Q&A: Greece's debt crisis

by Aditya Chakrabortty

Guardian
July 31, 2011

Just how bad is the Greek economy?

Of all the economic horror stories produced since the banking crisis, Greece must be the most frightening. It has easily the worst economy out of all the 16 nations in the eurozone. The country is in its third-straight year of recession, with national income on course to plunge by nearly 5% in 2011 – and to fall further in 2012. Fifty-thousand businesses closed last year, and unemployment has shot up. Over one in six workers are out of a job, and 40% of young people can't get into the labour market. That's not all: George Papandreou's government is more heavily indebted than Silvio Berlusconi's administration in Italy, which is some feat. Ministers in Athens have spent much of the past 18 months unsure whether they will be able to borrow enough from financial markets or other governments even to pay social security cheques and their own civil servants.

How did this happen?

That question has as many answers as Greece has islands. But to keep it simple: soon after getting elected in autumn 2009, the leftwing Pasok government discovered that the public finances had been fiddled: a budget deficit of 3.7% of national income was in fact touching 14%. This would have been bad at any time, let alone in the wake of the near-collapse of the banking system. Big investors who Athens would normally have approached for a loan, in return for a government bond, would only lend at punitive interest rates – or not at all. After much foot-dragging, the European commission, the IMF and the European Central Bank (otherwise known as the troika) agreed in May 2010 to lend Greece €110bn (£96bn). The deal had three big problems. It was far too late; the loan was offered at an interest rate of about 5% – five times the official ECB rate; and the cash came with a series of tough demands on Athens to slash state spending and jack up taxes. Papandreou could barely afford the loan, and his attempts to implement the troika's austerity plans have depressed the economy further and met with ferocious popular opposition, with strikes and huge demonstrations in Athens and elsewhere.

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Greece debt crisis: The 'we won't pay' anti-austerity revolt

by Angelique Chrisafis

Guardian
July 31, 2011

Among the chic bars along Thessaloniki's historic waterfront, one restaurant stands out. "We want our money!" reads a banner dangling from the terrace of an American-themed diner and grill. Inside, 12 staff have changed the locks, are serving cans of supermarket beer to supporters and taking it in turns to sleep nights on the restaurant floor in protest at months of unpaid wages and the restaurant's sudden closure. This is the new symbol of Greece's spiralling debt crisis: a waiters' squat.

Margarita Koutalaki, 37, a softly spoken waitress, divorced with an 11-year-old daughter, worked here part-time for eight years, earning about €6.50 (£5.70) an hour. Now she is taking turns to sleep on an inflatable mattress in an upstairs room, guarding the squat, while her parents babysit her child.

"I'm owed about €3,000 in unpaid wages," she says, warning her plight is shared by legions of workers all over Greece who are waiting for months for outstanding pay from struggling business owners. "At first we were told we'd be paid the following month, then the pay stopped completely and we were told by phone that the restaurant was closing. We're still working, we're keeping the place going, providing food and drinks to our supporters. We've got more clients than before. This protest is all we can do. It comes naturally."

The waiters serve cheap drinks and cut-price dinners to a new clientele of leftists and protesters from the four-month-old "indignants" movement, who would previously never have set foot in this bastion of imperialism, the Greek franchise of US giant Applebee's. A banner in English tempts tourists with cheap souvlaki and meatballs "in support of the workers".

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Europe’s Sovereignty Crisis

by Joschka Fischer

Project Syndicate
July 31, 2011

Finally, German Chancellor Angela Merkel has accepted a new form of European Union. More than ever, the EU must combine greater stability, financial transfers, and mutual solidarity if the entire European project is to be prevented from collapsing under the weight of the ongoing sovereign-debt crisis.

For a long time, Merkel fought this new EU tooth and nail, because she knows how unpopular it is in Germany – and thus how politically dangerous it is to her electoral prospects. She wanted to defend the euro, but not to pay the price for doing so. That dream is at an end, thanks to the financial markets.

The markets issued an ultimatum to Europe: either embrace more economic and financial integration on a federal basis, or face the collapse of the euro and thus the EU, including the Common Market. At the last moment, Merkel chose the sensible option.

Had the European Council’s heads of state and government taken this foreseeable decision a year ago, the euro crisis would not have escalated to the extent that it has, the total bill would have been lower, and European leaders would have been rightly praised for a historic feat. But, as I said, back then Merkel did not dare to act.

The agreement at the most recent European Council will be more expensive, both politically and financially. Despite doubling financial aid and lowering interest rates, the agreement will neither end the Greek debt crisis and that of other countries on the European periphery, nor stop the EU’s associated existential crisis. It will only buy time – and at a high cost. Further aid packages for Greece may seem impossible to avoid, because the losses imposed on Greek debt holders have been too modest.

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A hapless union has lost its direction

by Edward Chancellor

Financial Times
July 31, 2011

There are many economic challenges around the world today. The US teeters on the brink of default, deleveraging continues across the west, cracks are appearing in China’s fixed asset investment boom, Japan remains stuck in the deflationary doldrums, while inflation is picking up in emerging markets. None of these problems, however, is as intractable as those facing the eurozone.

It is common to view Europe’s woes in terms of a crisis of public finances. Greece, after all, owes a lot of money to its European neighbours. The markets have also started to question Italy’s sovereign debt, which is currently around 120 per cent of GDP. Yet rising credit spreads among the periphery of Europe are a symptom of deeper troubles within the monetary union.

After all, other nations have proven capable of sustaining larger public debts. Britain’s ratio of government debt to GDP exceeded 250 per cent after the Napoleonic Wars. More recently, Japan’s large domestic savings have supported a public debt that now exceeds 200 per cent of GDP.

By contrast, Europe’s stricken periphery is characterised by low savings. The savings rate in Greece and Portugal in recent years has been insufficient to sustain economic growth let alone finance their fiscal deficits. Italy’s savings rate appears to be in structural decline as its population ages. Spain and Ireland have a better record on this front, but they frittered away a great deal of their savings on their housing bubbles. Countries which save too little and invest poorly are likely to experience weak economic growth.

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In an ideal world, Kafka would restructure Greece

by John Dizard

Financial Times
July 31, 2011

With this comprehensive set of measures, approved at the eurozone summit, we prevented Greece’s sovereign debt crisis from becoming a crisis that could damage the eurozone as a whole, and the euro as a consequence. But we are not naive.François Baroin and Wolfgang Schäuble, FT July 28 2011

The right understanding of any matter and a misunderstanding of the same matter do not wholly exclude each other.
Franz Kafka (1883-1924) – The Trial (Der Process) 1925

Usually, in the hierarchy of proposed stories facing any editor, strong joint statements of principle by continental leaders on the critical issue of the day will be at the top of the list, and new client assignments by law firms would be at the bottom, if anywhere at all. However, in the present Greek crisis, that order should probably be inverted.

Last week, it was announced that Cleary Gottlieb, the New York headquartered international law firm, had been engaged by the Hellenic Republic. I believe this tells us a lot about the direction euro area finance will take.

In an ideal world, Franz Kafka, trained in the law of the Austro-Hungarian Empire, would still be available to work on the Greek government’s restructuring issues. Anyone involved in the country’s workout, or observing it closely, would agree that he would have brought the most appropriate perspective to dealing with European and multilateral institutions. His alleged schizoid disorder would be a feature, not a bug, as we say now.

