Global Trends by Martin Khor

Monday, 7 November 2011

Greek tragedy sours G20 Summit

The G20 summit last week was scripted to celebrate a European strategy to exit the debt crisis, but it was diverted instead into a new act of the Greek tragedy that can lead to global recession.


Last week saw pure drama on an epic scale, as the Eurozone plan to exit its debt and currency crisis almost crumbled when the Greek Prime Minister announced he needed a national referendum to approve a bailout programme.

This bombshell came last Monday on the very eve of the G20 Summit in Cannes which had been expected to cheer the European leaders for finally getting their act together.

Instead, the G20 summit became another new Act in the Greek and Euro Tragedy.  The summit concluded last Friday without any concrete results.  “Global recession grows closer as G20 summit fails,” warned the headline of the London Guardian.

The Eurozone play will now stumble on at least until next February and probably beyond.  New scenes and acts will get worse, until it finally gets better, hopefully.

The European plan, so painfully pulled together and announced on 27 October, had three aspects.  First, Greece would get a new Euro 130 billion bailout loan, while its creditors (mainly European banks) would take a 50% haircut (be repaid only half) on their loans to Greece.

This is a default, but (hopefully) not to be termed such, because the creditors would be persuaded by their governments to accept the haircut, and the debt restructuring would be “orderly.”

Second, it is recognized that European banks (especially those that suffer a blow from the haircut) will require recapitalization to withstand the growing financial storm. They should mobilize additional capital themselves or else they would be assisted by their national governments or if necessary by the European Financial Stability Facility (EFSF).  It is estimated that Euro106 billion is required for the banks’ recapitalization.

A combination of the first and second measures is supposed to stem the Greek and Euro crisis (at least for now).

Third, the European Financial Stability Facility (EFSF), which now has Euro 440 billion but would have to use part of it for the first two actions, would be boosted so that it can command more than 1 trillion euros.  This is needed for the next big battle – preventing a new and much bigger debt crisis in Italy.

This multiplying of the EFSF’s firepower was planned to be done through getting China and other developing countries to provide loans in a “special vehicle”, and leveraging the EFSF’s funds through loan guarantees to private creditors.  The IMF is also asked to chip in with its own mega loans.

The three-piece solution was to be presented to the G20 Summit with the hope that China, other major developing countries and the IMF would buy into the plan and cough out the needed billions.

But the Greek premier George Papandreou upset the apple cart through his own plan to put the Greek bailout to the public in a referendum. Just the prospect of a public rejection would have scuttled the whole European strategy.

Even though Papandreou withdrew his referendum idea after being scolded at a pre-G20 dinner by the furious French President and German Chancellor, and even after he won a Parliamentary vote of confidence, the damage had been done.

At the G20 summit, neither China nor any other country agreed to join the European bailout.  Understandably so, since the political uncertainties heightened the possibility their money would not be safe.

The G20 leaders also did not authorize the IMF to increase its bailout loans or to issue special drawing rights (SDRs) to the Europeans.  They forwarded the decision on this to the G20 finance ministers’ meeting next February.

Till then, more convulsions can be expected.  The next fire to put out, and a much bigger one than Greece, is Italy. It has 1.9 trillion euro of debt, and it has to refinance Euro 300 billion in borrowing in 2012.  An early test comes this November and December, when it has to raise Euro 53 billion, and many are nervous how that will proceed.  The interest to be paid is prohibitive: yields on Italy’s 10-year bonds have shot up to euro-era record highs, being 6.4% at the end of last week.

The Italian premier Silvio Berlusconi rejected an IMF facility, and only agreed  under pressure by other G20 leaders to subject Italy’s economic performance to a quarterly scrutiny by the IMF.

What should not be lost as events unfurl is the great tension between the proposed technical solutions and the political reality on the ground.

The reason the Greek politicians are scrambling is because the Greek citizens are up in arms in protest against the policies attached to the bailout.

Big cuts in government jobs, social spending, pensions and wages, privatization, and so on, have already caused the people hardships, and this is just the beginning. Even by 2020, Greece’s debt will be the equivalent of 120% of GNP.  In other words, after a decade of severe and increasing pain, they will be back at square one.

Something is surely wrong with the solution.  In a perceptive column, the renowned British economist Samuel Brittan wrote in the Financial Times why he himself would vote No in a Greek referendum.

“The condition of financial support is ever more severe fiscal austerity,” he wrote. “Never mind that Greek national output is already more than 9% below its 2008 level. Never mind that unemployment has hit 17%.  The Greeks are being asked told to squeeze, squeeze, squeeze. I know how I would have voted in a referendum, had it gone ahead.”

The Greeks may have to decide, now or later, whether the pain is worthwhile taking to stay in the eurozone.  Or whether they should opt out, re-introduce their drachma currency, regain monetary independence, and change economic policy so that they can grow their way out of the crisis.

That may require a bigger default than the orderly 50% being planned, and a period of being labeled a “pariah”.   But as Argentina and Iceland showed, a combination of default, clearing of the decks, and growing again is possible, if done correctly.