Does Europe need debt relief?

Position:A SYMPOSIUM OF VIEWS
 
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The conventional view is that the eurozone's weak periphery economies are suffering from a lack of demand. Thus, so-called "fresh money" from central banks should lead to higher growth in coming years. Yet other experts, from Thomas Piketty to Hans-Wemer Sinn, question whether a different medicine is also needed--namely some form of debt relief (and possibly some means of temporary euro exiting and currency depreciation).

At issue is economic growth. Is the political status quo sustainable under the current slow-growth policies, or is a new approach to higher growth rates necessary? By the same token, how can a debt relief program be initiated without igniting a host of unattractive unintended consequences including the diminishing of the credibility of the periphery's credit markets in the long run?

In 1986, then-U.S. Senator Bill Bradley (D-NJ), at a conference in Zurich, called for emerging-market debt relief. At the time, Washington officials labeled this policy initiative highly controversial if not destructive to the financial order. Yet within less than half a decade, many of the same officials were boasting of the success of Brady Bonds.

Is the eurozone in a similar situation--in desperate need of a major conference on debt relief? .Are we in the midst of a tectonic shift on debt? Or would such a conference merely encourage more of the fiscal policies and lack of restructuring that led to the economic underperformance and excessive debt in the first place?

More than thirty observers offer their assessment.

HANS-WERNER SINN

President, Ifo Institute for Economic Research, and Professor of Economics and Public Finance, University of Munich

In terms of extra credit from the Greek printing press, net purchases of Greek government bonds by other central banks, and fiscal rescue credits provided by other countries, the credit help Greece has received from its partners in the eurozone stood at 325 billion [euro], or 182 percent of GDP, by the end of the first quarter of 2015. This sum was 062 billion larger than five years ago, when a possible Grexit was first vigorously debated in Europe, eventually leading to voluminous fiscal and monetary rescue operations. To put this sum in context, Greece has been supported with the equivalent of thirty-five Marshall Plans of the kind Germany received after the war, which, accumulated over the years, amounted to 5.2 percent of Germany's 1952 GDP. About one-third of the money publicly lent to Greece has been used for financing the Greek current account deficit since 2008, another third was used to replace net foreign debt existing already before 2008, and the remaining third enabled capital flight by Greeks who sold their assets to the banks or borrowed the money to transfer it to other countries.

Despite all the help, the Greek economy is in a shambles. Manufacturing output is 26 percent below the pre-crisis level, while the unemployment rate hovers at 26 percent, more than twice what it was five years ago, when the fiscal rescue measures started. Youth unemployment exceeds 50 percent. Spreads and interest rates are at record levels. On April 16, the interest rate for Greek government bonds with a remaining time to maturity of two years yielded a nominal rate of return of 28 percent.

Surprisingly, capital markets are not spooked by all this mess. The spreads of Italian, Spanish, Portuguese, or Irish government bonds relative to the German bunds are lower than ever. Market participants expect no particular turmoil should Greece default or exit the euro. The explanation is that practically all private financial investment in Greece has by now been replaced with public credit from the printing press or from the fiscal rescue operations.

It is time now for Greece's public creditors to face the truth and accept that the country is bankrupt. Even Greek Finance Minister Yanis Varoufakis insinuated as much in a BBC interview. Whether they like it or not, it is better for the creditors to write off their claims than to throw good money after bad, because that way they would extend the drama and the amount of money being burnt. Relief should be given for government debt, for the Target debt resulting from excessive issuance of money, and for bank debt vis-a-vis the local central bank, as they are all interrelated.

At the same time, the ECB should force Greece to impose capital controls, as was done in Cyprus, by stopping the extension of emergency liquidity assistance credit. ELA credit is refinancing credit that the Greek central bank provides to commercial banks purportedly at its own risk. In fact, however, the Greek central bank's risk-bearing capacity is limited by the size of its equity and its ownership share in the Eurosystem's monetary base, which currently amounts to 44 billion [euro]. Given that ELA has already reached 74 billion [euro], the admissible limit has been exceeded by 30 billion [euro]. This surplus may turn out to be a full gain in wealth for Greek citizens, since most of the money has been used to make their capital flight possible, forcing other central banks to credit Greek citizens' foreign bank accounts in exchange for Target claims that in all likelihood will never be serviced.