Instead, the Cleary team working on Greece will be headed by Lee Buchheit, the partner who has previously represented Iceland, Argentina, etc, etc. Trusted by distressed governments, cursed by former optimists with long positions, his is the mobile number of choice for sovereigns that believe they have unsustainable debt burdens.

Mr Buchheit published his strategy on restructuring Greece for the world to read in April of last year, along with his co-author Gaurang Mitu Gulati of Duke Law School, in a professional journal article called “How to Restructure Greek Debt”. People who spend their days cultivating Brussels and Frankfurt insiders should take a look at it.

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Read the Paper

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Τι σηματοδοτεί το δεύτερο πακέτο στήριξης

τoυ Nίκου Oικονομίδη

Καθημερινή
31 Ιουλίου 2011

Οι δύο προηγούμενες εβδομάδες ήταν εξαιρετικά κρίσιμες για το μέλλον της ελληνικής οικονομίας, και αποδείχθηκαν ιδιαίτερα μαύρες. Εχοντας δημόσιο χρέος πάνω από 150% του ΑΕΠ, η Ελλάδα χρειαζόταν μια πολύ σημαντική μείωση του δημοσίου χρέους της τάξης του 50% που θα το έφερνε στα επίπεδα 60-90% του ΑΕΠ, που είναι βιώσιμα για την ελληνική οικονομία. Αντί για την αναγκαία μείωση 50%, το β΄ πακέτο αναφέρει μείωση του χρέους της τάξης του 20%. Προσεκτική ανάλυση των όρων του πακέτου από αναλυτές της Μπάρκλεϊς και άλλων τραπεζών δείχνει ότι στην πράξη το «κούρεμα» θα είναι πολύ μικρότερο, κατά μέσο όρο περίπου 9-10%. Ομως, όταν τα ελληνικά ομόλογα ανταλλάσσονται στην αγορά κατά 30-40% κάτω από την ονομαστική τους αξία, γιατί δέχεται η Ελλάδα να πληρώσει τους ιδιώτες δανειστές 20-30% παραπάνω από τις τιμές στην αγορά; Μπορεί να μας εξηγήσει η κυβέρνηση γιατί δίνει στους ιδιώτες δανειστές μπόνους 30-50 δισ. ευρώ στη διαδικασία ανταλλαγής;

Τι σημαίνει το β΄ πακέτο; Η Ελλάδα έχασε ίσως την τελευταία ευκαιρία να βγει από την κρίση. Μετά το β΄ πακέτο, οι τόκοι του χρέους θα είναι κάθε χρόνο 18-20 δισ. για τριάντα χρόνια, δηλ. 9-10% του ΑΕΠ ή 25% των εσόδων του κράτους. Για να το καταλάβουμε καλύτερα, το Δημόσιο που σήμερα έχει ετήσιο έλλειμμα ίσο με 25% των εσόδων του, θα χρειάζεται από εδώ και μπρος να έχει ετήσιο πλεόνασμα μεγαλύτερο από 25% των εσόδων του, γιατί μόνο οι τόκοι του χρέους θα κοστίζουν 25% των εσόδων. Ακόμα κι αν όλες οι μεταρρυθμίσεις πετύχουν (και είναι απαραίτητο να γίνουν), είναι εντελώς απίθανο να μπορεί η Ελλάδα για τα επόμενα τριάντα χρόνια να πληρώνει αυτά τα ποσά. Η κρίση και η ύφεση παρατείνονται για πολλά χρόνια ακόμα και βρισκόμαστε μόνο στη δεύτερη πράξη της τραγωδίας του ελληνικού χρέους. Ετσι όπως πάνε τα πράγματα, η τρίτη πράξη, σε ένα έτος ή και νωρίτερα, με πραγματική χρεοκοπία (όχι επιλεκτική) θα είναι πραγματικά καταστροφική.

Γιατί χάθηκε κι αυτή η ευκαιρία; Δύο είναι οι βασικοί λόγοι. Πρώτος, η Ελλάδα ποτέ δεν εκπόνησε σχέδιο για τη μακροχρόνια βιωσιμότητα της ελληνικής οικονομίας. Χωρίς σχέδιο, εθνική στρατηγική για το χρέος και στοιχεία, η Ελλάδα δεν πήγε ποτέ στην Ε.Ε. να πει την αλήθεια, ότι αν δεν μειωθεί το χρέος της κατά πολύ (50%) δεν θα μπορέσει ποτέ να το αποπληρώσει. Αντίθετα η ελληνική κυβέρνηση έκανε τον όρο «χρεοκοπία» ταμπού για 20 μήνες. Ετσι δεν δημιούργησε στρατηγική για το πιο μεγάλο πρόβλημα της ελληνικής οικονομίας. Δεύτερος λόγος. Η Ελλάδα ποτέ δεν διαπραγματεύτηκε το χρέος με τους δανειστές της. Στις διαπραγματεύσεις για το δεύτερο πακέτο στήριξης, η Ελλάδα ήταν απούσα. Η Ελλάδα δεν είχε τη δική της πρόταση για το χρέος και δεν ήταν παρούσα στις διαπραγματεύσεις. Το πακέτο συμφωνήθηκε μεταξύ Γερμανίας, Γαλλίας και ΕΚΤ και μετά ανακοινώθηκε στην Ελλάδα. Ετσι, δεν είναι καθόλου παράξενο που οι όροι του β΄ πακέτου είναι ιδιαίτερα συμφέροντες για τις ευρωπαϊκές τράπεζες και ιδιαίτερα επαχθείς για την Ελλάδα.

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Επτά μαθήματα για την κρίση

του Λουκά Τσούκαλη

Καθημερινή
31 Ιουλίου 2011

Με αφορμή την ευρωπαϊκή σύνοδο της 21ης Ιουλίου, προτείνω επτά γενικά συμπέρασματα-μαθήματα που ίσως φανούν χρήσιμα για την περαιτέρω αντιμετώπιση της κρίσης.

Πρώτο μάθημα, για όσους βιάστηκαν να ξεγράψουν την Ευρώπη. Συνεχίζει μεν να βρίσκεται ένα-δυο βήματα πίσω από τις εξελίξεις στις περιβόητες αγορές, αλλά μπορεί ακόμη να παίρνει αποφάσεις που θεωρούνταν αδιανόητες μέχρι πρόσφατα. Η Νομισματική Ενωση αλλάζει ουσιαστικά, χωρίς στρατηγικό σχέδιο, αλλά κυρίως με σειρά μέτρων πυροσβεστικού χαρακτήρα. Το πολιτικό σύστημα της Ε.Ε. δυσκολεύεται, αγκομαχάει. Να δεχθούμε τουλάχιστον ότι η πρόκληση που αντιμετωπίζει είναι χωρίς προηγούμενο.

Δεύτερο, παραμένουν πολλές ασάφειες και ερωτήματα στα συμπεράσματα του Συμβουλίου, κυρίως όσον αφορά τη συμμετοχή του ιδιωτικού τομέα. Αυτό ήταν και το πιο αμφιλεγόμενο κομμάτι του πακέτου. Η ασάφεια δεν είναι τυχαία, αν και η υλοποίηση των αποφάσεων θα είναι από μόνη της εξαιρετικά περίπλοκη.

