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Why, for Greece’s and Europe’s sake, the PSI ought to fail

17/01/2012

Headlines the world over ‘agonise’, on behalf of Greece and Europe, on whether the PSI+ negotiations will come to a conclusion. The presumption is that, if they succeed, Greece will be reprieved and Europe (with France and the EFSF having recently been downgraded) will buy some much needed extra time to put, at long last, its house in order. Nonsense, I say!

This PSI+ is yet another assault on Reason. It constitutes, as I have already argued, a fallacy in search of a rationale. It should be allowed to die a quiet death. Greece should simply announce that its March bond repayments are postponed until a comprehensive solution is found; one that includes a solution not only to the Greek malaise but also to the problems of Ireland, Portugal, Spain, Italy and, of course, of the French and German banks (not to mention those of the periphery). If anything can persuade Mrs Merkel and Mr Sarkozy to act in a rational manner, it must be an unruly Greek default. Averting that default in March will simply give our leaders yet another excuse to keep fiddling while the eurozone is burning.

But will a Greek default not mean that the CDSs will fire? Yes, it will. Will this not cause our banks big problems? Of course it will. Will the ECB not have a fit at the thought that it will end up with oodles of worthless Greek bonds on its books? It surely will. But these ‘disasters’ are, compared with what is going on presently, blessings in disguise:

  • The CDS payments will force Europe to end the denial regarding its banks’ state.
  • The banks will become much more amenable to recapitalisation by the EFSF (as opposed to relying on the ECB’s LTRO and on shrinking their loan books). 
  • As for the ECB itself, it will have to come clean about the true nature of its LTRO and bond purchasing program; to abandon the pretence of having nothing to do with the eurozone’s fiscal side of things.

Europe will be, in summary, forced to look, for the first time since the Crisis erupted, for a comprehensive solution, as opposed for a way of hiding its problems under a very thin carpet.

My rationale is simple: From the beginning, in May 2010, the various Greek bailouts have given Europe an excuse for avoiding the harsh realities of this systemic Crisis. They kept buying time by micromanaging Greece’s debt repayments month-in-month-out. Meanwhile, the Greek social economy was imploding (with investment grinding to an halt and capital flooding out) and the contagion was spreading like a runaway forest fire northwards and westwards. Something has to give. This vicious cycle has to be broken somehow. The announcement of some PSI+ pseudo-deal will feed this cycle, not break it. In contrast, an official PSI+ failure, followed by a Greek default in March, stands a great chance of devastating the vicious cycle currently consuming the eurozone.

To those who argue (especially here in Greece) that Greece can still be saved in the context of the recently agreed policies, my response is: Nonsense! The combination of Greece’s Bailout MkII and of the Greek PSI+, even if it succeeds fully, cannot put Greece back on a sustainable path (to… 120% of debt-to-GDP). That would require not only a 100% participation rate in the PSI+ (something that will simply never occur) but also a growth rate for the Greek economy of at least 2%. Under the current recessionary climate both within and without Greece, the latter is as likely as the prospect of a flood in central Sahara. So, since Greece’s debt is, independently of the PSI+ deal, on an unsustainable path, it is imperative that we stop kicking the proverbial can up the hill and opt for a comprehensive default.

The result will not be pretty. But it will be far preferable to what we are experiencing now. To those who take for granted that a Greek default leads naturally to a Greek exit from the eurozone, I have a simple question: Why? Why can Greece not default within the eurozone? Why can the official sector (the EU-ECB-IMF troika, together with the EFSF) not fund the banks directly (without giving the hedge funds a penny and, instead, letting private investors benefit from the CDSs they have bought)? Indeed, why would the surplus countries want to throw Greece out of the eurozone when it is abundantly clear that this move would start a short, sharp process of disintegration (with Portugal and Ireland following suit)? By what legal means will the surplus countries force Greece out, even if they choose to do so? And why would Greece choose to leave if it can default within the eurozone?

In short, any jovial announcement of the PSI+’s success will be detrimental to Europe. On the other hand, an official failure of the PSI+ negotiations, followed by a temporary cessation of payments by Greece to its creditors (until a genuinely comprehensive solution is found for the Euro Crisis as a whole), appears as possibly the eurozone’s last chance for arresting this agonisingly slow slide into oblivion.

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