The basic flaw in the IMF-EU sponsored program to restore Greek fiscal sustainability through a program of draconian public expenditure cuts is that if successfully implemented it will have the unwanted effect of increasing rather than reducing Greece’s public-debt-to-GDP ratio. Since if Greece’s nominal GDP were to decline over the next few years by 30 percent as a result of a deep recession and price deflation, Greece’s public-debt-to-GDP ratio would arithmetically rise from its present level of around 120 percent towards 175 percent. It is calculations of this sort that have recently led Standard and Poor’s to warn Greek bond holders that they might eventually retrieve only 30 to 50 cents on the dollar on their bond holdings.
A major write-down of Greece’s $400 billion sovereign debt would deal a serious blow to an already enfeebled European banking system, which holds the majority of that debt. Indeed, if Greece’s debt does need to be written down by anywhere near the Standard and Poor’s estimate, one could see the IMF having to revise up by at least 20 percent its present estimate of the European banks’ likely loan losses from the 2008”“2009 global economic crisis.
The even greater risk to the European banking system from a Greek failure is that it would bring very much into play Portugal, Spain, and Ireland. These countries, which between them have around US$1.5 trillion in sovereign debt, suffer from similar, albeit less acute, public finance and international competitiveness problems. And they too are stuck in a Euro-zone straightjacket that severely constrains their ability to deal with these problems in a credible manner.
In considering the timing of the Federal Reserve’s exit strategy, Bernanke would make the gravest of errors were he to underestimate the potential fallout of a Greek failure on the U.S. and global economies….
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Desmond Lachman: Greek Tragedy Could Have Multiple Acts
The basic flaw in the IMF-EU sponsored program to restore Greek fiscal sustainability through a program of draconian public expenditure cuts is that if successfully implemented it will have the unwanted effect of increasing rather than reducing Greece’s public-debt-to-GDP ratio. Since if Greece’s nominal GDP were to decline over the next few years by 30 percent as a result of a deep recession and price deflation, Greece’s public-debt-to-GDP ratio would arithmetically rise from its present level of around 120 percent towards 175 percent. It is calculations of this sort that have recently led Standard and Poor’s to warn Greek bond holders that they might eventually retrieve only 30 to 50 cents on the dollar on their bond holdings.
A major write-down of Greece’s $400 billion sovereign debt would deal a serious blow to an already enfeebled European banking system, which holds the majority of that debt. Indeed, if Greece’s debt does need to be written down by anywhere near the Standard and Poor’s estimate, one could see the IMF having to revise up by at least 20 percent its present estimate of the European banks’ likely loan losses from the 2008”“2009 global economic crisis.
The even greater risk to the European banking system from a Greek failure is that it would bring very much into play Portugal, Spain, and Ireland. These countries, which between them have around US$1.5 trillion in sovereign debt, suffer from similar, albeit less acute, public finance and international competitiveness problems. And they too are stuck in a Euro-zone straightjacket that severely constrains their ability to deal with these problems in a credible manner.
In considering the timing of the Federal Reserve’s exit strategy, Bernanke would make the gravest of errors were he to underestimate the potential fallout of a Greek failure on the U.S. and global economies….
Read it all.