Τρίτο, οι αποφάσεις του Συμβουλίου είναι εξαιρετικά σημαντικές για την Ελλάδα, πολύ λιγότερο για την υπόλοιπη Ευρωζώνη. Το επιχείρημα (ευχή;) ότι η Ελλάδα είναι μια πολύ ειδική και μεμονωμένη περίπτωση θα αποδειχθεί πιθανότατα στην πράξη αβάσιμο (ίσως πιο σύντομα από όσο αντέχει η Ευρώπη). Η μάχη πολιτικής και αγορών μπαίνει σε νέα, ακόμη πιο επικίνδυνη, φάση.

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Europe on the Brink

by Peter Boone and Simon Johnson

Peterson Institute for International Economics
Policy Brief 11-13
July 11, 2011


Europe’s efforts to stabilize its finances are failing, and the region needs to prepare for widespread restructuring of sovereign and bank debt. Peter Boone and Simon Johnson argue that Europe’s financial system has relied on a policy of protecting creditors from default and has thus spread pervasive moral hazard—a presumption by creditors that they will not take losses on their loans to Greece and other ailing countries. The authors argue that this situation is no longer tenable and examine three possible scenarios for the coming months as the sovereign debt crisis evolves. Under the first scenario, the euro area would try to reassert its commitment to avoid defaults and inflation. This continuation of the moral hazard regime would require severe austerity for Greece and other countries on the periphery of the euro area. The second scenario involves elimination of the moral hazard regime. The euro area would admit that some sovereigns have too much debt. A series of debt restructurings would follow. The final scenario would be for policymakers to continue to contradict themselves by promising selective defaults or restructurings of some countries’ debts while maintaining that they can ensure the stability of the rest of the euro area. But the authors argue that it is an illusion to believe that selective restructuring would not introduce contagion. Such an approach would result in panic, massive capital flight, and disorderly defaults. The ensuing chaos would in turn lead to a negatively charged political atmosphere that would make consensus nearly impossible.

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Έχουν μέλλον οι ιδιωτικοποιήσεις;

του Τάκη Μίχα

Protagon.gr
31 Ιουλίου 2011

Υπάρχουν δυο σειρές επιχειρημάτων υπέρ της ιδιωτικοποίησης κρατικών οργανισμών. Η πρώτη κατηγορία επιχειρημάτων είναι η λανθασμένη. Η δεύτερη σειρά επιχειρημάτων είναι η σωστή. Η κυβέρνηση του ΠΑΣΟΚ έχει δυστυχώς υιοθετήσει κυρίως την πρώτη σειρά επιχειρημάτων.

Η πρώτη σειρά επιχειρημάτων, η λανθασμένη, βλέπει την ιδιωτικοποίηση ως ένα εισπρακτικό μέσο -κάτι ανάλογο με την αύξηση των φόρων ή την μείωση των συντάξεων. Ο λόγος για τον οποίο ιδιωτικοποιείς μια επιχείρηση είναι για να βρεις χρήματα τα οποία χρειάζεσαι άμεσα -π.χ. για να ξεπληρώσεις το χρέος στην ελληνική περίπτωση. Αυτή είναι η επιχειρηματολογία που προβάλλει κυρίως η κυβέρνηση για να προωθήσει το πρόγραμμά της.

Η δεύτερη σειρά επιχειρημάτων βλέπει την ιδιωτικοποίηση ως ένα αναπτυξιακό μέτρο. Η ιδιωτικοποίηση είναι ένα καλό μέτρο διότι όταν μια επιχείρηση λειτουργεί σε ανταγωνιστικά πλαίσια, αριστοποιούνται οι αποδόσεις των παραγωγικών συντελεστών. Αυτό σημαίνει επίσης και μεταξύ άλλων ότι οι επιχειρήσεις παύουν να είναι ζημιογόνες και να τρέφονται από τον δημόσιο κορβανά και αντίθετα γίνονται κερδοφόρες και πληρώνουν φόρους στο δημόσιο.

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What eurozone leaders are doing about the debt crisis

by Herman Van Rompuy

Guardian
July 30, 2011

A week ago the leaders of the euro area met in Brussels. We had two aims in mind: to ensure the financing of the Greek programme and improve the sustainability of the Greek debt, and to restore market confidence in sovereign euro debt. We took important decisions for the future of Greece and for the euro area as a whole. Probably for the first time we covered all the sides and angles of the debt crisis in the euro area. However, a number of misunderstandings have arisen over the past few days. Some are due to the complexities involved, some to the requirements of parliaments in certain member states, and some may even stem from positions taken in the markets. As a consequence I think it is useful to clear up a number of issues under discussion.

We wanted to address the concerns related to the sustainability of Greece's debt. Although the last review by the IMF, the ECB, and the European commission had concluded that this debt is sustainable, we decided to alleviate this burden. Our decisions were threefold.

First, we will provide additional funding to support the Greek programme up to 2014. Second, we lowered the interest rate on the public funds we are lending to Greece to close to our cost of funding (ie between 3.5% and 4%), and we extended their maturity from the current five years to a minimum of 15 years and up to 30 years with a grace period of 10 years. This will reduce the Greek debt by €25bn between 2011 and 2020, which will diminish the debt-to-GDP by 10%.

Third, we agreed upon and supported the voluntary involvement of private bondholders, with a menu of options (roll-over, exchange, buy-back) covering payments due up to 2020. The voluntary participation of private creditors – of which we previously aware that this would be considered as "selective default", and therefore cannot be considered as a surprise – is unique, unprecedented and restricted to Greece.

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Euro stability hinges on whether Greece is in or out

Reuters
July 29, 2011

Securing the future of the euro has divided opinions on whether it is best to defend unity at all costs or to remove the weakest link. Insider talks to experts on opposite sides of the debate.

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Rescuing sovereigns: Why it was easier then

Economist
July 29, 2011

A book doing the rounds in Brussels by the veteran American financier Bill Rhodes, describes how the Citibank executive persuaded the big banks of his day to restructure loans to Latin American governments from the 1980s onwards. In the most recent, and famous, example — a 2003 offer to extend the maturity of Uruguayan bonds by five years — he achieved a 93% participation rate.

Today the International Institute of Finance (IIF) is trying something similar for Greece. IIF members—global banks, insurance funds and investment managers—account for nearly all privately held Greek bonds. The IIF wants its members to extend the maturity of their Greek bonds maturing before 2020, while also reducing the overall amount owed by the Greek government. Mr Rhodes says the IIF should aim to exceed its 90% target for participation, if markets are to be convinced the plan can stabilise Greek debt. Is this likely?

One key difference between the 1980s and today is the variety of bondholders. In the 1980s syndicates of banks financed governments directly though loans. Every bank had a strong interest in ensuring that governments avoided default. Today’s Greek bondholders include hedge funds, mutual funds and even private individuals, many of whom will have purchased bonds on the secondary market at below-par prices. The diversity of bondholders, and their varying levels of tolerance of a default, makes coordination complicated.

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Europe Gets Debt Relief One-Third Right

by Harald Uhlig

Bloomberg
July 29, 2011

On July 21, European leaders decided on a new plan for Greece and new rules for the European Financial Stability Facility. They also came up with two remarkable oxymorons: The private sector will voluntarily agree to losses and Greece won't default for now, but instead will selectively default on some of its obligations. President Nicolas Sarkozy of France and Angela Merkel, the German chancellor, seemed to be smiling.

