There are three possible ways of handling the Greek phase of the running Euro crisis.
1. Muddling through – or Pretend and Extend. This is the way favoured by the current Euro establishment. Greece is offered loans on special terms from Euroland members and the IMF in return for promising to make major cuts to spending, increases to taxation, and to sell assets.
2. Devalue and default. Greece could withdraw from the Euro, establish the drachma again, devalue, and come to an agreement with creditors about how much of past debt will be repaid, and on what terms.
3. Press on to political union for the Euro zone. The richer areas within the Union would then have to send more money by way of grant to the weaker areas, including Greece. Greece would have a budget controlled or influenced by the central Euro political auithority, and would be able to benefit from the common interest rate for borrowings that were part of the Euroland budget.
Today I wish to explore Pretend and Extend, as this is the main option on offer. Its attractions to the political establishments of Europe are obvious. It delays having to take the losses on Greek sovereign debts. The authorities can still pretend that banks that have lent to Greece on favourable terms will get all their money back on time. It leaves open the chance that Greece will sort out its domestic economic problems sufficiently to be able to borrow again in the normal way from the markets and banks. It does not require richer Euroland members to have to send more grant to Greece, which their own electors might oppose.
Many people in the markets are sceptical. They do not see how Greece can get back to a credit worthy position. They point out that the first loan package was meant to buy enough time for Greece to sort herself out, but it has not been successful. Every addition to the Greek debt mountain makes future budgets that much more difficult, as the interest rate bill is constantly rising. The authorities can pretend that the banks have not lost money on their Greek loans, but if they were to mark them to market – value them at today’s prices – they have already lost a lot.
The Greek people are not impressed. They think they are being asked to sacrifice too much as they see the tax rises and the spending cuts. The Greek government was unable to hit targets for reducing the deficit in the first half of this year. There are serious questions over how successful its latest austerity programme will be. There are doubts that it can raise as much money as planned from asset sales, as Greek assets are not popular at the moment. The protests of the Greek people against their EU and domestic governments make Greece a less attractive place to holidaymakers and investors.
The Greek recovery plan needs a lively pace of economic growth. Greece is restricted in seeking this. It cannot devalue to price itself back into world markets as the US and UK are doing. It cannot create extra money to stimulate activity. Its banks are losing deposits, as savers withdraw their money in fear of adverse changes to their wealth.
If Euroland is determined to save Greece from within, they need to sit down and hammer out a new plan. Pretend and Extend on its own delays but does not resolve the crisis. This may well require EU intervention to an even greater extent in Greek budgets and EU involvement in the implementation of a deficit reduction programme. It also needs changes to Greek banking and to policies for growth and enterprise to give the Greeks some chance of working their way out of the problem. It would help if the Euroland area accepted more of the responsibility for funding Greece, by sending more grants to her to offset the adverse consquences of the currency on that part of the zone.