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German Chancellor Angela Merkel (AXEL SCHMIDT)
German Chancellor Angela Merkel (AXEL SCHMIDT)

Eric Reguly

Good for Greece, bad for Germany Add to ...

When Athens erupted in demonstrations and fire bombs during a nationwide strike in October, I asked people fleeing the tear gas whether they would rather suffer 10 more years of recession brought on by the endless austerity programs, or a quick and nasty debt-crunching exercise that might risk Greece’s ongoing use of the euro. The typical response: Ditch the debt so we can get on with our lives, even if it means we’re ousted from the euro zone.

Many Greeks, perhaps the majority of them, consider the austerity programs to be a national suicide pact. Germany, Europe’s paymaster, prime sponsor of Greece’s back-to-back bailouts and enthusiastic critic of Greece’s corruption, tax evasion and penchant for luxuriously youthful retirement ages, wants the country’s crushing debt load to come down, big time, so Athens no longer has to be propped up by Europe’s wealthiest taxpayers.

But Germany’s dirty little secret has always been this: It knows that what is good for Greece—a massive debt-reduction exercise—is not necessarily good for Germany.

Greece is insolvent, its debt load unsustainable. In 2011, the country’s debt was worth about 160% of its annual gross domestic product, up from 22% in 1980. The ratio is expected to rise to an awe-inspiring 186% in 2012 as the recession persists, along with budget deficits equivalent to nearly 10% of GDP. Barring a miracle, repayment of a debt of that scale is impossible.

But didn’t Germany insist that the private sector take a big fat writedown on its Greek sovereign bonds? True, a 50% haircut on privately held bonds was agreed to in late October, up from the 21% bandied about in July. But the writedown is far less impressive than you might think. It doesn’t mean that Greece’s estimated €360-billion debt load would fall by that amount—not even close.

Only about two-thirds of Greece’s debt is held by the private sector. If you assume a 50% cut goes through—and remember that it’s voluntary—Greece’s overall debt would fall by only one-third (that is, half of the two-thirds held by the banks and other private investors). Add in the cost of boosting the capital of the Greek banks taking the loss on the bonds and the 50% haircut would reduce the Greek debt by a mere 22%, according to estimates by UBS.

Société Générale’s calculations are roughly similar. It figured that a 50% loss would cut Greece’s debt-to-GDP ratio to 147% in 2012 and 119% in 2020. That’s still outrageously high for a country that probably will not see any growth for years.

So why doesn’t Germany encourage a default that would eliminate half or more of Greece’s debt? With, say, an 80% debt-to-GDP ratio (similar to Canada’s), Greece just might have a fighting chance to repair its finances, lure back investors and get its economy rolling.

The answer is that a default of such magnitude would do no favours to Germany in either the psychological or financial sense. Germany would lose the barely disguised joy of disciplining a little country that had the nerve to gatecrash the wealthy countries’ party, Molotov cocktail in each hand. As long as Greece suffers, it and other countries that blew up their fiscal houses might think twice before engaging in such reckless behaviour again.

Financially, a massive default would, in effect, reward Greece for decades of epic economic mismanagement. If Greece were to be allowed off the debt hook, why not Portugal and Ireland as well? A cascade of defaults would wipe Europe’s banks off the map, triggering a global recession.

The European Central Bank is the other factor behind Germany’s apparent reluctance to trigger a monster Greek debt restructuring. Not only has the bank been providing liquidity to clapped-out Greek banks, it has been buying Greek sovereign bonds, and the bonds of Italy and other ailing countries, by the bucket-load. By October, the ECB had spent €170 billion on bond purchases. Many economists and policymakers argue that the ECB purchases are sustainable and non-inflationary. The bank also receives interest payments that fund its capital base. That’s not a bad deal for the ECB or for Germany.

So it appears that the plan is to keep Greece in the bailout and austerity lockbox for many, many years. (At the G20 summit in November, Germany and France essentially ordered Greece to scrap a referendum on euro zone membership.) Avoiding a large-scale Greek restructuring prevents me-too debt overhauls, teaches the Greeks and other profligate countries a lesson and parks a share of the Greek life-support burden with the ECB. This may be sensible for Germany, but it is unbelievably nasty for Greece because its debt load remains wholly unsustainable, haircut or not. Judging by the violence in the streets of Athens, the Greeks are beginning to realize that they, and probably their kids, are the new lost generations.

Follow on Twitter: @ereguly

 

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