Did they have reason to celebrate? While the leaders took a step in the right direction, I would argue that the glass is only one-third full. The euro zone still faces several thorny issues, but the proposals that were offered to resolve them are more in conflict than in harmony.

First is the question of Greece. It is suffering under its weak economy, out-of-balance government and enormous debt burden. Will it be able to repay? The European leaders have agreed to reduce that debt by about 20 percent to 30 percent of gross domestic product; some of the relief will be achieved via transfers, some of it through elective defaults. Yet many believe that won't be enough. Greece's debt accounts for less than 5 percent of all sovereign debt in the euro zone. If the goal was simply to bail out Greece, it would have been easy for other member countries to do so, and not particularly costly. Clearly, that wasn't the point.

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The Euro-American Debt Dilemma

by Michael Boskin

Project Syndicate
July 29, 2011

Wealthy Europe and America, crown jewels of mixed capitalist democracies, are drowning in deficits and debt, owing to bloated welfare states that are now in place (Europe) or in the making (the United States). As Europe struggles to prevent financial contagion and America struggles to reduce its record deficits, their dangerous debt levels threaten future living standards and strain domestic and international political institutions. The ratings agencies are threatening additional downgrades; others envision an eventual breakup of the euro and/or demise of the dollar as the global reserve currency.

The economists Ken Rogoff and Carmen Reinhart estimate that public debt/GDP ratios of 90% are associated with sharply diminished growth prospects. Greece’s debt ratio is over 120%, Italy’s is around 100%, and the US is at 74%, up from 40% a few years ago – and rapidly approaching 90%. The International Monetary Fund estimates that each 10-point increase in the debt ratio lowers economic growth by 0.2 percentage points. Thus, increases of 40-50% of GDP risk cutting long-run growth in half in parts of Western Europe, and by one-third in America – a devastating reduction in gains in living standards over the course of a generation.

Worse yet, the burden of banking losses that will sooner or later be socialized, and that of future unfunded public pension and health costs, are often understated in official debt figures. Moreover, the problematic finances of some sub-national governments, for example in the US and Spain, will place pressure on central governments for fiscal aid.

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Greece’s 2nd bailout: Debt restructuring with no debt reduction?

by Ricardo Cabral

Vox
July 29, 2011

On 21 July 2011, the Council of the EU agreed to a second bailout for Greece. The deal was predicated on “private-sector involvement”. This column explores what this actually means. It estimates that the haircut for private bondholders may well be one-third of the figure initially proposed. It stresses that such uncertainties could spell more trouble for Greece and Europe as a whole.

The Council of the EU agreed on 21 July 2011 to a second bailout for Greece (Council 2011). This deal is predicated on “private-sector involvement”. The Council seems to have implicitly endorsed a form of private-sector involvement made by a private institution – the Institute of International Finance.

The proposal consists in a voluntary debt restructuring with a bond-exchange menu with four options (IIF 2011). The Institute indicated the exchange will result in a 21% “haircut” or reduction in the net present value of an estimated €135 billion of Greece’s sovereign debt that matures between 2011 and 2020. Two recent press columns, Nascimento-Rodrigues (2011) and Dixon (2011), argue that this will likely result in an increase – not a reduction – in Greece’s indebtedness.

This column uses one of the exchange options to replicate and explain the issues with the Institute of International Finance haircut estimate. It argues that a much lower post-exchange discount rate should be used and that in such a case the net present value of Greece’s debt subject to the exchange offer would actually increase.

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The euro is still far from out of danger

by Samuel Brittan

Financial Times
July 28, 2011

During an enforced absence from column writing I tried to keep up with events – not so much by reading a vast number of books, analyses and speeches, which would have been incompatible with eating and sleeping, but by reflecting on what might have happened if Greece had not joined the euro in 2001. Similar reflections might apply to other peripherals such as Portugal but might need modification in relation to Spain, Italy and Ireland.

The first thing to say is that neither the Greek government nor the Greek private sector would have been able to borrow for so long at German interest rates. The drachma discount rate hovered between 14.5 and 21.5 per cent in the 1990s. Its place was then taken by a scarcely credible 3.25 per cent European Central Bank repo rate from 2002 onwards. Outside the euro, the drachma would certainly have fallen, either gradually or in lurches. Greece would therefore have borrowed less on international markets, and invested more wisely.

I am pretty confident of this initial stage of analysis. But what would have happened afterwards depends, as in so many of these exercises, on innumerable counterfactuals.

In the most optimistic version Greece might have settled for a gradually falling currency; and higher but more realistic borrowing rates might have curbed the budget deficits. In a more pessimistic scenario, the drachma might have fallen in lurches leading to a series of so-called crises. One can imagine Greece having had to go to the International Monetary Fund. But a country accounting for 3 per cent of the eurozone’s population and 2 per cent of its output would not then have threatened the European and international financial systems.

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Second thoughts on the euro rescue

Financial Times
Editorial
July 28, 2011

Eurozone leaders’ agreement last week on a new Greek rescue plan marked a big step forward from the previous agonisingly piecemeal approach. The distance to a truly comprehensive solution, however, remains bigger. Although the political deadlock was indeed broken, leaders have glossed over the details that are gradually coming out, and many still seem oblivious to how much those details matter.

If eurozone policymakers really believe their stated conviction that Greece can service its debt at reasonable interest rates, they should have no qualms about standing behind Athens: there is money to be made for taxpayers in stepping in where supposedly irrational markets fear to tread. Their timidity in doing so betrays their uncertainty, naturally fuelling that of private investors. The inconsistencies in the eurozone’s thinking are now probably the single most important cause both of peripheral sovereign’s inability to return to market and of the growing risk of further contagion.

Those inconsistencies remain in place in the new package, which, while going further than what came before, is not comprehensive in either size or scope.

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Our plan will rescue Greece and protect Europe

by François Baroin and Wolfgang Schäuble

Financial Times
July 28, 2011

Europe and the euro are at a crossroads. Dealing with Greece’s debt and lack of competitiveness is crucial for containing the risks of contagion to the rest of the eurozone. The recent summit approved a road map for Greece to find its way back to sustainable growth and debt levels.

Given the Greek government’s commitment to stabilise its finances and strengthen its competitiveness, eurozone countries, together with the International Monetary Fund, will offer new financing, in view of Greece’s difficulty regaining market access. The private sector will bear its responsibilities, assuming a large part of Greece’s financing needs and easing its debt burden. The European financial stability facility, and later the European stability mechanism, will be strengthened too, including allowing them to act preventively where contagion threatens eurozone countries.

Greece can succeed in making its debt sustainable in the long term if it succeeds in both increasing growth and reducing its debt ratio. Greece has committed itself to additional drastic consolidation measures, with the goal of bringing its budget deficit below 3 per cent of gross domestic product by 2014. It has also committed itself to profound structural reforms to strengthen growth and competitiveness, as well as extensive privatisation. European Union structural funds for Greece will also be more closely targeted at increasing growth and competitiveness. On this basis, Greece will be able to overcome its debt problems and return to growth.

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Is the ECB Reading the Signs?

by Terence Roth

Wall Street Journal
July 28, 2011

This week brought more signs that the euro zone could be heading for a stall – or even a contraction – by the end of this year. It also brought signs of confusion from the European Central Bank, which as of May has been busy pushing up interest rates even as markets worry about a new recession and another credit crisis.

