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Greek Deal Is Another Dangerous Wimp-Out

The Greek deal reached in the early hours of last Monday and ratified by the Greek parliament Wednesday drew a sigh of relief from investors. Unfortunately, that reaction was not simply premature. It’s completely misguided.

Greece would be far better off leaving the eurozone, and the common currency would be strengthened by its departure. Meanwhile, another Greek bailout will encourage other irresponsible governments, such as Portugal, Spain, and Italy.

The deal provides Greece with 85 billion euros ($95 billion) in new loans in return for tax code reform, an overhaul of the state pension system, safeguards for the government’s independent statistics agency, and modest budget cuts. It also reiterates a call for 50 billion euros’ ($56 billion) worth of privatization of state-controlled assets, the proceeds of which will be kept in a trust fund to satisfy Greece’s creditors.

But – as with previous bailouts, which have now totaled over $250 billion – implementation of austerity measures requires the cooperation of the Greek government, something Syriza has proven incapable of thus far.

An Empire of Debt

Greece now has 320 billion euros ($360 billion) of debt, about twice its GDP. It has been running large budget deficits ever since it entered the EU in 1981, in spite of its massive access to EU poverty and agriculture funds.

The massive subsidies and government overspending raised Greece’s GDP per capita to a peak of $32,000 in 2008, more than several Western European countries that were very clearly more productive.

When you compare Greece to its neighbors Bulgaria, Romania, and Macedonia, it’s no more productive or capitalist and just as corrupt – hence it should be no richer. That sets a target equilibrium Greek GDP per capita in the $10,000 to $15,000 range. At that level, Greece would survive without massive handouts, and might possibly be able to service its debt.

The attempt since 2010 to use austerity to halve the living standards of the Greek people was always very unlikely to succeed. It also allowed the “austerity” cuts in public spending and living standards to be blamed on EU bureaucrats rather than the impersonal forces of the market. Thus it was no surprise when the hard left party Syriza won elections in January.

As I’ve said before, if Syriza is successful, this will encourage similar forces in other troubled economies, such as Podemos in Spain and Beppe Grillo’s Five Star movement in Italy (both of whom have expressed support for Syriza). Their triumph is not inevitable, though, because the level of austerity required in those two countries is very much less.

A Graceful Grexit

Even at this late juncture, it would still make the most sense for Greece to exit the eurozone and adopt a “new drachma.” The country would then have to find its feet without outside, artificial support, and the new drachma would fall until Greece’s living standards had been brought to their proper level.

If Syriza remains in power, it’s likely the standard of living would be further reduced by Syriza’s own overspending, bureaucratic meddling, and generally poor economic management. In that case there would be no outsiders to blame and Greeks would soon tire of Syriza’s depredations.

With the new bailout, Greece’s future is grimmer. Syriza will attempt to evade the provisions of the new agreement, especially those on privatization, which it will be able to block ad infinitum, as the previous Greek government did. Thus, Greece’s wages will remain too high, while its economy becomes steadily less efficient under the twin tutelage of Syriza and the austerity-seeking creditors.

Inevitably, Greece will be back for money, probably as soon as early 2016. At that point, the country’s debt will have increased still further, while the gap between Greeks’ ability to produce and the amounts they receive in income will become still greater.

Dio Dangers

I believe a Grexit is inevitable, no matter how much money the EU and International Monetary Fund pour into the country.

In that belief, I have good company. Wilfred Schauble, Germany’s long-standing financing minister, has made it clear that he favors a Greek euro exit. When it exits, Greece will default on its international debt – which doesn’t much matter, since only 60 billion euro ($68 billion) of that debt is now held by private banks and investors, and the remainder is held by people who can just print money to replace it.

There are two dangers, though.

One is that the euro will be badly weakened by the perpetual Greek crises. Greece leaving the eurozone would damage it less. It would show that the euro group had decent internal discipline, and would ensure that other borderline countries obeyed the eurozone fiscal and economic rules.

The other danger is that further handouts to Greece could encourage bad actors in other countries. In Spain, for example, an election must be held soon, probably on November 29, and Podemos, a Syriza-like party, is currently running at 21% in the polls, requiring only a modest boost to win the election against a splintered opposition. If that happened, Spain’s admirable progress on reform would be reversed and the country would become a much larger burden on other euro members than Greece could ever be.

I don’t expect this saga to end well. But for the sake of other European countries, everyone should hope it comes to a close soon in the form of a Greek default and an exit from the eurozone.

Good investing,

Martin Hutchinson

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