By Rob Parenteau, CFA, sole proprietor of MacroStrategy Edge, and a research associate of The Levy Economics Institute.
Below is the leaked Greek bailout document that everyone has been talking about. Yesterday, the Financial Times wrote:
Greece’s economy has deteriorated so severely in the last three months that international lenders would have to find €252bn in bail-out loans through the end of the decade unless Greek bondholders are forced to accept severe cuts in their debt repayments.
The dire analysis, contained in a “strictly confidential” report by international lenders and obtained by the Financial Times, is more than double the €109bn in European Union and International Monetary Fund aid agreed just three months ago.
Here is my understanding of what the Troika analysis demonstrates about the European Sovereign Debt Crisis. We have embedded the document at the bottom of this post.
This leaked Troika “debt sustainability analysis” submitted to the EU Summit yesterday will no doubt be a part of the deliberations in the Greek debt restructuring proposals to be hammered out by Oct. 26th.
Point 1. A. on the first page is a pretty open and blatant admission that expansionary fiscal consolidation (EFC) has proven to be a contradiction in terms, at least in Greece. Moreover, there is a serious policy incompatibility problem, at least over the intermediate term horizon, with efforts at internal devaluation (ID) – that is, attempting nominal domestic private income deflation in order to improve trade prospects when one has a fixed exchange rate constraint.
This latter point is further amplified in the "stress test" scenario discussed on the bottom of page 5, which I think we all know is soon to become the Troika’s base case scenario. They stop short of recognizing that their demands and the actions they have imposed on Greek policymakers are setting off a Fisher debt deflation implosion of the Greek economy. But clearly, the EFC policy is rupturing any semblance of a social contract, and ripping the social fabric to shreds as well.
This is a very large step for the Troika to have taken; admitting that EFC is not working, and that pursuing internal devaluation will aggravate matters further, including the ability of Greece to hit fiscal targets, is a fairly large step in the recognition of the reality of the situation. This is not something that Troika economists are often prone to do. It is not what their incentive structures, formal and informal, tend to encourage them to do.
More importantly, this admission by the Troika shows the rest of the periphery, the UK, the US, and even Japan that the road to debt deflation hell is paved with good intentions – intentions the Troika appears even now prepared to question – but of course, only in the very special conditions of Greece.
We must argue Greece is not a special case, but rather a case in point of what happens when you impose fiscal consolidation on countries with high private debt to GDP ratios, high desired private net saving rates, and large, stubborn current account deficits. Many of my colleagues have laid the groundwork for this type of case to be made, including speeches at the Minsky conference in 2010 and numerous blog posts over the past two years. With this document, now it is evident that analysts at the EU, the IMF and the ECB understand these points as well.
My recommendation: That this become a launching pad for proposing alternative policy approaches and plausible exit/default strategies for oppositional governments that may emerge as Greece and other nations go ungovernable as popular reactions against the Troika’s policies are rejected.