When translated by some media outlets, this came out as “very strong vigilance.” And that, as every ECB-watcher knows, The ECB’s policy-signalling turned comic this week when board member Christian Noyer said in a French newspaper interview that the ECB must continue to pursuue “ tres grande vigilance” on inflation.

This is code red for an imminent hike in the ECB’s official interest rates. ECB chief Jean-Claude Trichet used the “”strong vigilance” expression just prior to each of this year’s increases in interest rates.

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Europe’s Last Taboos

by Jean Pisani-Ferry

Project Syndicate
July 28, 2011

You can always trust the Americans, Winston Churchill said, because in the end they will do the right thing, after they have exhausted all other possibilities. For the last 18 months, this has been Europe’s method for confronting its sovereign debt crisis as well: it has taken the necessary decisions, but always as a last resort.

Once again, on July 21, the eurozone’s leaders proclaimed that what was previously unthinkable was, in fact, necessary. They gave up the pretense that Greece is solvent; admitted that excessive interest rates could only make the problem worse; agreed to extend more and longer-term loans; called for private lenders to bear some of the burden; guaranteed that even if Greek government bonds are rated in selected default, Greek banks would not be cut off from access to liquidity; recognized the need to support economic growth; and agreed to broaden the scope of the European Financial Stability Facility, making it a more flexible tool for intervention.

For Germany, France, the European Central Bank, and other players, these about-faces have a cost in terms of reputation, political capital, and legal leeway. July’s decisions were sufficiently wide-ranging for everyone to be able to claim success. But the players will have to have to explain why red lines were crossed. All, no doubt, will claim that this is the last time.

Is that true? Have the last taboos been broken? Or will another crisis summit need to be convened soon with even bolder measures and denials?

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How much closer a union?

Economist
July 30, 2011

At the emergency meeting of euro-zone leaders on July 21st Jean-Claude Trichet, president of the European Central Bank, circulated a set of charts showing how bond spreads had blown out after every summit over the past year. He also handed out a ranking of countries deemed by markets most likely to default: Greece, Portugal and Ireland were at the top, riskier than Venezuela and Pakistan; Spain was less safe than revolutionary Egypt. Mr Trichet’s point was clear. The response to the crisis had been inadequate and often made matters worse, with markets seeing Europe as more of a basket-case even than Africa.

The leaders were determined to reverse this grim trend. So they agreed to slash interest rates on bail-out loans for the most crippled members, and to double their maturities to 15 years (and, if need be, be ready to double them again, to 30 years). The summit promised to keep up the subsidies until Greece could return to the market. Ireland and Portugal got the same terms. Greece’s private creditors were asked to pay, but only a bit.

To limit contagion, the leaders gave enlarged powers to the European Financial Stability Facility (EFSF) to extend short-term loans, recapitalise banks and buy bonds of troubled sovereigns in the markets. To France’s delighted president, Nicolas Sarkozy, this was the birth of a European Monetary Fund. The markets were pleasantly surprised, even euphoric for a while. Finally, said some analysts, euro-zone leaders were taking the bold steps required. But those taking off on their summer holidays would be wise not to switch off their mobile telephones. Spain and Italy, in particular, have been wobbling yet again this week.

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Bazooka or peashooter? Greece’s new bail-out helps, but should have gone further

Economist
July 30, 2011

When Henry Paulson, America’s then treasury secretary, readied a plan to prop up Fannie Mae and Freddie Mac, two teetering housing agencies, in the summer of 2008, he spoke of having a “bazooka” in his pocket. In their response to the sovereign-debt crisis, Europe’s policymakers have tended to favour the peashooter. Their latest salvo in defence of Greece on July 21st produced some favourable initial reports, but the bang has faded. In a strange inversion of the crisis to date, the new bail-out plan seems to have helped the weaker peripherals and hurt the stronger ones.

The latest Greek bail-out consists of two main elements. The first is the promise of an extra €109 billion ($158 billion) in official lending to Greece from other members of the euro zone (apart from Ireland and Portugal) and the IMF. Greece will get more time to repay its loans; Europe is also cutting the interest rate it charges Greece, to about 3.5% from 5.5%. In effect, the euro zone is allowing Greece, its flakiest member, to borrow at rates similar to those paid by Germany, its most creditworthy one.

The second element of the plan involves asking Greece’s private creditors to shoulder some of the rescue burden. Bondholders are being asked to choose from a bewildering menu of options under which they can sell bonds at a discount or swap them for 15- or 30-year bonds, either now or when they mature. Under the proposals, which were negotiated with the Institute of International Finance (IIF), a club of the world’s biggest banks, €135 billion in Greek bonds are meant to be exchanged between now and 2020. Combined with official support the plan could allow Greece to steer clear of bond markets for the rest of the decade.

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Tax Trio Would Put an End to Euro Arson

by Luigi Zingales and Roberto Perotti

Bloomberg
July 28, 2011

The latest effort by European policy makers to contain the debt crisis offers only temporary relief for the euro area.

The involvement of private creditors is a step in the right direction, though it is quantitatively too limited, and the buyback program may end up rewarding banks’ shareholders and bondholders. Most importantly, the plan doesn’t address a fundamental problem: Any support designed to backstop Spain and Italy would be funded mostly by Germany, the region’s largest national economy.

The latest measures still involve two massive transfers of wealth. The first is from German taxpayers to those of southern Europe. If the aim is to destroy the idea of Europe for a generation, we could do no better. The resentment of German taxpayers will weigh on the continent for decades. To get a sense of the reaction, consider that Italy was unified 150 years ago, yet even small transfers of taxpayer money from the Treasury to the south of the country prompt the Northern League political party to call for secession.

The second movement of funds in the European rescue is from taxpayers to banks. The 2008 bailouts of the financial industry generated enough populist anger. This time, we may face a revolt.

Even putting aside political considerations, the current plan has big economic drawbacks, which can be summarized in two words: moral hazard. Most policy makers, and many economists, think that when a house is on fire, you first extinguish the flames, and then you catch the arsonists. But if you put out the blaze in a way that makes it impossible to catch the arsonists, you are almost certain to have a lot more fires later.

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Europe Needs to Show Quicker Reflexes

by Richard Barley

Wall Street Journal
July 28, 2011

The euphoria didn't last long. Less than a week after Europe's leaders announced measures aimed at stopping the risk of contagion, Italian 10-year bond yields are once again more than three percentage points above their German peers. Europe may yet run out of time to prevent a market panic.

The European Financial Stability Facility is a key plank in the euro zone's attempt to stop markets taking aim at Spain and Italy. Euro-zone leaders agreed to three key changes to make the EFSF more flexible: It will be able to provide precautionary assistance, without a full-blown intervention program run by the European Commission and International Monetary Fund; it will be able to help recapitalize banks including in countries without such programs; and it will be able to buy bonds in the secondary market.

These measures are useful, but would have been more helpful and effective a year ago, before the bailouts of Ireland and Portugal. And even now, making these changes will take time. A legal amendment to the EFSF's framework must be ratified by the 17 euro-area member states, a process that in some cases will require parliamentary votes. That could take months.

