Two things I do not get about Greece

There are two things that baffle me about Greece.

First, the insistence on linking sovereign default with exiting the Euro area. Technically there is no relationship between the two. Greece can default on its debt and continue to use the single currency (in fact its seignoriage share could be confiscated by the creditors), just like many American states defaulted without stopping to use the dollar. Conversely, Greece could decide to exit the euro area and continue to meet its oligations. Indeed, there is talk in Finland of leaving the Euro and this has nothing to do with any looming sovereign default.

The Grexit ghost is a superstition which allows to mutualize the bailout among members of the eurozone in a way which is disconnected from their holding of Greek debt. Conversely, non euro area members contribute little or nothing to supporting Greece.

Second, the Grexit ghost is a way of manipulating public opinion in solvent euro area countries so as to make them accept the bailout. The implicit blackmail is that Greek default would trigger Grexit, then contagion and a collapse of the Eurozone, which would be a catastrophy. In order to avoid catastrophy, we are told, the taxpayer, not the holders of debt, should bear the cost of the Greek default. This blackmail is backfiring¬†against its conceptors as Greece voted for a government which plans on reneging on austerity and live off other people’s money. This blackmail works well as the troika has just offered another 15 bn euros of our money to postpone a decision by five months. Presumably the Spaniards are taking due notice of this hilarious joke and will gladly adopt the Greek mutilated beggar strategy in the next elections.

Second, the lack of recognition that Greece suffers from a debt overhang problem. Despite falling wages the economy is not recovering, because firms expect that the profits they make will be taxed so as to meet the sovereign debt obligations. This is a well understood problem that has been identified decades ago in the context of similar crises and popularized by prominent economists such as Dornbusch, Krugman, or Sachs.

There is no difference between erasing a debt and lending to your debtor the interests he owes you: in both cases you do not get your money back. But in the second case the debt overhang problem destroys the economic incentives of the debtor. Instead of renewing the loans in exchange for fuzzy structural reforms that are unlikely to work because of the debt overhang problem, the troika should erase 75 % of Greek debt once and for all and stop any new institutional lending to the country. Greece will then be able to grow again for ten years. Private lending will resume relatively fast, as suggested by the historical experience.

This has little to do with Euro membership, except that once private lending resumes, another crisis may graduallybuild up. Greece will be too happy to live again with large twin deficits financed by capital inflow, because this will generate an economic boom driven by demand, a welcome substitute for the structural reforms its government is unwilling to do. It will accumulate the competitiveness problems and the debt overhang of the next crisis. For this reason it is not in the interest of Greece to remain in the Euro. Should it have its own currency it could supplement its insufficient fiscal receipts with seignoriage (as recently as 1990, inflation in Greece was 20 %, yielding perhaps 2-3 % of GDP in seignoriage revenues). It could devalue to boost its competitiveness (prices have fallen by 2 % in Greece and only very recently, despite then huge fall in GDP), maintaining external balance despite its tendency to create inflationary surprises so as to boost the economy. All these considerations are important, but they do not imply conditioning exit on default. If anything, it is the future defaults that the exit prevents.