Expect a lot of noise in the coming days about a “breakthrough agreement” to forgive a big chunk of the Greek government’s enormous debts.
But don’t be distracted by it – Greece’s real problems are as bad as ever.
Greece’s private sector lenders – banks and assorted investors – will probably agree to recognise a 50% write-off in the amount they are owed.
Add in other sweeteners for Greece – a lower interest rate and more time to repay – and the total loss to lenders may be as much as 75%, depending on how you calculate it.
This “breakthrough” will be nothing more than a recognition of reality – financial markets have been valuing Greece’s debts at a mere 20-25% of their notional worth for the last two months.
Most of the banks who have lent Greece money have already officially recognised much of the losses in their accounts.
There will be grumbling about the European Central Bank’s role.
It owns a lot of Greek debt, but has refused to participate in the collective debt write-off – much to the annoyance of private sector lenders, who therefore have to take a bigger share of the losses needed to reduce Greece’s debts to a level that the country has any hope of being able to repay.
The final deal may well involve the ECB taking some losses as well, but with eurozone governments agreeing to shoulder them on the ECB’s behalf.
There is also the small question of the Greek banks. They own a large chunk of the Greek government’s debts, and will probably have to turn back to that very same government for a bailout, in the form of an injection of risk-absorbing capital, in order to cover their losses.
Which is to say that a large chunk of the debt being written off by Greece is simply money that it is picking from its own pocket.
Of course, it’s possible that a deal won’t be reached.
But the consequences are so catastrophic for all involved, that this seems unlikely.
The Greek government has a big debt repayment falling due on 20 March.
Without a deal, the government does not get any more bailout money from the European Union and IMF. Without that money it cannot make the debt repayment.
If it skips the debt repayment, the position of lenders will be even worse. Greece’s debts are mostly governed by its own law – so in the worst case the government could simply pass a new law cancelling much of its own debts.
An outright Greek debt default would also be bad news for the rest of the eurozone.
The biggest damage would be to the entire credibility of the bailout process.
If eurozone politicians fail to manage the Greek situation, what hope that they will deal with much bigger Italy?
Markets would start asking difficult questions again, with Portugal looking like the next one to run out of money.
A debt default would also be catastrophic for the Greeks themselves. It would cut off their one source of cash – rescue loans from the EU and IMF to the Greek government, and from the ECB to the Greek banks.
Without these, the government would be unable to pay for basic functions of the state.
Greece’s position in this respect has improved – in the last six months of 2011 the government actually earned slightly more in tax revenues than it spent on everything except debt payments. But don’t be fooled.
The government would have no money to rescue its banks.
And a government debt default – combined with a collapse of the country’s banks – would push the country’s economy even deeper into recession, meaning tax revenues would fall, while spending on unemployment benefits should rise – if the government had the money to pay for them.
The real story
So, given that failure is not an option, in all likelihood a last-minute deal will be stitched together in the time-honoured European fashion.
But here’s the thing. It doesn’t matter.
The focus on the Greek government’s ability to repay its debts completely misses the point.
The real question is whether Greece has the political will to remain in the euro.
Here are the four statistics that really matter:
- since joining the euro in 2001, Greek unit labour costs (a measure of wage competitiveness) have risen 32% compared with Germany
- Greece’s current account deficit – a broader measure of its trade deficit – was running at 10% of GDP (total economic output) in the middle of last year, according to data compiled by Bloomberg
- Greek households and companies withdrew 28% of the deposits they held in Greek banks in the three years to November last year, and the rate of withdrawals has been accelerating
- Greece’s economy shrank 5.5% last year, has shrunk a cumulative 12% since 2008, and is expected to shrink another 2.8% this year
What do these statistics tell us?
The first tells us that Greek workers cannot compete inside the euro without big wage cuts (or big wage rises in Germany).
Greek wages rose too quickly during the good years before 2008. Normally the Greek drachma would have compensated by losing value in the currency markets – but inside the euro there was no drachma. So Greek workers have priced themselves out of the market.
The second statistic is a symptom of that loss of competitiveness.
It tells us that Greece is spending far more buying things from abroad than it earns from selling things to the rest of the world.
In effect, the Greek economy as a whole is spending 10% more than it earns – even now, after all the Greek government’s spending cuts.
And really it needs to be reduced all the way back down to zero – or even beyond zero into a positive surplus – if Greece is to earn the money needed to repay its debts.
In the meantime, the Greek economy as a whole must continue to fund its 10% overspend by attracting an equivalent amount in financial investments – mainly in the form of lending – from the rest of the world.
But the rest of the world no longer wants to lend to Greece – which is why the EU and IMF have had to step in to rescue the government. And why the ECB has had to rescue the banks.
International lenders are not simply worried that the Greek government cannot repay its debts.
They are worried that Greece will leave the euro.
If that happens, then all Greeks – not just the government – will either default on their debts, or – if it is legally feasible – will convert their debts into new drachmas that are likely to lose over half their value against the euro.
And the fear of a euro exit is not just shared by international lenders.
Our third statistic makes clear that Greece has seen a slow run on its banks, as companies – and increasingly ordinary Greeks – take their money out in cash, or move it to the safety of a bank account in Germany.
So the problem is not just that money has stopped flowing into Greece. Now money is actually flowing out of the country.
And that makes it even harder for the Greek banking system to fulfil its basic function of supporting the Greek economy.
Which brings us to the final statistic.
Greece is in a deep economic slump. The banks aren’t lending. Companies aren’t investing.
Ordinary Greeks – out of work or scared of losing their jobs – have cut their spending. And of course the Greek government has been ordered to slash its spending.
Yet Greece as a whole is still overspending – and therefore needs to borrow from abroad – to the tune of 10% of the value of everything the country produces.
Either the pain of spending cuts – by all Greeks, not just the government – continues for years into the future.
Or else Greece takes the nuclear option and leaves the euro – the quickest and surest way of regaining competitiveness and eliminating its current account deficit – but also an extremely painful one.
Which brings us to one final statistic.
An opinion poll conducted in November found that over three-quarters of Greek voters still support membership of the eurozone.
One of those statistics will have to give.