Greece and the Fatal Flaw in an IMF Rescue
Simon Johnson and Peter Boone, the Huffington Post
In 2003 the International Monetary Fund published yet another internal review with an impressively dull title “The IMF and Argentina, 1991-2001“. But hidden in that text is explosive language and great clarity of thought – in essence, the IMF staff belatedly recognized that their decision to repeatedly bailout Argentina from the mid-1990s through 2002 was wrong:
“The IMF should refrain from entering or maintaining a program relationship with a member country when there is no immediate balance of payments need and there are serious political obstacles to needed policy adjustment or structural reform” (p.7, recommendation 4).
If Mr. Trichet (head of the European Central Bank), Ms. Merkel (German Chancellor), and Mr. Sarkozy (French President) have not reviewed this document yet, they should skim it immediately. Because one day soon Greece will be calling on the IMF for a loan, and it seems mostly likely that the mistakes made in Argentina will be repeated.
There are disconcerting parallels between Argentina’s catastrophic decade, 1991-2001, which ended in massive default, and Greece’s recent and impending difficulties. The main difference being that Greece is far more indebted, is much less competitive in global markets, and needs a commensurately greater fiscal and wage adjustment.
At the end of 2001, Argentina’s public debt GDP ratio was 62%, while at end 2009 Greece’s was 114%. Argentina’s public deficit reached 6.4% GDP in 2001, while Greece’s was 12.7% GDP (or 16% on a cash basis) in 2009. Both countries locked themselves into currency regimes which made it extremely painful to exit: Greece has the euro, while Argentina created a variant of a currency board system tied to the US dollar. And both countries had seen their competitiveness, as measured by the “real exchange rate” (which reflects differential inflation relative to competitors) worsen by 20% over the previous decade, helping price themselves out of export markets – and boosting their consumption of imports. In 2009 Greece had a current account deficit equal to 11.2% of GDP, while Argentina’s 2002 current account deficit was a much smaller 1.7% GDP.
The solution to such crises is rarely gradual. Once financial market confidence is lost, yields on government debt soar, private capital flees, and sharp recessions occur. The IMF ended up drawing tough conclusions from its Argentine experience – the Fund should have walked away from weak government policy programs earlier in the 1990s. Most importantly, IMF experts argued that from the start the IMF should have prepared a Plan B, which included restructuring of debts and termination of the currency board regime, since they needed a backstop in case the whole program failed. By providing more funds, the IMF just kicked the can a short distance down the road, and likely made Argentina’s final collapse even more traumatic than it would otherwise have been.
Sadly, the Greeks are today in a similar situation: the government’s macroeconomic program is not nearly enough to calm markets, or put Greece’s debt on a sustainable path. By 2012 we estimate Greece’s debt/GDP ratio will rise from 114% of GDP to over 150%. The interest payments alone on this would amount to 9% of Greek’s incomes at current rates, and almost all those funds are transferred to the German, French, and Swiss debt holders.
Greece’s 2010 “austerity” program is striking only for its lack of credibility. Under that program Greece, even in 2010, does not pay the interest on its debt – instead the government plans to raise 52bn euros in credit markets to refinance all its interest while at the same time it borrows 4% of GDP more. A country’s “primary budget” position measures the budget without interest expenses — at the very least, the Greeks need to move from a 4% of GDP primary budget deficit to a 9% of GDP primary surplus – totalling 13% of GDP further fiscal adjustment, in the midst of what will be a massive recession, just to have enough funds to pay annual interest on their 2012 debt. This is under the rather conservative assumption that interest rates would settle near 6% per year, where they stand today. The message from these calculations is simple: Greece needs to be far more bold if its austerity program is to have a serious chance of success.
How did Greece manage to get into such a terrible situation?…
(6 April 2010)
UK household savings lowest in 40 years say ONS
People in the UK are saving less than at any time in the past 40 years, according to the Office for National Statistics (ONS).
The household saving ratio in the UK in 2008 was 1.7% of total resources, the lowest recorded since 1970, and well below the 7.6% average for that period.
The ONS Social Trends survey reveals that housing, water and fuel now represent the biggest area of spending.
In 1970 the highest proportion was spent on food and non-alcoholic drinks.
(8 April 2010)
Sovereign debt crisis at ‘boiling point’, warns Bank for International Settlements
Ambrose Evans-Pritchard, The Telegraph
“The aftermath of the financial crisis is poised to bring a simmering fiscal problem in industrial economies to the boiling point”, said the Swiss-based bank for central bankers — the oldest and most venerable of the world’s financial watchdogs. Drastic austerity measures will be needed to head off a compound interest spiral, if it is not already too late for some.
The risk is an “abrupt rise in government bond yields” as investors choke on a surfeit of public debt. “Bond traders are notoriously short-sighted, assuming they can get out before the storm hits: their time horizons are days or weeks, not years or decade. We take a longer and less benign view of current developments,” said the study, entitled “The Future of Public Debt”, by the bank’s chief economist Stephen Cecchetti.
“The question is when markets will start putting pressure on governments, not if. When will investors start demanding a much higher compensation for holding increasingly large amounts of public debt? In some countries, unstable debt dynamics — in which higher debt levels lead to higher interest rates, which then lead to even higher debt levels — are already clearly on the horizon.”
Official debt figures in the West are “very misleading” since they fail to take in account the contingent liabilities and pension debts that have mushroomed over recent years. “Rapidly ageing populations present a number of countries with the prospect of enormous future costs that are not wholly recognised in current budget projections. The size of these future obligations is anybody’s guess,” said the report. The BIS lamented the lack of any systematic data on the scale of unfunded IOUs that care-free politicians have handed out like confetti.
Britain emerges in the BIS paper as an arch-sinner. The country may have entered the crisis with a low public debt but this shock absorber has already been used up, exposing the underlying rot in the UK’s public accounts.
Tucked away in the BIS report are charts and tables showing that Britain faces the highest structural deficit in the OECD club of rich states, with a mounting risk that public debt will explode out of control…
(8 April 2010)
The report can be accessed here.