The United States marches solemnly towards yet another fiscal cliff, awaiting only the command from the Goddess of Reason to halt. Unfortunately for Greece, that country plugged its ears back in March last year, when its creditors agreed to restructure its debt in return for yet more Greek pledges to soldier onward towards its own cliff.
Like the US, Greece made prior commitments on spending and taxation in order to bind itself to the mission of deficit reduction. Unlike the US, Greece left itself little means to unbind itself. Its massive restructuring in March only reduced its ratio of debt to gross domestic product from 170% to 150%, but in the process made further significant restructuring much more difficult – as shown in the chart below. And whereas the European Central Bank's Outright Monetary Transactions scheme has brought joy to the Spanish and Italian debt markets even before the ECB has committed a cent, Greek debt does not qualify for OMT support.
Before the March restructuring, Greece owed private sector creditors €177bn in obligations governed by Greek law and only €30bn worth governed by international law, the latter being vastly more difficult to walk away from. After the restructuring, Greece owed private sector creditors only €86bn, but all of it was now governed by international law. And it also added €75bn to its €124bn stock of official sector (EU and International Monetary Fund) obligations, bringing that total to a whopping €200bn.
Though Greece desperately needs to shed more debt, it faces the problem that its private sector creditors are now all shielded by international law, and its public sector creditors are protected by the power to hurl it into unsplendid economic and political isolation. This suggests strongly that Greece should simply have repudiated all its Greek-law private sector debt back in March, when it had the chance. Why didn't it?
Many reasons, some of which flimsy – such as fears of triggering credit default swaps if the restructuring were legally labelled "involuntary." But the most pressing reason was to avoid crushing the Greek banking sector, which was exposed to Greek sovereign debt to the tune of about €50bn. The €25bn lent to Greece by the so-called European Financial Stability Facility in order to recapitalise its banks would then have to have been a much higher €50bn. Still, Greece would be at considerably less risk of hurtling over the fiscal cliff today had it avoided taking on the additional €56bn worth of non-repudiable private sector IOUs in March.
Greece's recent debt buyback, though portrayed as a clever means of reducing Greece's debt burden by about nine percentage points, added to its official eurozone debt obligations while further depleting the official capital levels of participating Greek banks – creating yet another debt hole for the Greek government to fill. Greece is still well off the path to debt sustainability.
Although many private sector Greek debt holders were willing to endure a further 60% to 70% write-down, the official sector is still not budging. German finance minister Wolfgang Schäuble rules out official losses on bailout loans, saying that German law would then preclude further lending to Greece. A cessation of official Greek funding would push the country over the cliff and oblige it to bring down its deficit overnight from 9% of GDP to 0%, as the capital markets remain shut to it. This would bring with it ruinous economic and social hardship.
Figuring out how to distribute the resulting default losses among the euro area governments, the ECB and the IMF would also make the ongoing US fiscal stand-off between House Republicans and the White House look like child's play.
Still, optimists contend that German Chancellor Angela Merkel understands that the current strategy of keeping Greece precariously perched on the edge of the cliff with loans and guarantees will inevitably push the country over it. She will therefore only persist with a hard line until the autumn German elections, after which she will finally write the big cheque that saves the day.
This is naïve. If the Chancellor believes that Spain and Italy can survive a Greek eurozone exit, she may well choose to precipitate it as a means of capping German liabilities. More importantly, by then Greece may effectively be ungovernable.
Rise of the right
This goes well beyond matters of the country's legendary bureaucratic inefficiency and corruption. The rise of the far-right Golden Dawn party, which garnered nearly 7% of the vote and won parliamentary seats for the first time in June, is particularly ominous.
Fond of displaying symbols of modern Greece's pre-democratic past, such as the flag of the nation's 1967-74 military dictatorship, party members have been widely implicated in attacks on immigrants and threats of violence against opponents.
"We can now carry guns legally, and will not be arrested on the spot in the event of an incident," party spokesman and MP Ilias Kasidiaris was recently filmed telling supporters. "This means we can be more relaxed about our movements."
It is tempting simply to assume that the police will deal with violent party elements but, as a senior Greek police officer recently revealed anonymously to a British newspaper, the party has already infiltrated the ranks at various levels.
Politically, it may be too late to stop this rapidly unfolding Greek tragedy. If there are lessons in it, they may therefore be for other sovereigns in other times. Among them should be that debt restructurings, to be effective, must be singular events, large enough to reverse – and not just slow – a deathly debt dynamic.
Benn Steil is director of international economics at the Council on Foreign Relations and the author of The Battle of Bretton Woods. Dinah Walker contributed to this column.
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