Wednesday, February 15, 2012

Greece is standing on the trap-door

The media is filled with stories about the coming Greek depression, supposedly unprecedented in the modern era. This would come as news to millions of central and eastern Europeans who lived through the painful transition from communism to capitalism only twenty years ago.

What sets Greece apart is not the degree of economic adjustment required to resume growth, which is certainly less than was required in eastern Europe. What distinguishes Greece is the degree of mental adjustment required. Unlike the eastern Europeans, the Greek people have no desire to make the transition from socialism to capitalism. This transition is being forced upon the Greek electorate by Greece’s total loss of credit market access. Greece’s credit cards are maxed out and it needs to find a real job making things that foreigners will pay for, not subsidize.

It is instructive to observe the Greek public reaction to national bankruptcy. Anger, disbelief, bargaining, denial, and, of course!, destructive rioting. No comprehension that the government has run out of money, only loud demands for “social justice”. Not one politician is advocating structural reform on the lines of what Poland implemented in the nineties. They seem to think that there is an alternative to radical change.

Either Greece will accept and implement the austere terms of the EU bailout, or the government will be unable to pay its bills next month. Either way, the Greeks will be forced to change their way of life, and pronto.

Greece is currently running twin fiscal and current account deficits of 10%, which are being financed by the ECB (via the banks). One year from now, perforce, both of these numbers will be zero (excluding foreign charity). Greece’s budget and current account will both be balanced, because it will have no one left to borrow from. The ECB window will be closed by then.

This adjustment will occur because of a collapse in aggregate demand. (The adjustment will necessitate a collapse in aggregate demand.) Government, businesses and households will be forced to reduce spending due to “hard budget constraints”. The prices of domestic nontradables will fall, especially real estate values which will probably fall by 90%. (There will be no privatizations in the absence of a legal system). Wages not controlled by the government or labor contracts will fall as the safety net is removed and the necessities of life force people to emigrate or find work. Unemployment will approach 40%, while unemployment benefits are reduced or eliminated. The defense budget will be cut, with the obvious implications for domestic stability: it is hard to fire colonels in countries like Greece.

What I have outlined is not a risk; it is a certainty.

One would have to believe that such an object lesson would be a major blow to European social democracy and a boost for austerity-minded politicians such as Merkel, Sarkozy, Monti, and Cameron. It will be interesting to see which comes first: Greek collapse or the French presidential election. If Hollande wins, he will have a memorable presidency.

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