Greece lied its way into the euro launch in 2001, cloaking its unsound public finances from the EU’s nearly blind eye. The boost to credibility allowed Greece to borrow its way to unsustainable growth and exorbitant spending. The financial crisis of 2008 tore away the façade. In October 2009 Greece revealed a budget deficit of 12.5% of GDP, later revised to 15.7%, and warned it would default absent substantial aid or debt forgiveness


It’s been downhill ever since, thanks to the EU’s good intentions. The EU and the ECB helped Greece to bury its debt problem. Yet Greek debt didn’t die. Instead it turned zombie. It rouses periodically to terrorize the living. It has now roused again—yields on two-year Greek bonds have jumped 400 basis points in the past two weeks—and this time threatens the EU more than it does Greece.


What woke the zombie was a call from the IMF. In effect, the IMF is insisting it won’t be a party to further reburying deals until European lenders explicitly kill EU 100 billion or more of Greece’s debt. While the direct economic damage isn’t that great—since Greece isn’t going to repay it anyway—the potential political impact is huge. If Merkel and other EU pooh-bahs accept yet another big write-down, they implicitly admit that their previous salvage efforts failed and that they threw record amounts of citizens’ prudent savings down a black hole. If they reject it, Greece’s leftist government will threaten default, Greece’s exit from the euro (“Grexit”) will rise to the fore again, and Greece will face another run on its banks.


Considering what’s at stake, the 400 basis point jump in yields is rather modest. One of the reasons is that the IMF belongs to leading governments and despite its vaunted impartiality usually finds a way to bend to their will. The EU has been especially good at using the IMF as cover, not least because all 11 heads of the IMF, including the current head Christine Lagarde, come from the EU or its predecessors. However, the US is the IMF’s single most powerful member, with close to veto power, and the recent Presidential election has replaced an ardent EU supporter with an ardent critic. Ted Malloch, Trump’s alleged nominee for US ambassador to the EU, has been speaking about Grexit more as something to approve than to regret. Britain too seems unlikely to press the IMF to cater to EU. Meanwhile the Netherlands has declared that it won’t support another Greek bailout without IMF participation.


Nominal aid and debt forgiveness to Greece now sums to EUR 30,000 per inhabitant. That’s roughly twice the average annual global GDP per person, calculated at purchasing power parity. To put it another way, the aid promised to 11 million Greeks surpasses total yearly GDP for the 300 million people living in the world’s 15 poorest countries. Granted, aid programs love to double- and triple-count their support, while Greece promised to repay cut-rate interest. Still, the support is grossly disproportionate to Greece’s real needs, its real merits, its importance in the global economy or its capacity for havoc. Greeks aren’t even a majority in the Balkans, have much higher average incomes than most their Slavic or Albanian neighbors and have experienced less violence and economic trauma.


The aid, or rather the portion of aid not rerouted to lenders, has largely been a bribe to engage in IMF-led restructuring. This restructuring has focused on four areas: raising taxes with better enforcement, reducing excessive regulation, trimming the public sector, and cutting pension payments. Tax collection has been successful in the narrow sense—revenues have risen by about 5% of GDP—and failing in the broader sense—tax burdens were already quite high at 40% of GDP and higher marginal tax rates dampened employment ad investment. Deregulation has been only moderately successful, as vested interests strongly resist and the clampdown on the shadow economy stifled Greeks’ main counter to red tape. Trimming the public sector made little progress until 2013. As for pension payments, they actually grew before declining as Greece had lavish early-retirement provision and high pension-to-prior-earnings replacement rates, particularly in the public sector.


Meanwhile unemployment has exceeded 20% for five years running and unemployment among young workers is on the order of 50%. Greece’s GDP has fallen by roughly 30%. The government’s debt-to-GDP ratio, considered worrisome in 2008 at 113% of GDP, now exceeds 180% of GDP. Moreover, the IMF claims that Greece can’t reasonably expect to run more than a 1.5% primary surplus, which means that it can’t service even a 50% debt to GDP ratio at current market rates.


Longer term, Greece faces a severe demographic problem. Between retirees living longer and birth rates falling below replacement, old-age dependency ratios are soaring. The huge implicit support tax on young workers compounds the pressures to emigrate, further raising dependency ratios.


Both Greece and the Eurozone would have been far better off to part in 2010. Greece would have tried various snake-oil remedies, failed faster, made painful decisions sooner, and be on the mend now. The Eurozone would have shined in comparison. Poland, Spain and Italy would have tightened up more willingly. Germany would be more respected and more willing to help others. The ECB would be guaranteeing substantially less worthless debt.


Greece’s bailout programs have been so big, so unfair, so dumb and so disastrous that I didn’t expect them to last nearly as long as they have. I badly underestimated EU determination to stay the wrong course and am not sure how much it has withered. Churchill once said that the US could be counted on to do the right thing, having tried everything else first. Would that we could have such confidence in the EU.


None of this puts Bulgaria in imminent danger. However, I would encourage the Bulgarian monetary authorities to consider alternative currency anchors for the lev, including the SDR currency basket promoted by the IMF or a euro-SDR mix. The aim isn’t to make any quick changes, just to think calmly about emergency measures, well before an emergency occurs.


By Kent Osband

This entry was posted in Europe and tagged , , , , , by Kent Osband.

About Kent Osband

Dr. Osband is an American economist, strategist, financial risk analyst and longtime student of Bulgaria. He is the author of two well-known books on quantitative risk analysis (Iceberg Risk: An Adventure in Portfolio Theory and Pandora Risk: Uncertainty at the Core of Finance) and has served both in the public (IMF, WB) and private sectors (Goldman Sachs, CSFB, Fortress Investments).
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