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EU and the PIIGS

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EU and the PIIGS

The title of my blog sounds like a new grunge rock group. While the fiscal crisis might turn out to resemble the lyrics of some of the 1990’s grunge rock songs, we are not quite there yet.

I am going to focus on Greece, one of the PIIGS, since it can serve as the poster child for the leisure-entitlement society which permeates much of the EU and is a source of several of the economic problems facing Greece and the EU. Greece is enmeshed in a fiscal crisis as the government’s budget deficit approaches 13% of GDP and the outstanding government debt exceeds 120% of GDP.

There are three main groups of players in this drama: Greece itself, the creditors (primarily European banks), and the other members of the EU. The question that needs to be addressed is: What costs will each group bear in order to get Greece’s fiscal position back to a more sustainable level?

I start with the creditors. If they are following mark-to-market rules, they already have recorded significant losses on their holdings of the sovereign debt of Greece.  So it stands to reason that they could offer to help by converting their existing holdings, at the current market values, for new debt. This would reduce Greece’s outstanding debt by $40 to $75 billion, and reduce the government’s interest expenses as well. Indeed, the Government of Greece should demand that the creditors take a further loss of 10%, reducing  Greece’s debt by an additional $30 billion.

Even if the creditors agreed to this, the assistance would not be sufficient to resolve the fiscal crisis for Greece. While the creditors should be forced to absorb some losses, they will resist, insisting instead that either the IMF or the EU step in and help Greece. The creditors prefer that either of these two groups reimburse them for the full value of the outstanding debt; that is, either the IMF or the EU should lend Greece the money to repay 100% of the outstanding value of the debt – much like what the U.S. Treasury did with AIG and the counter-parties to AIG’s CDS transactions (in turn, this would enable the creditors to record a substantial gain on their holdings).

The creditors will argue that in the absence of full reimbursement, Greece will not be able to tap the capital markets in the future. This argument is self-serving because they already have recorded losses, and once the fiscal crisis is resolved, the same creditors will be back buying new debt issued by the Greek Government. Thus, the creditors should not be left off the hook. They should make a significant contribution towards resolving the problem.

Next the EU: If the EU were a real political entity, a federation similar to the U.S. for example, the central government of the EU would be paying for a number of health, social and infrastructure programs in Greece. The EU also might provide additional fiscal support to Greece in order to avoid massive layoffs of government employees and an increase in the EU-wide unemployment rate. A substantial portion of Obama’s fiscal stimulus went to state governments to mitigate their fiscal problems and minimize the number of state government employee layoffs.

But the EU is not a real political entity. On the other hand, the fiscal crisis in Greece, by putting downward pressure on the Euro, actually helps all of the EU countries. A depreciation of the Euro should make many companies in the EU more price competitive in the global markets.

Thus, the EU should take a hit as well, and provide financial assistance. The assistance could take the form of buying new debt issued by Greece, and/or of direct transfers to the Greek Government.

Finally Greece itself: Greece will have to bear the brunt of the fiscal adjustment. The government will have to reduce its spending, largely by reducing all entitlements, including guaranteed employment and current wage levels for government employees; and by increasing taxes. The government will have to make a concerted effort to bring the underground economy above ground so that it can pay its share of taxes.

The contributions by the creditors and the EU should provide a cushion that allows the Greek Government to phase in the necessary fiscal adjustments over a period of four to six years. The Greek economy is too fragile at this time to absorb a substantial hit in a very short period.

The opinions expressed in this blog do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.

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