How Greece can avoid its downward spiral

A greek haircut by any other name.

Today a new bailout and cuts package was agreed with Greece. After weeks of posturing with the IMF threatening to pull out after previous conditions were not met, Germany wobbling at the cost, and Greece hesitant about privitisation.

Reports suggest an almost doubling of the current bailout with costs split between the IMF, EU and the proceeds of privatisation.

Banks will be called to swap their short term Greek bonds with new ones maturing 10 to 15 years later.Although this would be ‘voluntary’ to avoid the perceived problems of default they will know that if they dont a haircut will be imposed – so Greece will negotiate preferential terms and the lengthening of maturity will be a haircut in itself. This is default but negotiated in private.

Meanwhile Greek people and cash flood out , as much as the bailout costs in a year, Greeces economy furthers a downward spiral probably inducing another bailout in a few months time.

The market will impose its own solution. With Greece closed to the international debt markets the elasticity of the mouth of the IMFs wallet is vertical. If bondholders hesitate to cut their losses the markets will sniff bullshit from the ECB about the finality of any settlement and no need for defaults. Economic modelling also shows the longer default/renegotiation is delayed the more painful it will be to all concerned.

The IMF preferred solution is ‘internal devaluation’ i.e. Latvia, spending and paycuts hopeing eventually ‘Says law’ will kick in. Well Latvia eventually started to grow again, but only at the cost of losing 25% of the economy, much more than it needed to be because of fixed exchange rates. If the IMF says this is the future then Greeks have seen it and are getting themselves and their money out, so the eventual ‘bottom’ for Greece will be lower. The Greek government know this which is why there are hesitant about the scale of loss of income required – no government could sell that.

We know from history that countries have only ever recovered from such calamities through default and devaluation. Banks argue that because Greek debt is held in Euros default could cause another credit crunch. However these are non-performing assets and payments are only being made through international payments. These countries are squeezing their own people to pay. Credit is already being squeezed through loss of income from the higher government spending to pay for the bailouts. In any event with debts traded between banks and so many European banks state owned these are just transfer payments – not ‘real’ debts – they could cancel out if mutual forbearance is shown. Default will only become contagious if the scale of it causes lack of confidence and contagion. If it became predictable it would be containable.

Their are historical examples. Argentina, Russia and Khazackstan have all recovered from default and devalution crisis in the last dozen years. Argentina is still a dirty word in the IMF because they played by different rules.

If there was compulsory replacement of bonds by Greece by long terms bonds with a heavy discount rate at least it would be predictable in impact. The ECB and IMF could underwrite the long term maturity, in return for a fee paid for by Greek asset sales, effectively a debt for equity swap. These fees could be used to provide a plan b for bondholders, selling now for a much heavier discount.

This is possible without Greece leaving the Euro but would happen much more quickly and less painlessly if it did. No anti euro dogma – just pragmatism. If the long term maturity were in drachmas rather than euros the market would expect short term falls -improving recovery, followed by long term rises, increasing the yield on bonds.

The new currency would need confidence – it would need to be rock solid and stay there. If it commenced at a heavy devaluation (for which Greece might have to impose a weeks bank holiday to print the new currency and prevent cash flight) but then tracked a global export orientated basket – including the Yuan, it would gain market confidence.

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