But just writing off the debt and stopping capital flight is not enough, as the country must be made competitive in the sense that it must be able to return to high employment without resorting to current account deficits. The best measure to achieve this is a temporary exit from the eurozone, as the subsequent devaluation of the drachma would redirect Greek demand from foreign to domestic products, boost tourism, and, above all, make it attractive for investors to return to Greece to buy real assets at bargain prices and further invest in the country. Nearly all seventy or so state bankruptcies that the world has seen in recent decades that were coupled with devaluations turned into success stories, with the upswing coming within a year or two.

The demonstration effect of such a measure would also be useful, as it would clearly signal that the Eurosystem is no fiscal union, but a currency union without debt mutualization and with rules that have to be obeyed. Keeping Greece in the euro and financing its lack of competitiveness with new public credit, as would undoubtedly be necessary to prevent political turmoil, would have dramatic political contagion effects for other crisis countries, blunting their reform efforts and making Europe sink in a morass of debt.

HENRY J. AARON

Bruce and Virginia MacLaury Senior Fellow, Brookings Institution

The eurozone has three problems: national debt obligations that cannot be met, medium-term imbalances in trade competitiveness, and long-term structural flaws. The short-run problem requires more of the monetary easing that Germany has, with appalling shortsightedness, been resisting, and less of the near-term fiscal restraint that Germany has, with equally appalling shortsightedness, been seeking. To insist that Greece meet all of its near-term current debt service obligations makes about as much sense as did French and British insistence that Germany honor its reparations obligations after World War I. The latter could not be and were not honored. The former cannot and will not be honored either.

The medium-term problem is that, given a single currency, labor costs are too high in Greece and too low in Germany and some other northern European countries. Because adjustments in currency values cannot correct these imbalances, differences in growth of wages must do the job--either wage deflation and continued depression in Greece and other peripheral countries, wage inflation in Germany, or both. The former is a recipe for intense and sustained misery. The latter, however politically improbable it may now seem, is the better alternative.

The long-term problem is that the eurozone lacks the fiscal transfer mechanisms necessary to soften the effects of competitiveness imbalances while other forms of adjustment take effect. This lack places extraordinary demands on the willingness of individual nations to undertake internal policies to reduce such imbalances. Until such fiscal transfer mechanisms are created, crises such as the current one are bound to recur.

Present circumstances call for a combination of short-term expansionary policies that have to be led or accepted by the surplus nations, notably Germany, who will also have to recognize and accept that not all Greek debts will be paid or that debt service payments will not be made on time and at originally negotiated interest rates. The price for those concessions will be a current and credible commitment eventually to restore and maintain fiscal balance by the peripheral countries, notably Greece.

PHILIPP HILDEBRAND

Vice-Chairman, BlackFtock, and former Chairman of the Governing Board,

Swiss National Bank

While its GDP per capita remains among the highest in the world, eurozone growth performance in recent years has been poor, with GDP still below its pre-2008 crisis level. This is indeed partly due to a large public and private debt overhang in many countries. However, a conference on debt relief is not needed and would in fact be dangerous. What Europe needs most is reforms that raise its long-term trend growth.

Many eurozone countries have accumulated large sovereign debt-to-GDP ratios as a result of a combination of insufficiently conservative fiscal policy in boom times, banking sector rescues, and recession in the aftermath of the global financial crisis and then the eurozone crisis.

What these countries now need is to grow faster than the interest rate they pay on their debt, and run sensible fiscal policies. The ECB's quantitative easing policy is creating a unique window of opportunity to set those high debt-to-GDP ratios on a declining path, by delivering ultra-low interest rates--but this will last only for a while, less than two years if all goes according to...

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