When Greece joined the EMU in January 2001, ECB President Wim Duisenberg was warning that Greece had to adopt a tough austerity program aimed at making deep cuts in public spending. Back then, many investors did not agree with the EU-11 enlargement fearing that the decision would send out the wrong signal to financial markets, suggesting that in future other weaker economies might be allowed in without complying fully with membership conditions. Over the last decade, the Greek government has got involved in manipulating accounting rules and derivatives markets to run up unsustainable debts. By using the swap contracts and not having to record these transactions as debt, Greece managed to scrape in under the Maastricht criteria for EMU membership. This financial engineering helped the Mediterranean country accumulate more debt that would otherwise have been possible, pushing the country deeper into a sovereign debt crisis.
The problem in Greece is emblematic: people on the street corrupt both the public and the private systems, the systems corrupt the politicians and the politicians corrupt the people. According to a study by Transparency International, the Greeks paid an average of EUR1,355 in bribes last year for services such as getting a driver’s licenses or a construction permit, getting admitted to public hospitals or manipulating tax returns. In December 2009, Premier George Papandreou offered assurances that Greece would not default on its EUR298 billion debt. At the same time he stated that “salaried workers will not pay for this situation and the government will not proceed with wage freezes or cuts”. If Greece were to impose the drastic pay cuts across the public system, it would deepen depression and cause tax revenues to collapse further.
Current Greek crisis is very similar to that of Argentina in 2001, when the government initially tried to cut wages instead of eliminating the dollar-peg. Eventually, the peg collapsed, sending the peso down the tube but within few years Argentina achieved strong GDP growth rates. In theory, Greece could apply the same recipe: restore its currency – drachma, and restructure its foreign debt. In that scenario, bondholders would lose significant money, but that could produce the least amount of pain amongst stakeholders. Asking the Greek government to implement an austerity program in exchange for an EU and/or IMF loan would make investors happy but it would inflict years of misery on households and businesses. These days, investors expect that though European Central Bank may not bail out Greece directly, but it may buy Greek bonds in the open market. That would not fix the underlying issue. Instead, it will increase Greece’s debt, prolonging the agony. Fairly speaking, ECB monetary policy was one of the causes of the current sovereign crisis, offering low interest rates to countries like Greece, Portugal, Spain, Italy and Ireland, pushing them into a property bubble and wage boom.
Bottom line, Greece would do everyone a favor by declaring a moratorium and forcing a debt rescheduling.