February 28, 2012

Did Greece get bailed out or did it default? A little from column A and a bit from column B

Filed under: Economics, Europe, Government, Politics — Tags: , , , , — Nicholas Russon @ 09:56

Detlev Schlichter explains what happened in the “big fat Greek bailout”:

Greece was bailed out for the second time in four months. Or did it default? Well, a bit of both, I guess.

All bondholders are equal. But some are more equal than others. If you are the ECB, your Greek bonds were exchanged, par for par, for new Greek bonds, and you can go on pretending that they are worth their principal amount. You won’t have to report a loss for now. But if you are a ‘private’ entity — and that is a rather loosely used term these days as it includes the banking industry which is either now partially owned by the state or to a considerable degree dependent on ongoing support from the lender-of-last resort — more than half your Greek investment was wiped out. So Greece defaulted. But as you ‘agreed’ to the ‘haircut’ it was in fact a ‘voluntary restructuring’, although you really had no choice.

[. . .]

I guess we shouldn’t lose sight of the fact that Greece’s economic model is fundamentally unsustainable, whichever way you cut it. Greece has been living beyond its means for a long time, and has managed to do so by flying under air-cover of the EMU project and with the tailwind of cheap credit and easy money. Spending by the Greek state accounts for more than half of registered economic activity, and a third of the workforce is employed by the public sector. ‘Activities’ are being subsumed under the heading of ‘Greek GDP’ that nobody would voluntarily pay for, that are to a large degree wasteful, and that are simply unaffordable under anything but the most bizarrely generous credit conditions, i.e. precisely those that Greece enjoyed from 2001 to 2008. Easy money has been used to paper over grave economic imbalances. Some of what is generously labelled ‘GDP’ should be discontinued — and fast.

To even suggest that such an economic model would be manageable if Greece, a country with about three quarters of the population of metropolitan Los Angeles but with less than half of L.A.’s GDP, only had its own paper currency and could inflate and devalue to its heart’s content, is economically illiterate. No country ever prospered by running budget deficits funded by the printing press or by creating domestic inflation. Devaluing your currency may give your exporters a shot in the arm — for about five minutes. But it scares your domestic savers away for years to come and severely diminishes your ability to keep or attract capital, the backbone of any sustainable economic model. To even try and attempt to ‘inflate away’ a debt load worth 160 percent of a generously calculated GDP would cause economic damage of gigantic proportion. One must have swallowed the Keynesian mythology of deficit-spending whole to believe that the country could borrow and print itself out of this mess. A proper default on its existing debt and rebuilding from a lower base — but with a hard currency — are the better options.

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