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How European funds can help Greece grow

by Jean Pisani-Ferry, Benedicta Marzinotto and Guntram B. Wolff

Financial Times
July 27, 2011

European leaders have called for a comprehensive strategy for growth and investment in Greece and a task force will be appointed to set out the details of how European Union structural funds could be used to that end. We had floated such ideas in February. Here is what the EU should do.

Substantial funds are available. We calculate Greece still has more than €12bn in unused structural funds, which could be used to leverage loans from the European Investment Bank, increasing the potential funds available over the next two to three years to €16bn. This would not involve any additional transfer to Greece beyond that already allocated to Athens in the EU budget.

However, governance must be reformed. EU structural funds are earmarked for regional development and subject to long procedures, not least because of political give-and-take. Spending priorities have little to do with current urgencies. The EU should pass emergency legislation reallocating the money to an Economic Revival Fund for the duration of the International Monetary Fund/EU assistance programme. The fund’s spending priorities should match the economic objectives of the programme, with a focus on growth and competitiveness, and faster disbursement procedures.

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A Greek Catch-22

by Eduardo Levy Yeyati

Project Syndicate
July 27, 2011

Desperate times bring desperate measures. The latest package to cope with Greece’s insolvency offers a bond buyback to lighten the country’s debt burden. In essence, this is a back-door debt restructuring: Europe’s bailout fund, the European Financial Stability Facility (EFSF) would lend the money for Greece to buy back its own debt in the secondary market at deep discounts, thereby imposing a loss on private bondholders without the need to declare a default.

A recurrent characteristic of Europe’s debt-crisis debate is a Latin American precedent. Indeed, many highly indebted countries in Latin America conducted similar debt buybacks in the late 1980’s. Bolivia’s 1988 buyback of close to half of its defaulted sovereign debt, an operation funded by international donors, is a classic example. But the most relevant Latin American experience with debt buybacks is a more recent and far less studied case: Ecuador in 2008.

President Rafael Correa had been toying with default since the 2006 presidential campaign (debt repudiation was part of his platform), and quickly earned a CCC rating from Fitch. The reasons invoked by Correa (legal concerns about how the bonds were issued in the 2000 debt exchange) were beside the point. The default threat was a way to depress bond prices in secondary markets, only to buy them back at a discount through the back door. That task was outsourced to Banco del Pacífico, which bought the soon-to-be-defaulted Ecuadorian paper at 20 cents on the dollar and above – a level low enough for a deep haircut but high enough to fend off “vulture” investors.

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EU's Greek deal no turning point, but perhaps first step

Reuters
July 27, 2011

The European Union's latest rescue package for Greece should not be seen as a turning point from which the euro zone debt crisis will start to be resolved, but simply a step in the right direction, a Reuters poll of economists showed.

While heralded by Europe's government heads as a new sign of determination to stem the crisis, a firm majority of analysts -- 31 out of 50 -- were unwilling to back the view that t he latest accord would necessarily mark a turning of the tide.

Euro zone leaders agreed last week to send an extra 109 billion euros ($158 billion) to Athens, while approving broad new powers for their financial rescue fund to prevent ma rket instability spreading.

Most economists surveyed this week instead said the package was just one of many measures that may be needed to quell the sovereign debt crisis that has also overcome Ireland and Portugal, while threatening to drag down heavyweight economies like Spain and Italy.

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Europe's €200 billion reverse wealth tax explained

by Harald Hau

Vox
July 27, 2011

Last week, the European heads of government added €109 billion to the existing €110 billion rescue plan for Greece. As Europe’s financial sector would have otherwise taken a huge hit, this column address the question: How did the financial sector manage to negotiate such a gigantic wealth transfer from the Eurozone taxpayer and the IMF to the richest 5% of people in the world?

When the deal was announced, German Chancellor Merkel highlighted the private-sector involvement. She stressed that this was the result of German intransigence. According to the spin, private creditors have to accept a 21% write-down on their claims. This amounts to a €37 billion private-sector contribution. They also provide €12.8 billion in new loans for debt buyback. This buyback, however, should not count as a private-sector contribution as it amounts to an exchange of one debt for another.

The private creditors’ contribution is therefore extremely modest compared to the €109 billion in new public commitments. Especially given that private creditors had the most to lose. Given that the market discount was already 50% for Greek debt, giving up 21% could be viewed as a gain. This has to be qualified as a very bad negotiation outcome for the Eurozone taxpayer.

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Time for the Greece Rescuers to Dig Deeper—for Courage

by Paul Hannon

Wall Street Journal
July 27, 2011

Another summit, another deal, another disappointment.

The euro zone's struggle to get to grips with its fiscal crisis grinds on, each failure edging more of its members toward the threshold three have already crossed.

The initial reaction to the new funding package for Greece agreed by the 17 euro-zone leaders last week was one of relief, since any deal was considered to be better than no deal, and expectations of its substance hadn't been high.

But as the days have passed, investors have taken an increasingly jaundiced view of the agreement, so much so that the Spanish government is once again paying more than 6% to borrow for 10 years, or just below the level at which the governments of Greece, Ireland and Portugal were forced to seek help.

So, unless there is a major change in sentiment because of developments elsewhere—across the Atlantic, for example—Europe's leaders will have to interrupt their August vacations and come up with a proper plan.

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The shaky basis of the Greek rescue

by Pieter Spiegel

Financial Times
July 26, 2011

Did the eurozone’s presidents and prime ministers understand the Greek rescue package they signed up to on Thursday after an eight-hour emergency summit in Brussels?

That was the question buzzing around the European Council’s headquarters for hours after leaders returned to their hotel suites, since senior aides from the key capitals spent much of the night giving conflicting accounts of what, exactly, the surfeit of numbers meant.

It would be easy to chalk up the confusion to yet another example of the European Union’s inability to communicate to financial markets. Except that days after the deal was struck, confusion still reigns.

How much will the eurozone’s €440bn bail-out fund need to raise for Athens – and how quickly? Is the estimated €33bn in Greek bonds to be repurchased in a buy-back programme any more than a number pulled out of thin air? And is the International Monetary Fund going to shell out a third of the €109bn total bail-out package, as it has in the past, or just a third of the €34bn in new direct loans to Athens?

The truth is, nobody knows. “Not everything has been agreed in detail so not everything can be explained yet,” chuckled one senior EU official involved in the negotiations.

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Kipling’s game theory lessons for Greece

by John Kay

Financial Times
July 26, 2011

The game theorist Martin Shubik invented an unpleasant economists’ party game called the dollar bill auction. The players agree to auction a dollar bill with one cent increments to the bids. As usual, the dollar goes to the highest bidder. The twist is that both the highest bidder and the second-highest bidder must pay.

You might start with a low bid – but offers will quickly rise towards a dollar. Soon the highest bid will be 99 cents with the underbidder at 98 cents. At that point, it pays the underbidder to offer a dollar. He will not now gain from the transaction, but that outcome is better than the loss of 98 cents. And now there is a sting in the tail. There is no reason why the bidding should stop at a dollar. The new underbidder stands to lose 99 cents. But if a bid of $1.01 is successful, he can reduce his loss to a single cent.

The underbidder always comes back. So the auction can continue until the resources of the players are exhausted. The game must end, but never well. There are reports that over $200 has been paid for a dollar in Shubik’s game. That would be a contender for the most valuable dollar bill in existence had not $43m been paid for Andy Warhol’s representation of 200 of them.

