Greece’s Bailout Offer Is a Total Con
European leaders should realize that Greek Prime Minister Alex Tsipras’ surprising last-minute offer of reforms in return for additional bailout financing is a con. The only real question is whether Tsipras is himself in on the con that he is pitching to his nation’s creditors.
The inescapable fact is that if Tsipras were to believe that a “Grexit” (Greek exit from the euro) is either desirable or inevitable, his logical move would be to make exactly the offer that he made on July 9. Here’s why.
Forget the €53.5 billion in new loans that Tsipras is requesting. Those would just be recycled to Greece’s creditors (the IMF, the EU, and the ECB) to pay the interest and principal on existing debts. The key point is that a bailout agreement would restore European Central Bank (ECB) “Emergency Liquidity Assistance” (ELA) to the Greek banking system. This would allow Greeks that still have deposits in Greek banks (€136.5 billion as of the end of May) to get their money out of those banks, and to transfer it out of the country.
Prior to the bank closures, the ECB had provided €89 billion of ELA to Greek banks. Much of this went to finance capital flight from Greece. The ELA (which is a loan) is “secured” by Greek government bonds, which are essentially worthless.
A new bailout deal could see total ELA rise by as much as there are deposits left in Greek banks. In the all-too-likely case that Greece ultimately defaults, a new bailout deal could have the effect of transferring another €100 billion from European taxpayers to Greek citizens.
While anything is possible, it is hard to imagine that Tsipras has not figured all of this out. If nothing else, it must have become obvious to him by July 9 that he had to do whatever it takes to get the Greek banks reopened as quickly as possible. With its banking system crippled, the Greek economy has been grinding to a halt.
Tsipras is proposing that Greece’s European creditors provide money now in return for reforms later. Many of his proposed measures would be phased in, and all of them would be reversible at any time, at the whim of the Greek government.
Crucially, Tsipras’ proposal is silent regarding paring down Greece’s bloated government workforce, which Tsipras increased by 12,000 after taking office. This, more than anything, shows that Tsipras is not serious about restoring fiscal sanity to Greece.
For the sake of the Greek people, we must hope that Tsipras’ offer is, in fact, a con. It would be more ominous if he were actually serious about implementing the program that his proposal describes. This is because what is killing Greece is a lack of economic growth, and the meat of Tsipras’ bailout proposal consists of growth-killing tax hikes.
The media and the economics profession have been framing the alternatives for Greece in terms of a choice between “austerity” and “stimulus.” Unfortunately for Greece, austerity has come to mean tax increases, and stimulus has come to mean using “other people’s money” (mainly that of German taxpayers) to support Greek welfare state outlays. So, if “other people” aren’t willing to fund more Greek government spending, then the only option the “experts” can imagine is to raise taxes on an economy that is already being crushed by excessive taxation.
It is both sad and telling that the creditors’ initial demands included raising Greece’s corporate income tax rate from 26% to 28%. No one that understands economic growth would suggest any such thing. Tsipras’ inclusion of this tax hike in his July 9 proposal suggests that either he doesn’t understand growth either, or that he knows that his proposal is just a ruse for conning European taxpayers out of more money.
It’s not clear that there is any way to avoid a Greek economic and societal collapse at this point. However, if there were to be a road out of the quagmire in which Greece finds itself, it would have to be paved with economic growth.
Much has been made of the fact that Greek government debt currently stands at 175% of GDP, a level that is widely considered “unsustainable.” Actually, it is Greece’s stagnant, socialism-soaked economy, not Greece’s debt, which is unsustainable.
Let’s do the math.
Greece has promised to achieve a “primary surplus” (revenues less non-interest spending) of 1% in 2015, and to increase its primary surplus to 3.5% of GDP by 2018. The 3.5% target has been called farfetched; so let’s just look at the sustainability of Greece’s debt with a long-term primary surplus of 1% of GDP.
A primary surplus of 1% of GDP means that Greece could support debt equal to 1% of the present value (PV) of its future GDP. For calculating PVs, we’ll assume a real interest rate of 2.3%, which is the latest forecast from the Congressional Budget Office for the long-term real interest rate on 10-year U.S. Treasuries. This happens to be far above the real interest rate on the bailout loans that Greece has received from the EU and the ECB (which will probably turn out to be negative), so our PV estimates will be conservative.
Under these assumptions, if Greece could achieve and maintain 1.72% real economic growth, its current debt load would be sustainable. No “haircuts” on existing debt would be required. Unfortunately, Greece’s real GDP (RGDP) growth rate over the past 6 years has been -5.24%.
At an RGDP growth rate of -5.24% (and with the unrealistic assumption that a nation whose economy was contracting could sustain a primary surplus of 1% of GDP), Greece’s debt capacity would be only 13% of GDP. This rounds to zero, which happens to be Greece’s market-perceived debt capacity right now.
There is hope, however. The math also points to a way out of the trap in which Greece finds itself. At an RGDP growth rate of 2.5%, Greece could support debt equal to 3,100% of current GDP.
This means that Greece should be developing a reform plan based upon cutting taxes to boost economic growth. It also means that, if the EU and the ECB are prepared to advance additional capital, they should be offering to fund a Greek growth plan, rather than to subsidize another economic roller coaster ride around the austerity amusement park.
Of course, Greece needs supply-side reforms that go far beyond just cutting taxes. For 2015, Greece ranked #130 on the Heritage Foundation’s “Economic Freedom” country list. In contrast, Germany ranked #16.
Economic freedom is essential to economic growth, and Greece’s creditors should be insisting that Greece free up its economy. The fact that Tsipras’ plan does not directly address economic freedom suggests that it is either clueless or a con.
Greece’s fate is in the hands of the Greeks. A nation whose level of economic freedom is sandwiched in between that of Suriname (#129) and Bangladesh (#131) will ultimately sink to a Third World standard of living. Greece can only save itself by liberating its markets, its economy, and its people.
The one thing that the Greek government must not do is to abandon the euro and reintroduce the drachma. No one would be willing to hold drachmas, so the value of the drachma would quickly plunge toward zero, taking real Greek government revenues (which would be collected in drachmas) with it. Pensioners and other Greeks dependent upon government checks could face starvation.
There has been a lot of loose talk from left-wing economists of the wondrous benefits to Greece of having its own currency. Of course, one thing that these economists have in common is that, if their advice were taken, their salaries would not be paid in drachmas.
Tsipras has probably figured out what would actually happen if the Greek government tried to reintroduce the drachma. This would explain why he made a bailout proposal on July 9 that was essentially identical to the one that Greek voters overwhelmingly rejected on July 5.
Life comes at us as a series of lessons, and Greece may have to suffer through a total economic collapse in order to get socialism out of its system. However, it is Tsipras’ job to try to put off the inevitable as long as he can, while conning as many euros out of his gullible neighbors as he can. In that context, Tsipras’ July 9 bailout proposal was a brilliant move.
Article originally published on RealClearMarkets.
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