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David Paul

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Back to the Drachma: Time to Let Greece Be Greece

Posted: 02/ 5/2012 8:41 pm

"The pace and composition of the deleveraging process needs to be consistent with the macroeconomic scenario of the adjustment program and should not jeopardize the provision of adequate levels of credit to the economy."

Thus spoke one European finance official this weekend, as one more confab of ministers from the eurohood gathered to assure the world that all is proceeding apace toward "a more balanced monetary union governance model and effective firewalls."

The tendency to speak in finance jargon--one is reminded of the incomprehensible utterances of Alan Greenspan--may suggest to some that they have the problem under control. However, the lack of frank discussion of the underlying issues suggests instead that they have a tiger by the tail and are making it up as they go along.

Each week now brings new assurances that a deal is imminent, and yet as the weeks go by it is becoming harder and harder to imagine that after all of the complex negotiations, the end will not be more straightforward: Greece defaults and exits the eurozone.

It may be inevitable, and it may be for the best. Maybe not for Germany, maybe not for the banks, but for Greece.

The United States began as poorly structured fiscal union. The debts of the nation and the debts of the states were comingled and the boundaries of responsibility poorly defined. Like Europe, the United States is a federation with a single currency and centralized monetary policy, but with fiscal authority retained at the state level. And early on, there were periods of fiscal crisis that were first resolved with the federal government assuming the debts of the states. But it was only after state defaults on their own debts that long-term stability was achieved, as new working rules--established under state constitutions--were established that clearly delineated the responsibilities of the states and of the central government.

Europe--or more precisely the eurozone--was created with similar failures to define boundaries of responsibility. It is not surprising that nations bound together with a common currency, but each retaining spending authority, would find themselves subject to fiscal pressure. This problem was exacerbated by the implied debt guarantees that allowed each state to borrow freely, while giving the banks and other investors little incentive to make credit decisions reflective of each country's management of its fiscal affairs.

The European experience mirrors the experience of nations that have pegged their currency to the dollar. There are benefits of maintaining a common currency, but the peg cannot be sustained if a nation fails to manage their affairs--such as was the case of Argentina--or if they outperform the nation to which they have pegged their currency--such as Taiwan and Singapore. In either cases, market forces will exert pressure over time to move away from the peg and allow their currency to depreciate or appreciate until a new balance is achieved.

Greece is the Argentina of Europe, and enjoyed the benefits that access to a common currency offered, until it was no longer able to pay its bills. Argentina finally defaulted a decade ago, but not before its families of means squirreled their pesos away in dollars stashed in foreign banks--much as Greeks are doing today.

There was no impediment to Argentina's ultimate default. The currency market did for Argentina all of those things that are being demanded of Greece today. Everything was adjusted downward in real terms. Salaries and pensions--public sector and private alike--funding public services. The population became poorer, their futures cast into doubt, but unlike Greece, no public official had to cast a ballot.

Each week, the Germans--along with their junior partners in France--are putting the hammer to the Greeks. Cut public sector spending. Cut worker salaries. Cut pensions. Sell the airports and trains. And this week demands to cut private sector salaries by 25%. Now, German ministers have taken the final, inevitable step and suggested that Greece must have a fiscal overlord to set budgets and spending levels.

While the world has focused on Greece's failures--with the implication that it was German beneficence that allowed Greek participation in the euro in the first place--it is easy to lose sight of the fact that Germany has been the greatest beneficiary of the creation of the eurozone. The advent of the common currency eurozone with 330 million people created a massive, captive market for the German export machine. After China and ahead of the United States, Germany is the second largest exporting nation on earth, and the bulk of what it sells is to other European countries. There are no innocents in this morality tale. All those Greek bonds and Italian bonds and Spanish bonds and other bonds that are now at risk were issued to sustain an economic bubble of consumerism from which German exporters were among the largest beneficiaries. If Greece lied on its application for admission, the Germans had good reason to look the other way.

Those who have benefited from the euro want it to survive this crisis. Failure is not an option--insisted European Central Bank member this weekend. It is not an option for Germany, whose currency would skyrocket if the eurozone nations went their separate ways, punishing its export-dependent economy. It is not an option for France, for whom the euro is the key both to containing the German colossus with which it has fought several wars and to creating a counterweight to U.S. global power and prestige. It is not an option for China, that badly needs an alternative currency to the dollar for its massive foreign currency holdings.

And then there are the financial imperatives of achieving an orderly unwinding of the exposure of the European banks to Greek default risk. Each week, we are assured, a deal to restructure Greek debt--theoretically averting a default--is almost done. The parameters of such a deal are not in question. The banks holding Greek bonds would write off more than half of the value of their bonds against their fictitious capital reserves--fictitious because those reserves have been invested in sovereign euro-denominated bonds, among which are these very same Greek bonds. Hedge funds will be strong-armed into accepting the same deal, though their write-offs will be against their own--rather than other people's--money.

But essential to the suggested resolution would be the forbearance by the ISDA--the International Swap Dealers Association--in pronouncing that no "credit event" has taken place, such that those same banks will not have to pay out on credit event losses as the sellers of credit default swaps against those same Greek bonds. Such an outcome would seem to be unlikely based on the merits, but in a world that has dangerously comingled the financial and the political, anything is possible.

For all of this--to sustain the illusions that are Europe and the stability of its banks--all that is asked of Greece is that it voluntary cede its powers of democracy and self-determination. Yes, Greeks can still elect their leaders, but those leaders will no longer control the destiny of the nation.

But even if a default by Greece on its March 20th bond payment is diverted, nothing will actually have been solved. At best, a new package of loans will be arranged, and the default will be delayed until some later date.

This solution is backwards. Instead of affirming Greece's responsibility for its own choices, it will have been stripped of its sovereignty. Instead of having to face up to the challenge of building its own future with real rules--as ultimately each nation must--it will move forward instead as a vassal state to its Franco-German overlords.

Perhaps it is time to gather those ministers and elected leaders into a room and tell them to go home. For all of their sakes, perhaps it is time that they open their eyes and let Greece be Greece. Better now than later, because all is not proceeding according to plan.

Because there is no plan. They are just making it up as they go along.