You might resolve not to enter such an auction. Perhaps, but if everyone takes that sensible line a dollar bill will be there for the taking. Shubik proposed the paradox as a problem to which game theory offered no solution. You may by now have resolved not to mix socially with economists – if you had not made that decision already. And that is exactly the right answer. Avoid situations that mimic the structure of this game.

However, this is not so easy. The essence of Shubik’s problem is that it always seems worthwhile to offer a small amount to avert a larger loss. It is plainly better to write down Greece’s debt, even to agree a permanent underwriting of the Greek economy, than to risk the breakdown of European economic integration. It would have been far less expensive to assume the costs of a rescue of Lehman than to bear the costs of a near collapse of the global financial system. It is manifestly preferable to make concessions to the Republican right than to risk the consequences of a US debt default.

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A double act of self-inflicted crises

by Alan Beattie

Financial Times
July 26, 2011

Fearing the audience was bored after more than two years without a financial crisis, Europe and America, that veteran double act, have decided to put on a variety show. In Europe, the eurozone announced a second Greek bail-out after belatedly realising it was heading for default; meanwhile in the US, the Congress is trying hard to make a solvent government look like Greece.

All functional politics may be alike, but each dysfunctional government is dysfunctional in its own way. The twin crises show how the two political systems have evolved in an unhelpful fashion.

In Europe’s case, the problem involves a somewhat successful model of policymaking being applied in an increasingly inappropriate environment. Ever since it started as a six-nation coal and steel cartel in 1951, the European Union has developed an intractably iterative form of policymaking. It involves consensual relationships between multiple poles of power – member states, the Commission, the parliament – whose interactions become ever more complex. Another constitutional treaty is passed; new member states join; the parliament gets more say; another infinitesimally different set of interests has to be assimilated.

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Greek tragedy

by Hans-Werner Sinn

Vox
July 26, 2011

The Eurozone crisis is far from over. Greece still needs substantial reforms if it is to regain competitiveness and survive without support. This column argues that the pain of doing so will be unbearable for Greek society. It claims that the best solution for all concerned is if Greece temporarily leaves the euro.

The European monetary union is stuck in a severe balance of payments crisis. Capital flight from Ireland and the huge current-account deficits of Greece, Portugal and, partly, Spain were financed in the past three years with money printing by the ECB to the tune of more than €100 billion per year, as I reported several times. But the well is running dry for the ECB, prompting it to push the euro members to provide credit. The French banks, which had by far the largest exposure to Greek debt, have been doing their best to unload Greek sovereign debt on the Eurozone countries. And they have been successful. As a result of their pressure, a €110 billion rescue package for Greece was agreed one year ago.

Now the intention is to safeguard the Greek living standard and to help the Greek creditors even further. No less than €120 billion are to be provided until 2014 to secure redeeming of sovereign bonds maturing in the coming three years. It is assumed that around €100 billion in Greek sovereign bonds will have to be returned to the creditors until that time. Fifty billion euros are to be made available by the European taxpayers in the form of fresh credit. Of this sum, €30 billion will be used for direct payments to creditors, and €20 billion will go into an investment fund that purchases AAA-rated sovereign bonds from other countries. The remaining €50 billion will not be redeemed but will be reinvested by the banks in 30-year Greek government bonds. The AAA-rated investment fund serves the purpose of securing in increasing proportions the €50 billion over time, since compound interest will eventually turn the €20 billion into €50 billion. Even if a risk remains in the meantime, which irritates the rating agencies no end, this is a model sure to produce windfall profits for the bank system with taxpayer money, since Greece has been bankrupt for a year already.

Much worse, however, is the fact that Greece has lost its competitiveness. Its government took on massive debt under the euro, inflating Greek wages and prices. Greece’s current-account deficit reached 10.5% of GDP in 2010. Aggregate consumption exceeded national income by 16.5%.

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Lawrence Summers on the Euro Crisis: 'It Was Always Understood the European System Would Evolve'

Spiegel
July 26, 2011

In a SPIEGEL interview, Lawrence Summers, 56, Harvard economist and former advisor to United States President Barack Obama, discusses the way forward for Europe's stricken common currency and a debt crisis and budget battle in the United States that has baffled many a European.

SPIEGEL: Professor Summers, the European Union has just adopted another set of emergency measures to save the euro and the European currency union. Is this just another Band-Aid or is it a sustainable path toward recovery?

Summers: Some significant steps were taken at the summit in Brussels and a number of fundamental issues were addressed: Sustainability of debt, provision of support to banks, preventive support for some countries. But saying fundamental issues were addressed does not mean they were resolved. Clearly, there is still much that needs to be done in terms of crisis resolution and mechanisms assuring liquidity and fiscal responsibility.

SPIEGEL: Aren't more radical steps needed, such as a drastic haircut for debtor nations like Greece?

Summers: It is premature to judge that. Successful growth-generating policies and determined efforts of fiscal consolidation are imperative. And creditors will need to take realistic views of the situation.

SPIEGEL: It seems a currency union across borders without a fiscal union cannot work. Do we have to steer toward a United States of Europe in order for the euro to survive?

Summers: No. Surely, the common currency has been insufficiently supported by common political approaches. But we will learn over time from the European experience what elements have to be common in order to make the system work.

SPIEGEL: Has the response of European leaders to the crisis so far been too dogmatic and bureaucratic?

Summers: There is no politician who will ignore the laws of physics when building a bridge. But there is a tendency in politics in every country to suppose that the laws of economics are flexible and can be adjusted to political necessity. At some points this belief has led to a lack of focus on economic realities in Europe.

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Europe's "Marshall Plan" for Greece may disappoint

by Greg Roumeliotis

Reuters
July 26, 2011

Europe is promising to help kick-start economic growth in Greece as a way of dragging the country out of its debt crisis, but the scheme looks likely to move too slowly to have much impact in the next couple of years.

At last week's summit announcing a second international bailout of Greece, leaders of the 17-nation euro zone pledged "a comprehensive strategy for growth and investment in Greece" that would "relaunch the Greek economy".

The emphasis on growth is an important shift in Europe's approach to the crisis; the first bailout of Athens, launched in May last year, focused instead on slashing the Greek budget deficit, and the reduction in spending hit the economy hard.

Greece's recession was a key reason that it missed targets for cutting its debt under the first bailout. So ending its economic slump quickly would increase its chances of bringing its debt down to manageable levels over the next several years.

Details of Europe's plan so far, however, suggest it will be a limited scheme that concentrates on channelling funds for infrastructure development to Greece and has little impact over the next two years, which will be a key period in determining whether Athens forces more losses on private creditors.

"Greece will get the money, but most will reach the economy in 2014 and 2015. Too many projects have yet to be set in motion," said Nikos Diakoulakis, a former Greek development ministry official who advises the government on European Union funds.

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Why Germany and Greece are right to blame each other

by Paul Donovan

Financial Times
July 26, 2011

The ongoing epic of the eurozone crisis is by no means over.

Greece will probably selectively default next month (or thereabouts), and then have a pause before properly defaulting (with a debt haircut) at some later date. There are still many other options for crises out there, and politicians will no doubt have many opportunities to create even more.

