Greek Debt: Default or Restructuring?

After Greece, what?  Hungary?  Or a low growth prospect for Europe?  Or disappointment with American recovery?  Or, still Greece?  The international financial markets are always nervous and unstable — sometimes sad, sometimes euphoric, but always in a dialectic of rationality and irrationality.  Despite our more “scientific” air, we economists make the same mistakes.  So, perplexed politicians and entrepreneurs — the agents in the real economy — don’t know what to do.  To invest or not to invest?  To continue expansive fiscal policy, or is it already time to take care of each State’s high public debt and each country’s sometimes high foreign debt?  And they ask: is this the beginning of a W-shaped crisis?

Greece’s problem in fact posed the threat of a strong recurrence of the crisis.  Germany’s delay contributed to worsening the problem.  However, in the end, Germany and the European Central Bank (ECB) did what was expected of them: they guaranteed Greece’s debt and, more broadly, the debt of the other countries of the eurozone, and, although this did not solve everything, the crisis eased off.  Everyone knows that, structurally, Greece’s problem is not solved because, even if it carries out its program of fiscal adjustment to the letter and its GDP falls around 3% to 4% in the next two years, at the end of that period its public debt/GDP ratio will still be 150%.

Given such a setting, the question arises again as to whether Greece will withdraw from the euro system, but this is very unlikely.  The advantage of having a currency that would begin its history already depreciated as compared to the euro does not compensate for the risks of remaining outside the protection of the euro system.  There is, however, the possibility of restructuring the public debt within the euro system.  This would be the best course of action for Greece, given its insolvency, because, even if the interest rate on its securities goes back to a reasonable level and stabilizes at that level, Greece will not be able to honor its financial obligations and to grow again.

But the reader might ask: are you then proposing a “default”?  No, my friend, I am suggesting that Greece should “restructure” its debt at a discount.  Which is the same as a default and yet something entirely different.  It is the same thing, because the outcome is identical for the creditor: he recovers only part of his loan.  It is entirely different, because the word default has a derogatory tone to it that suggests an irresponsible debtor.  In contrast, restructuring has a milder connotation, not only because it divides the guilt between the debtor and the creditors, but mainly because in the end all or the vast majority will understand that it was the only rational solution to the problem, given the insolvency of the Greek State.

When a sovereign debt crisis is settled by a “default,” it is usually ill resolved because it means that there was no insolvency, or that the financial markets have not accepted the diagnosis of insolvency of the debtor country and consider that it acted in bad faith.  In contrast, restructuring, although it is basically unilateral or almost unilateral, solves the problem better, because, in the end, it legitimates the creditors’ loss that reasonably efficient financial markets must have already anticipated by pricing the debts at a discount.

The governments of countries facing sovereign insolvency are afraid of restructuring because they fear that this would be seen as a default.  I understand this fear.  The financial markets, the governments of rich countries, and the International Monetary Fund always do what is expected of the “establishment”: they put pressure on the country to make the adjustment instead of restructuring the debt.  And they always warn that the action will be considered as a default and that, ultimately, the country will be forced to yield, given the power of the creditors or the power of international law.

If the situation is not insolvency, but a problem of liquidity — a mere imbalance between maturity dates and revenues — these threats may carry weight.  However, in a situation of clear insolvency, as is the case of Greece today, these threats are rhetorical rather than real.  The financial markets already know that restructuring is necessary.  They know it because their economists and traders are aware of the figures and know what they mean.  They also know it because economists such as Martin Wolf, and economic publications they respect, such as, for instance, The Economist, have already said that this will probably be the most appropriate solution to the Greek crisis.  Those economists and publications represent a sort of financial “public opinion.”  Which, like any public opinion, may be wrong, but that is not important — the important thing is that actions performed according to it promptly gain legitimacy.

There is no reason for the world to plunge once again into crisis.  The crisis is still costing rich countries a lot of money, but their governments knew how to deal with it, and their economies are on the way to recovery.  Meanwhile, crises such as the Greek one may occur, but, if its government has the courage and determination to do what must be done, the other governments and the financial market itself will understand, and this source of crisis will soon be neutralized, instead of festering for a long time.

Luiz Carlos Bresser-Pereira (Professor Emeritus, Getulio Vargas Foundation) is an economist.  Em Português.

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