the Greek banking system, but this would be partial compensation for the losses imposed on creditors by drachmatization.

Greece would also have to restructure and reduce its public debt again. The Troika’s claims on Greece need not be reduced in face value, but their maturity would have to be lengthened by another decade, and the interest on it reduced. Further haircuts on private claims would also be needed, starting with a moratorium on interest payments.

Some argue that Greece’s real GDP would be much lower in an exit scenario than it would be during the hard slog of deflation. But that is logically flawed: even with deflation, real purchasing power would fall, and the real value of debts would rise (debt deflation), as the real depreciation occurs. More importantly, the exit path would restore growth right away, via nominal and real depreciation, avoiding a decade-long depression. And trade losses imposed on the eurozone by the drachma depreciation would be modest, given that Greece accounts for only 2% of eurozone GDP.

Reintroducing the drachma risks exchange-rate depreciation in excess of what is necessary to restore competitiveness, which would be inflationary and impose greater losses on drachmatized external debts. To minimize that risk, the Troika reserves currently devoted to the Greek bailout should be used to limit exchange-rate overshooting; capital controls would help, too.

Those who claim that contagion from a Greek exit would drag others into the crisis are also in denial. Other peripheral countries already have Greek-style problems of debt sustainability and eroded competitiveness. Portugal, for example, may eventually have to restructure its debt and exit the euro. Illiquid but potentially solvent economies, such as Italy and Spain, will need support from Europe regardless of whether Greece exits; indeed, without such liquidity support, a self-fulfilling run on Italian and Spanish public debt is likely.

The substantial new official resources of the IMF and ESM-- and ECB liquidity-- could then be used to ring-fence these countries, and banks elsewhere in the eurozone’s troubled periphery. Regardless of what Greece does, eurozone banks now need to be rapidly recapitalized, which requires a new EU-wide program of direct capital injections.

The experience of Iceland and many emerging markets over the past 20 years shows that nominal depreciation and orderly restructuring and reduction of foreign debts can restore debt sustainability, competitiveness, and growth. As in these cases, the collateral damage to Greece of a euro exit will be significant, but it can be contained.

Like a doomed marriage, it is better to have rules for the inevitable divorce that make separation less costly to both sides. Make no mistake: an orderly euro exit by Greece implies significant economic pain. But watching the slow, disorderly implosion of the Greek economy and society would be much worse.

How lucky were the Turks that they never were accepted into this nightmare scenario? They're certainly having the last laugh now! Austerity without growth is the mean-spirited conservative consensus and even obvious failure isn't moving the needle-- at least not among the delusional bankster-class. And there are a significant number of low-info American voters-- Republicans-- eager to embrace this in the form of a economically and fiscally clueless con man. Mixing David Korten with Roubini may seem like oil and water but in his book, Agenda For a New Economy Korten advocates steep taxes on sociopathic behavior by hedge fund managers and Wall Street banksters. When confronted by the argument that these taxes will retard "financial innovation," Korten blurts out what every sane American has come to realize since he wrote his book:

Good. That is the intention. We should not be providing incentives to financial predators to come up with ever more innovative forms of theft.

Amen! And there has never been a candidate who has represented this class of financial predator more thoroughly than Mitt Romney, destroyer of businesses and destroyer of lives on the alter of quick turnover greed and avarice. Romney truly is the culmination of financial evil in a capitalism adrift from its moorings. Like Wall Street, the Romney model "doesn't develop its business plans to meet our needs; it develops its plans to place us in a position of dependence on Wall Street products that afford it the greatest opportunity to profit at our expense." But, as the Romney team was pointing out loudly as I was blogging this, at least he's white. Korten never mentioned Romney or his financial backers by name here but... well, draw your own conclusions:

Real investors commit funds and entrepreneurial energy to creating and growing businesses. People who buy and sell pieces of paper in hopes of making unearned gains on price movements are engaging in speculation, otherwise known as gambling, and those who hold the bets and distribute the winnings are bookies or dealers. Simply using honest language would help distinguish between real investors creating real wealth and speculators creating financial wealth with financial games.