It's all Greek to me

First published in the Telegraph on 23 April 2010

Don’t be fooled into thinking that the Greek fiscal crisis, which today culminated in the stricken country officially requesting a bail-out package from the IMF and euro states, is an isolated problem. Although ministers are keen to try to characterise the country’s problems as sui generis – a particular country lied about how much money it had borrowed – this episode is actually an illustration of the second painful leg in the global financial crisis.

Leg one was the collapse of various different banks, which countries “solved” by effectively transferring debt onto their own balance sheets (either directly, by buying the banks or the bad loans, or indirectly by shouldering the economic impact of the financial crisis and seeing their budget deficits go up). Leg two is where countries start to crumble under the weight of these debts.

Whereas leg one felt rather unreal (some people lost their jobs but, aside from the palpable sense of crisis, the real pain of the disaster was not widely felt), leg two is different: it involves a far wider dispersion of misery, as governments seek a way of repairing their balance sheets – and this time around the only quick alternative to the pain is default (which would likely precipitate national conflict).

The scale of repair work is difficult to comprehend. The best analogy is probably the 1920s, when a whole range of countries (the UK included) imposed widespread deflation on their economies in order to get back onto the gold standard. In the UK, that involved the deepest recession in history. This time around, the scale of adjustment – at least for countries like Greece – is even greater.

This analysis will not seem particularly palatable for the Greek people, who can legitimately declare to have been thousands of miles (figuratively and literally) from Lehman-style misbehaviour. The problem is that their economy was hit hard by the global recession, which has flushed them out as a particularly vulnerable economy: current account and budget deficits that stick out like sore thumbs.

And what makes life particularly difficult for Greece is that its membership of the euro – far from helping them escape such problems – has actually exacerbated the pain. Unlike Britain, which can and has devalued (not that this is a silver bullet, but it helps), the only option available to Greece is to deflate. However, there is a very real risk that deflating (and this means public sector cuts deeper even than the ones which, when proposed earlier this year by George Papandreou, caused riots) could take down 1. the economy. 2. the Government. There is not all that much sympathy for Greece among other world leaders, but there is a recognition that the country is on the precipice – something which is good for no-one.

This, by the way, is not journalistic hyperbole. I am writing this blog from Washington, where the G20 and IMF are meeting for their spring summit, and ministers are very, very worried about Greece. Though they don’t admit it, they also privately suspect that this crisis will be the biggest challenge yet for the euro project. And for many it is no longer anathema to suggest that the euro may not survive this crisis – at least not in its current form.

To economists, it now seems more likely than not that Greece will find some way to default – though this would most likely be dressed up as “restructuring” which can be camouflaged through external financing. But this represents unchartered territory for the euro. There are no rules or allowances for situations like this built into the euro’s structures: the whole point, when the single currency was set up, was the understanding that there would be no bail-outs, and that instead countries’ finances should be bound by the Stability and Growth Pact. That undertaking has been officially laid to rest today.

The big question now (and many suspect they already know the answer) is whether the package, at an estimated 45bn euros, including around 15bn euros from the IMF (though this figures are yet to be confirmed) is enough. Usually IMF bail-outs are designed to be bigger than they need to be – in order to ensure quick recovery. No-one is suggesting (in private) that this amount does anything more than buy some time. But at 15 times Greece’s IMF quota, this is, proportionally speaking, already one of the biggest IMF bail-outs in history. Gulp. So on top of everything else, the ugly question of whether we are now reaching the limits of what the IMF can afford is rearing its head. Double gulp.

Can the euro survive? Can Greece survive? What are the implications for other indebted nations? Three chunky questions without any obvious solutions. It promises to be an interesting weekend.