Plans A, B and C

Plan A is the current official approach to Greece. It provides eur 110 bn in official loans for an initial 3-year period to sustain deficits which cannot be financed in the market. (The funds are charged at 3-month euribor +300 bps, rising to 400 if extended beyond three years.) Greece uses this breathing space to shrink those deficits and put the fiscal path on track to stabilise debt at an unspecified ratio of GDP; it peaks at 150% in 2013 and falls thereafter, crossing 120% in 2020. The government will also push through considerable structural reforms: privatize some SOEs; cut the minimum wage, weaken employment protections and collective bargaining power; and dismantle the barriers to entry/exit for the private sector. Finally, part of the overall loan package finances a stability fund to recapitalize domestic banks should they suffer a wave of asset failures. The ECB also provides unspecified liquidity support. (I am getting this from the IMF programme document (pdf).)

It’s hard to know where to start. Why not just cite the programme itself. Verbatim:

  • overall debt service will rise sharply after the program: payments to both the Fund and EU would peak at 62 percent of exports of goods and service, and about 17 percent of GDP in 2015.
  • Wage and price deflation, and contraction in activity could lead to sharp reductions in tax revenues, (upsetting the deficit trajectory).
  • Fierce resistance from entrenched vested interests has stalled reforms in the past and the burden of adjustment will test the cohesiveness of Greek society. 
  • Downwardly rigid private sector wages and prices given inflexible markets are a further risk, 
  • as is the possibility of yet higher interest rates. 
  • loss-making public enterprises could yet present additional pressures on the budget
  • risks to banks are also acute until confidence in a strong downward path for the fiscal deficit takes firmer hold. 
  • External risks include the possibility of negative spillover from other highly indebted countries in the region.

Plan B starts from the assumption that Plan A won’t work; that Greece will arrive at year 2013 still insolvent. The economy has contracted sharply so the external debt is even less sustainable. These adverse dynamics all the while send out destabilizing signals about the outlook for other indebted euro-members, creating a permanent euro-anxiety problem in the markets. Since markets prize certainty, Plan B gives it to them. Retained from Plan A are as much of the structural reforms as possible. To make these feasible, they take place in a growth environment. (Flexible labour markets in a contracting economy flexibly shed labour.) To make growth feasible, the drachma is re-introduced 1:1 with euro; its subsequent depreciation in the fx market ensures a positive external balance for the economy by reducing domestic costs. To ensure the latter, labour unions agree not to index wage demands to expectations of inflation, for some fixed period e.g. four years. This devaluation makes debt unpayable in euros; it is therefore decreed by force majeure to be payable in drachma. This is a unilateral default. Because the economy is generating an external surplus, it is not tapping external finance anyway. Such force majeure abrogations have been done many times; not least in the United States by FDR and Congress. The Greek public can hang on to euros if they wish, but they must pay taxes in drachma. Moreover, public sector pay will be in drachma.

It’s easy to find this revolting. But what are its virtues? Well, it crystallizes the problem now, not later, and frees the economy to begin growing again. Markets are no longer wondering what’s down the road. “What about the capital position of Greece’s external creditors?” you might ask. These banks will need a capital injection from official sources. Convert the EU loan package into exactly this recapitalisation fund. (Perhaps use the IMF credits to provide interim financing for Greece.) “Is this a breakup of the eurozone?” No. It’s a restructuring of the euro-zone. Each member has to assess the costs and benefits of membership at the present juncture. Greece is unlikely the only member to be best served by exit, but neither is it true that all members will exit. Moreover, this could be seen as an intermediate step toward a longer-term reunification of the EMU on much more solid fiscal foundations.

Plan C is really the alternative to Plan B, because Plan A is not an alternative at all. No democracy will put up with interminable austerity with little relief in sight. And it’s not clear that Greece’s concessionary creditors (German taxpayers) will be in the mood to continue providing exceptional financing after 2012 even though it is clear that this will be required. Germany (unwisely) has its own austerity law to comply with. OK, so what is the real alternative to Plan B? Let’s call Plan A “Fiction” because it’s no plan at all. Plan B is “Growth” because that is the emphasis. Plan C is “Shelter”. You end up with Plan C if the emphasis is on avoiding default. If the overriding goal is to make the creditors whole, then there is every reason to stay on the euro (why re-pay in a depreciated currency?). So Plan C keeps the euro. But since wages can’t be compressed enough to produce an internal devaluation adequate to generate an external surplus, and since that would anyway just blow out the debt/GDP ratio, and since there is no recourse to currency devaluation (vis a vis euro-zone neighbours), then the only choice is to devalue through trade and financial controls. Specifically: levy a special tax on imports and provide a special rebate to exports. Forbid all cross-border financial transactions except those cleared through a centralised external debt repayment agency.

As it happens, Plan C was pursued by many central European nations caught up in the Great Depression. They instituted exchange and trade controls to ensure that adequate foreign exchange was available for debt repayment. Naturally they kept the ex-ante pegged exchange rate, since this made the burden of repayment lighter than would a depreciated exchange rate. The point is that you had to get permission to transact. Far-fetched for a modern nation? Not really. Britain rationed foreign exchange for decades after the Second World War. In fact the very post-war international monetary system was designed explicitly with restrictions on foreign-exchange transactions, in order to help governments preserve their exchange-rate pegs. This collapsed not too long ago (late 1960s). And keep in mind that many modern-day economies ration foreign exchange for non-trade purposes; this is the definition of “capital controls”. Know too that inroads are already being made in that direction in Europe.

Europe’s choice is Growth or Shelter. Fiction is not a solution.


A point about Plan C. It isn’t really compatible with the freedom of citizens in any sustainable way. Since euros are rationed for cross-border transactions, one or more parallel currencies will materialise domestically, because the squeeze on domestic liquidity will be too fierce. Of course, the increasing emission of the parallel currency will drain euros out of the system, as we know from Gresham’s law. The only way to prevent this is for ever-more draconian steps to enforce the rationing of euros.

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