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Wednesday, October 12, 2011

Why not a haircut for Greece

Greece should never request a haircut from her creditors. If offered a haircut, Greece should refuse to accept it.

A forgiveness of debt is a stain on a country's reputation which it will not be able to shed for decades, if ever. Lenin allegedly once said that one of his revolution's greatest mistakes was to repudiate the debt of Tsarist Russia. Greece has been able to avoid that stain since her independence even though she had external payment problems and defaults during more than half of the time since then.

A country's wealth or poverty is much more than just a function of the state's budget situation. A state does not prepare a balance sheet; there is no accounting for its assets; there is no accounting for untapped natural resources. From an income/expense standpoint, the Greek state is bankrupt but no one can tell how it would look from an assets/liabilities standpoint.

A country's wealth or poverty is also a function of the condition of its economy. A well-functioning economy always has resources to provide the state with revenues because it functions well enough to pay even increased taxes.

Ultimately, a country's wealth or poverty is a function of the wealth of its citizens. A country of, say, the African continent whose state is bankrupt and without assets; where the economy no longer functions and where the citizens live barely above the poverty line can rightfully be deemed to be poor. For such a country, a debt forgiveness may ultimately be the only solution.

Don't forget that Greece is unquestionably a country of the 1st world. She is situated on the European continent and integrated into the EU and Eurozone. The mere thought that a country of the 1st world would be forgiven debt should scare every responsible politician because no one could judge the possible long-term damage to financial markets caused by such a precedent.

The Greek state, although bankrupt from an income/expense standpoint, is said to own substantial assets. The nearer-term privatization potential has been calculated by the Troika at around 50 billion EUR. The longer-term privatization potential has been cited at 200-300 billion EUR. Furthermore, Greece's problem is still one of tax revenues and not one of government expenditures. Greek government expenditures are 49% of GDP compared with 56% in France. Greece's government revenues, on the other hand, are only 39% of GDP compared with 53% in France. If Greeks came up with a tax contribution similar to that of France, Greece would have a budget surplus of about 3% today!

The Greek economy no longer functions well. Thus, its official tax-generating ability is likely to remain constrained for some time. However, things would probably look quite a bit differently if one could consider the "unofficial" tax-generating ability of the Greek economy. One is safe to assume that it would be much, much higher than the present official tax-generating ability.

Also, there is a difference between an oil producing country which still has huge oil reserves left for development and another oil producing country whose oil reserves are calculated to last only another 20 years. The latter has used up most of its potential whereas the former still has great potential to use. Greece has hardly used any of her potential during the last decades, be those natural resources or human capital. Consequently, Greece could be in a classic catch-up situation and no economy grows faster (at least for a number of years) than an economy which needs to do a lot of catching-up.

Finally, the wealth or poverty of Greek citizens must be examined. Greeks are said to be traditional home owners (as opposed to renters) and homes have often been owned long enough by the families to be free of debt. One could undoubtedly substantiate this claim with figures. Furthermore, the official savings deposits of Greeks in domestic banks amount to 193 billion EUR (that is: not even counting the hundreds of billions of EUR in foreign bank accounts nor the billions of EUR under mattresses). Note that the amount of Greece's sovereign debt which is owed to foreigners (instead of Greeks) is 179 billion EUR. In other words, Greek depositors (with only their official domestic deposits) could repay the entire foreign debt of the state and still have almost 20 billion EUR left over.

Put differently, Greek banks altogether have aggregated capital & reserves of 45-50 billion EUR. If those banks cleaned out their balance sheets of overvalued sovereign debt, the banks would then have properly valued assets but no longer capital & reserves. If Greek savers could be "motivated" to convert 45-50 billion EUR of their deposits into shares of Greek banks, Greek depositors would suddenly be the sole owners of good Greek banks and, hopefully, collect good dividends.

So, is Greece a country which should request a haircut and live with that stain for decades? It is obvious that this would be a high long-term price to pay for a short-term benefit of questionable value.

Should Greece be offered a haircut? Definitely not! If Greeks got their act together like the Slovaks did after the fall of the Iron Curtain, Greece could well become an economic tiger of the Eastern Mediterranean. Creditors would forever regret the decision to have forgiven debt to a country which had not first be given a chance to show how much value it can create when it gets its act together.

Instead, Greece should reschedule her debt out to at least 30 years and capitalize interest on much of that in order to reduce the debt service burden on the budget. But, again, no haircut!

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