Last Thursday, as global markets attacked Greece and its weak neighbors, leaders of bigger European powers announced that they would “safeguard financial stability in the euro area.” Greek prime minister George Papandreou was defiant. “We will not be needing help,” he said, later complaining that Greece had become “a laboratory animal in the battle between Europe and the markets.” Papandreou is right to be resistant. He would do the West a favor if he publicly told his would-be rescuers: “Thank you, but we don’t want your help. We will work with our creditors, our public sector, and our citizenry to solve our problems.”
Greek finances are certainly in trouble. The Mediterranean nation owes nearly 100 percent of its annual gross domestic product, even after balancing its debt against its financial assets, according to the Organisation for Economic Cooperation and Development. The average in the 16 nations that use the common euro currency, including Greece, is 58 percent. Greece’s deficit was nearly 13 percent of GDP last year, more than twice the eurozone average. Similar gaps loom for years to come unless the country wins spending fights against its powerful public sector.
Greece has been able to borrow in global markets recently only because the European Central Bank—Europe’s version of the Federal Reserve—has accepted the nation’s bonds from investors in return for cash. But this privilege could end soon. The ECB, like the Fed, is unwinding the extraordinary measures it has taken throughout the three-year-old global financial crisis. Even with this special support, moreover, Greece’s borrowing has lately become expensive relative to German government bonds, reflecting markets’ unease.
Greece’s euro membership appears to give it a big advantage over, say, Ukraine, which had to take an IMF bailout in 2008. France and Germany, the strongest of the eurozone nations, worry that the euro, their marquee economic project, won’t hold. Unless it gets help, Greece could abandon the euro; it could then reprint its old drachmas and export goods and services in a cheap currency, spurring economic growth. If Greece even hints at faltering on its national-debt repayments, bondholders could stop lending to Portugal, Spain, and other fragile eurozone members, creating the temptation for them to do the same.
So continental Europe, led by France and Germany, has made it clear—without quite saying so—that it won’t let Greece fail. Europe likely would buy Greek bonds if nobody else will, for example, or offer guarantees to bond buyers. In doing so, the Europeans would flagrantly break their own rules: the eurozone has a “no bailout” clause.
If France and Germany won’t stick to the no-rescue rules, Greece should. It should say that it will stay in the euro, but that it understands that its promises to its public sector and to its creditors are impossible to reconcile—so it will restructure them.
A Greek solution, as opposed to a European one, would be good for Greeks. European “help” likely won’t fix the country’s finances. The empty purse is Papandreou’s best tool for keeping public resolve strong in the face of crippling strikes by public workers. The Greek citizenry supports Papandreou’s plan to cut public-sector pay and benefits by 4 percent. In polls taken last week, “sixty-five percent . . . said the austerity measures were necessary and overdue.”
If Germany and France give the state another way out, though, Greece may take it. Sure, Europe is making noise about Greece having to get its fiscal house in order in return for a lifeline. But German and French leaders doubtless would be happy if world markets resume ignoring Greece’s obvious problems until some undefined time in the future, as markets did for a decade. Meanwhile, Greeks would continue to suffer in an economy suffocated by a bloated public sector and too much debt.
A Greek solution would be good for Europe, too. If Greece were to say that it would keep the euro even as it moves to revamp its finances, the currency likely would fall against the dollar. Investors in European bonds would realize that the no-bailout clause really does mean no bailouts. But a weaker euro would benefit Greece, Spain, and other tourism- and export-based economies—including Germany and France. Europe could sell its goods and services more cheaply to the rest of the world.
Over the years, too, a Greek solution would be good for the euro. A common currency that can bend will not break. If other indebted euro countries see from Greece’s example that they can fix their finances without leaving the euro, they’re more likely to stay committed to it.
Finally, a Greek solution would help the entire West, including America. It is past time for the world’s investors to understand that irresponsible lending invites borrower default, even if the borrower is a big bank or a government. If the financial world continues to think it can lend without consequences, the result will be a Western world so indebted that it can’t compete economically.
Over the past decade, global lenders and advisers have reaped huge profits helping Greece to borrow beyond its means. The biggest winners in a European bailout of Greece would be its bondholders and other creditors, including French and German banks that hold tens of billions of dollars in Greek debt. In America, citizens remain rightly outraged that the U.S. government’s 2008 bailout of insurance giant AIG protected the firm’s creditors from tens of billions of dollars’ worth of losses. A bailout of Greece would similarly protect Greece’s enablers. A bailout would also muzzle a necessary warning from markets. After nearly two years of bailouts, Western nations still have not taken steps to allow financial firms to fail in an orderly fashion without taking the world’s economy down with them.
“Strong” Western nations such as France and Germany—and the United States—cannot continue to protect bondholders and other creditors at all costs from the ramifications of lending money to borrowers unable reasonably to pay it back. Nor can the government protect financial firms that use financial engineering to make such lending appear less risky than it truly is.
This “too big to fail” mentality encourages the world’s creditors to abet Western debtors in a bizarre experiment: the mass competition to see which governments can raise the most debt the fastest to paper over their problems. In the U.S., no investor in his right mind would trust the states of California or New York with his money—but for the expectation of a federal bailout.
As the Western world’s “too big to fail” policy delays inevitable debt restructurings at banks, nations, states, cities, and industrial firms, we’re all moving up toward Greek borrowing levels. The U.S. owed 35 percent of its GDP in 2000; now, it owes 65 percent. And that’s not including Social Security and Medicare. Never mind that this experiment hasn’t worked in Japan, which, like Greece, owes 100 percent of its GDP.
Creditors as well as debtors must take responsibility for bad government debt and for the public-sector profligacy that bad debt enables. Debt becomes bad when nations, states, cities, and other entities have no chance of repaying it while still having a chance at decent economic growth. According to Carmen Reinhart and Kenneth Rogoff, authors of This Time Is Different: Eight Centuries of Financial Folly, growth suffers when debt hits 90 percent of GDP.
The West cannot prosper if it locks itself in debtors’ prison. Governments can show markets that they understand this truth now—or markets can teach them the hard way, later.