Our Big, Fat Greek Bankrupcty

What do you do when your economy is in a power dive and the ground is rushing up to meet you?  If you're Greece, you turn on your austerity afterburners so that you can blast out a bigger impact crater when you crash.

As this is written, the Greek parliament is doing another austerity rain dance, seeking to appease the bailout gods and obtain a few billion more euros to shovel into the unionized money incinerator that is the Greek public sector.  No matter.  The Greek economy is contracting so fast that EU/IMF bailouts have a shorter half-life than Iodine 125.

In modern economies, the effects of government policies show up first and fastest in employment.  Greece reports its monthly employment numbers two months slower than the U.S., but the pattern is clear.  The Greek economic situation is deteriorating so fast that reporters are writing silly things like the following, which was published on June 8:

March jobless rate hits 16.2%, new record.  The European Union expects it to average out at 14.6% this year and hit 14.8% in 2012.

Does no one think it odd that the E.U. expects Greek unemployment to average 14.6% for all of 2011 when it registered 15.1% in January, 15.9% in February, and 16.2% in March?

As of March 2011, total employment in Greece was down by 9.3% from its October 2008 peak, and was still falling.  In contrast, in the case of the U.S. recession, total employment fell by 5.9% from its November 2007 peak to its December 2009 trough, and then rebounded 1.5% by March 2011.

Given that not one worker in Greece's bloated public sector has yet lost his job to "austerity," the employment numbers imply that the Greek private sector is melting faster than the Wicked Witch of the West in a hot tub.  Because the Greek private sector has to both support the huge Greek public sector and to service the Greek government's debt, this is probably not a good thing.

Here is a quote from another news story published on June 8:

The May 2010 agreement between the IMF/EC/ECB and the Greek government projected a GDP drop of 4% in 2010, followed by a contraction of 2.6% in 2011.  In reality, GDP dropped by 4.5% (in 2010), leading to a revised forecast for 2011 at -3%.  So far, in Q1 2011, GDP has dropped by 4.8% year-on-year, which makes the revised 3% contraction for 2011 seem optimistic.

Seem optimistic?

Right now, Greeks are rioting in the streets as Prime Minister Papandreou struggles to push through yet another "austerity plan", this one calling for an additional 3.8 billion euros in spending cuts.  It appears that he will succeed.  However, at the rate that the Greek economy appears to be contracting, this would offset falling revenues for less than a year.  Then what?

No one seems to have noticed that the tax increases included in previous austerity programs have pitched the Greek economy into a violent contraction.  The plan being debated now includes even more tax hikes.  Despite all of this, the EU's financial projections assume that Greek GDP will shrink by only 3% in 2011, and then will grow by 1.1% in 2012.  If, instead, the Greek economy were to continue to contract at a 4.8% rate, in 2012 real GDP would be 7.6% smaller than the EU is expecting, and 11.5% less than it was in 2009.

Social order in Greece will break down before GDP shrinks to 88.5% of its 2009 level.  Ordinary people won't accept self-inflicted economic wounds of this scale.  If the Papandreou government continues on its austerity kamikaze mission, it will eventually fall.

With debt equal to more than 150% of GDP and a rapidly contracting economy, Greece must choose between declining the EU/IMF bailout and defaulting now, or imposing more austerity, getting more loans, and defaulting a few months from now.  So, why would the Greek government choose to go through all of this agony just to buy a few months?  And why would it want to pile on more austerity when what is needed is a program for economic growth?

It could be because Greek elites have not yet moved all of their capital out of the country.

Greek banks are frantically borrowing euros from the ECB, using Greek government bonds (valued at par, not at market) as collateral.  These ECB loans make it possible for Greeks to withdraw euros from Greek banks and transfer them abroad.  The moment that Greece defaults, its bonds will no longer be eligible for use as ECB collateral, the Greek banking system will collapse, and this process will screech to a halt.  Greeks with money may not want this to happen—at least not right now.

However, let's imagine that the Greeks wanted to change course and try to save their country.  What should their new economic plan be?  Before the Greeks find themselves going hungry, they might try "going Hungary."

In mid-2010, both Greece and Hungary were in financial trouble and were being pressured to adopt "austerity" measures in return for bailout loans.  While Greece chose to drink the IMF/EU tax-hike hemlock, Hungary declined the pact proffered by the IMF devil.

Greece raised taxes in the name of "austerity", while Hungary embarked on a radical tax reform program that included a 16% flat income tax and a 10% corporate income tax for small and medium-sized companies.  Let's see which approach produced better results.

In 2010, Hungary's GDP rose by 1.2%, while Greece's GDP fell by 4.5%.  While Greece's economy is expected (by the EU) to contract by 3.0% in 2011, Hungary's is forecasted (by the IMF) to grow by 2.8%.  From January 2011 to March 2011, Greece's unemployment rate increased from 15.1% to 16.2%, while joblessness in Hungary fell from 12.1% to 11.6%.

The whole point of austerity is to improve a country's ability to pay its debts.  However, all that a year of austerity did for Greece was to raise the market interest rate on its 10-year bonds from 10.5% to 16.8%.  In contrast, the interest rate on Hungary's 10-year bonds fell from 7.7% to 7.4% over the same time period.

Some economists say that the key to getting the Greek economy growing again would be to replace the euro with a "new drachma", which could then be devalued in order to improve Greek "competitiveness".  In this light, it is interesting to note that over the past year, Hungary's currency, the forint, has actually risen by almost 6% against the euro.  Accordingly, Hungary's economic progress was not produced by devaluing its currency.

Of course, in mid-2010, Hungary was in an economic/financial position where it could refuse bailout loans without defaulting on its debt.  In mid-2011, Greece is not.  However, as things stand, Greece is going to default.  At some point, we are going to have a big, fat, Greek bankruptcy.  The only question is whether the coming default is used to make things better for Greece, or is allowed to make things worse.

For Greece to truly recover, it must do now whatever it takes to get its economy growing now.  However, whatever else it does, Greece must stick with the euro.  Without a credible currency, an urbanized nation can quickly descend into chaos—and even starvation.

Broadly speaking, Greece needs to do the same things that the U.S. needs to do.  It must enforce the rule of law, expand economic freedom, maintain a stable currency, reduce and simplify taxes, cut government spending, open up trade, and reform burdensome regulations.  This path would not be (politically) easy for the U.S., and it may or may not even be possible for Greece.  We shall see.