Sunday, 1 February 2015

Let the games begin

On 2nd January 2015 I posted an article titled:

Preparing for the Greemany  (Greece and Germany) high stakes game of chicken

post 02 01 2015 preparing-for-greemany-high-stakes-game

Following last Sunday's result of the election in Greece and the election of Syriza to  government with a strong electoral mandate to address the unending economic distress, through growth rather than austerity, it means now that the dangerous game of chicken can begin.

Both sides have spent the first week digging in their heels.    From the German side the message was repeatedly that Greece has to honour agreements signed with the Troika ( IMF, EU Commission and ECB) to restructure its economy as a precondition for any concessions to lighten up the debt burden.   From the Greek side  the government has made it clear that it means to be faithful to the electoral mandate and does not feel committed to the austerity accepted by previous governments which crushed the Greek economy and sent unemployment to levels so socially offencive levels that made Syriza an automatic desperate choice for the Greek electorate.

This game of chicken is a very dangerous one.   It could very well lead to dismantling of what has been achieved by the European Union in its six decades of existence.    Something must be done to find a compromise honourable to both sides, a compromise that can build on sound foundations to make the European project the choice of the people, a European project that leads to a union among its people rather than becoming  as presently, a source of division.

There are three main issues that must be addressed:

1. Economic restructuring is needed and Greece cannot go back to its old ways of high public sector employment and low private sector investment where debts do not matter and tax evasion and corruption is tolerated rather than fought.

2. No country can redeem itself properly if its debt to GDP levels exceed significantly the 110% level. Even at this level it is only sustainable in a context of low interest rates.  A higher interest rate context will make the sustainable level even smaller possibly not far off from the 60% level enshrined in the Maastricht Treaty.

3. Economic restructuring can only be successfully delivered in the context of economic growth rather than one of austerity.  Economic restructuring requires a high dose of productive investment to stimulate the process of creative destruction, the phasing out of uncompetitive operators at a time where investment delivers new opportunities for economic growth, for new jobs and for new opportunities.

Any compromise which is not based on this tripod will be defective, unsustainable and will probably solve problems temporarily whilst creating bigger ones for the future.

Within this framework let me map out how a sustainable and honourable compromise can be found if the players move away from the current deadly game of chicken.

a. Greece must honour in substance, if not in all its details, the agreements it has with its international creditors, mostly IMF, EU institutions and EU countries.   Greece must continue to deliver a primary surplus in its fiscal budget and a surplus in its balance of payments position.  If the new government in Greece prefers to achieve this aim through better enforcement of tax collection which permits financing of social measures to ease the pain for those who are carrying a disproportionate load of the restructuring burden, that is a decision which rests within the sovereignty of the Greek government.

b. Greece must pursue an economic model which allows more space to private investment both domestic and international.   Government should have no qualms of moving away from its role of operator and adopt a regulatory stance. Privatisation must be not ideologically challenged but if properly executed without a suspicion of corruption, can be a useful ingredient in the creative destruction and economic growth model,

c. Greece creditors, mostly EU institutions and EU governments, must release Greece from the debt trap it is currently captured in as a quid pro quo for Greece pursuing sensible economic policies as above outlined.     In spite of private sector debt write off in 2012 the size of Greece debt to GDP has continued to increase and has now reached 175%.  Clearly the austerity recipe has delivered the opposite results from those intended.

d. The debt of all Euro area countries (not just Greece) exceeding 100% - 110% of GDP should be taken over by the ESM (European Stability Mechanism) against full reimbursement to present creditors and such debt is to be swapped to contingent 50 years bonds with a front 10 year moratorium and without a fixed coupon rate.   The coupon rate is to be variable and  contingent to the level of GDP growth registered by the debtor nation so that the debt burden remains sustainable.

e.  ESM is to finance such funding through cheap loans provided by the ECB ( better than the 1 trillion QE which is much less effective) and through contributions that countries enjoying structural balance of payments surpluses are to be obliged to make to the ESM to provide a cushion for any potential losses on its contingent bonds.    This is an equitable recognition that those countries that are enjoying structural balance of payments surpluses are enjoying a disproportionate benefit from their Euro membership given that had they, like Switzerland, been still in command of their domestic currency they would have lost competitiveness through automatic revaluation of their currencies.

f. Deficit countries who participate in such sustainable economic restructuring and growth plans should receive priority in financing of productive infrastructure investment through the EFSI of the Juncker Plan which again could easily be financed through the ECB. Countries enjoying strong economic growth and chronic balance of payments  surpluses should allow countries in distress such priority access to EFSI funding.

Let the games begin.  Not the deadly game of chicken but the serious games leading to sustainable  restructuring of the EU economy, greater solidarity, and greater determination by countries in distress to close the gap between their distress and the economic fortunes of surplus countries locked up in the same currency union.

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