The Greek Left Is Right

Includes: FXE, GREK
by: Shareholders Unite

A large part of the world thinks that Alexis Tsipras, leader of the left-wing Syriza party that could very well win the June Greek elections, is a dangerous left winger who is about to blow-up the whole euro area and plunge Europe (and by extension the world economy) in a deep depression. However, there are clearer heads around.

There are few more clearer heads than that of Sweder van Wijnbergen, a top economist from the Netherlands. In a former capacity as World Bank functionary (and consultant), he has ample experience with dealing with unsustainable debt problems.

He was highly involved in solving the Mexican debt talks in the 1980s, for instance. When Sweder speaks, people tend to listen. He can hardly be accused of being any kind of radical, but had surprising words to say about what Tripras and his Syriza party propose for a solution of the Greek quagmire.

According to van Wijnbergen, the solution proposed by them is both the right one and an orthodox economic textbook idea. Now that is a rather new sound in all the cacophony surrounding what is already long known as the Greek Tragedy. We had the personal honor of (briefly) being the colleague of van Wijnbergen and we can wholeheartedly testify to his rather intimidating razor sharp mind and depth of knowledge.

What Tsipras/Syriza propose is a three pronged strategy for Greece:

  • Much more debt reduction

  • An investment program to stop the economic free-fall

  • Continue with the reform program

Debt reduction
When firms or countries have taken on more debt than they can possibly service, the only solution is debt reduction. This is standard practice both in dealing with companies as well as countries. It is simply in the interest of everybody involved, including the debt holders.

In such a situation of 'debt overhang' (excessive debt), neither company nor country is able to finance projects that would otherwise generate ample returns, for the simple reason that nobody wants to finance them as much of the returns would go to servicing old debt.

This hold-up problem can be greatly reduced if old creditors can credibly commit to reducing their existing claims, that is, debt reduction. Greece with debts approaching 200% of GDP can not be expected to pay these off even with continuing reforms and austerity. Decades of high taxes to service the debt would stifle the economy to such an extent that even the creditors would suffer.

One can compare it with the Brady plan for indebted (mostly) Latin American countries at the end of the 1980s. Their debt, on average, was only half that of Greece's debt (versus GDP) now but they received a 50% debt reduction, setting their economies up for much better performance in the years following the plan and they could tap international capital markets soon after.

Wait a minute, one might react, didn't Greece get at least a 50% debt reduction? Well, yes and no. The point is, while private debt was exchanged for debt with longer maturity, lower interest rates, and lower nominal values, this didn't include the Greek debt in the hands of official creditors like the IMF and the ECB.

Also, by reducing the private debt Greek banks needed to be recapitalized by the Greek government. Guess how they financed that? With debt to the EFSF, the temporary eurozone rescue fund. All in all, Greek debt was only reduced some 15%. This is way too little.

Readers of our articles might remember that we already pleaded with some kind of 'Marshall plan' for Greece, to give people at least some perspective, some light at the end of the tunnel. The simple truth is that austerity in the midst of a financial crisis, especially a large one like this, does more harm than good.

We have historic experience with that (The Brühning years in the early 1930s in Germany, the Hoover years in the U.S., the premature fiscal tightening in 1937 in the U.S., the Hashimoto tightening in 1997 in Japan), but we don't have to go back in history for this.

The Greek, Portuguese, Spanish, Irish will tell you this from their own experience. Even the U.K., which isn't obliged through euro membership to embark on austerity, has a rather negative experience with it, to the extent that even the IMF is subtly warning about it.

Structural reform
The hardest part, perhaps. But structural reform is also what ultimately might make the eurozone in general, and Greece in particular, a better, more dynamic place. We have long argued for more emphasis on structural reform and less on slash-burn austerity in the midst of a financial crisis.

Despite what you read in many newspapers, Tsipras isn't that crazy, or that radical. His three pronged solution for Greece certainly is simple economic orthodoxy. And we would ask his critics the following question: Have the present slash-burn austerity policies bring us any nearer to solving the Greek economic problems?

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.