The central problem in Europe is, as I’ve noted before, that in the long term the euro does not work. The euro has never worked. Economists spent all of the 1990s saying “the euro will not work”. Economists were ignored. Bad things happen when economists are ignored. However, the failure of the euro to work as currently structured is compounding the near term problems that we face by leading to more and more political tension.

To hear the Germans tell it, the solution to the euro crisis lies in the hands of the discipline.

The Teutonic rallying cry of “we must have discipline” echoes around the council chambers of Europe. If only the periphery would knuckle down, raise productivity and lower wages, all would be well. This is exactly what Germany did during the first ten years of the euro’s existence. Germany entered the euro as a very uncompetitive economy. A decade of denial and self restraint later, and Germany was once more restored to the very epitome of competitiveness.

From the Greek point of view, the solution to the euro crisis lies in the hands of Germany.

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Frenemies: Two Greek Rivals Hold Nation's Fate in Balance

Wall Street Journal
July 26, 2011

As protesters battled police outside parliament last month in a hail of rocks and tear gas, Greece's beleaguered prime minister put his hopes in a secret phone call to an old friend.

"Let us form a government of national salvation," George Papandreou, the Socialist prime minister, said to his chief rival, Antonis Samaras, head of Greece's conservative opposition and a buddy since the two men were roommates at Amherst College in Massachusetts 40 years ago.

The details of their secret mid-June talks reveal the degree to which two friends—each with far different prescriptions for economic salvation—hold the fate of Greece in their hands as the nation tries to get its nearly $500 billion in government debt under control.

Their success or failure weighs on the potential survival of Europe's shared currency, the euro, the crowning achievement of 60 years of European unification.

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In Greek Debt Deal, Clear Benefits for the Banks

New York Times
July 25, 2011

Europe's latest plan to prop up Greece looks suspiciously like a plan to bolster European banks.

By agreeing to contribute a relatively modest amount to the rescue, the banking industry is getting something more valuable in return, analysts say. The industry is unloading much of its Greek risk onto the European Union and helping to quash fears that the sovereign debt crisis could become a second financial crisis.

The agreement reached in Brussels last week may anger anyone who thinks that banks have already gotten enough taxpayer favors. But the debt crisis has always been as much about banks as it has been about Greece. If the deal helps restore confidence, weaker institutions will be able to borrow on money markets again, so they no longer will be dependent on the European Central Bank for financing.

“I think this is a good use of resources,” said Carl B. Weinberg, chief economist at High Frequency Economics in Valhalla, N.Y. “This prevents the hit from becoming so large that it paralyzes the banking system.”

The oddity, of course, is that Chancellor Angela Merkel of Germany went to Brussels last week vowing to make banks pay their share of the cost of aiding Greece. She inadvertently seems to have done them a favor instead.

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Greece needs a new political culture

by Gideon Rachman

Financial Times
July 25, 2011

There are not many luxury hotels that allow stray dogs to lie sprawled across their entrance. So I was charmed last week to come across the “Greek riot dog”, sheltering from the summer heat, on the steps of the Grande Bretagne, the smartest hotel in Athens. The yellow pooch has become famous on YouTube because of the enthusiasm with which he participates in anti-government demonstrations. He may soon be back in action.

To secure the fresh funds promised by the eurozone last week, the Greek government has had to commit to years of strict austerity. The country’s future seems to promise blood, sweat and tear-gas.

The Greek elite is struggling to keep its nerve, under enormous pressure. One government minister says that for the past 18 months, “every week has brought a new catastrophe”, adding: “It is like a war. The country is in huge danger.”

Without new loans from Europe and the International Monetary Fund, the Greek government would have run out of money within months. The payment of wages and pensions might have stopped and banks could have collapsed. Greece also imports most of its food and energy – and that too could have been threatened.

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Contagion uncontained in eurozone

by Nils Pratley

Guardian
July 25, 2011

Meanwhile, last Thursday's solution to the eurozone's woes looks weaker by the day. In the fight against contagion, nothing has been achieved. The yield on 10-year Spanish bonds popped back above 6% yesterday and Italian 10-year yields stand at 5.66%. Such rates, if sustained for long periods, are simply unaffordable. Unsurprisingly, bank shares across Europe were also whacked yesterday.

The problem is twofold. First, the politicians didn't get to grips with the size of Greece's debt problems. After a round of modest haircuts for private-sector creditors and a reduction in the rate on the interest rate charged on the bail-out loans, the country's debt-to-GDP ratio should no longer hit 170% soon. But the revised figure – maybe 130% – still looks too high to allow Greece to recover. Its economy is still too uncompetitive and you have to be an extreme optimist to believe tax receipts will arrive when they are due.

So a third Greek bailout looks like only a matter of time. Get ready for more bitter rows over how the pain should be distributed between holders of Greek bonds and the taxpayers of other eurozone countries. That is no way to encourage companies to invest or consumers to spend – but it is the way to try the patience of German taxpayers.

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The Perverse Politics of Financial Crisis

by Luigi Zingales

Project Syndicate
July 25, 2011

In trying to understand the pattern and timing of government interventions during a financial crisis, we should probably conclude that, to paraphrase the French philosopher Blaise Pascal, politics have incentives that economics cannot understand.

From an economic point of view, the problem is simple. When a sovereign borrower’s solvency has deteriorated sufficiently, its survival becomes dependent on market expectations. If everybody expects Italy to be solvent, they will lend to Italy at a low interest rate. Italy will be able to meet its current obligations, and most likely its future obligations as well. But if many people start to doubt Italy’s solvency and require a large premium to lend, the country’s fiscal deficit will worsen, and it will most likely default.

Whether a borrower like Italy ends up in the lap of good expectations or tumbles into a nightmare scenario often depends upon some “coordinating news.” If everyone expects that a credit-rating downgrade will make Italian debt unsustainable, Italy will indeed default after a downgrade, regardless of the downgrade’s real economic effects. This is the curse of what we economists call multiple equilibria: once I expect others to run for the exit, it is optimal for me to run as well; but if everybody stays put, I have no interest in running.

Given this economic dynamic, there seem to be two obvious policy prescriptions. First, it is too dangerous for any country to come even remotely close to the point where insolvency can be triggered by a sunspot. While nobody knows exactly what this danger level is, it is clear where the alarm starts to arise. Given the enormous cost of a default, any government should stay far away from the danger zone.

The second prescription assumes that if, for any reason, a country does end up in the danger zone, only two responses make economic sense. Either officials recognize immediately the inevitability of default and waste no resources trying to prevent it, or they believe that a default can be avoided and deploy all the resources at their disposal as fast as possible. As in many wars, a staged escalation in a financial crisis often leads to the worst possible outcome: a defeat with large losses.

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Geithner urges Greek finance minister to continue reform

Reuters
July 25, 2011

Treasury Secretary Timothy Geithner urged Greece's new finance minister to push forward with efforts to strengthen Greek public finances on Monday as Washington struggled to break a deadlock on its own debt reduction plans.

In their first meeting, Geithner and Greek Finance Minister Evangelos Venizelos discussed the agreement reached by European leaders last week to strengthen Greece's bailout and restructure its debt, the Treasury said.

In a statement, the Treasury said the two ministers discussed "Greece's efforts to implement comprehensive reforms and restore growth to its economy. Secretary Geithner welcomed the progress Greece has already made toward strengthening its public finances and underscored the need for continued and full implementation of the program."

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