STOCK MARKET WATCH -- Monday, 2 March 2015

[Demeter]

21. Greece is being forced into purgatory to save the euro By Roger Bootle

http://www.telegraph.co.uk/finance/economics/11443653/Greece-is-being-forced-into-purgatory-to-save-the-euro.html

... Whereas the drop in UK GDP, from peak to trough, was about 6pc, in Greece it was more like 25pc. What’s more, that is where GDP stands today. I cannot stress enough how extraordinary a fall of this magnitude is. It is roughly the size of the drop in output in Germany and America in the 1930s. In the postwar world, there is no experience that bears comparison. After a drop in GDP of 25pc, how large is the output gap in Greece? No one knows, of course....BIG EDIT

So these should be the factors that figure in the debate about the Greek predicament: what is the size of the output gap; what is the cyclically- adjusted budget position; and, given that growth is all important, how can Greece generate it?

It is interesting to consider the IMF’s role in all this. The nickname for the IMF in the markets is “It’s mostly fiscal”, reflecting the IMF’s view that when a country gets into trouble, the manifestation is a huge government budget deficit. And the cure involves spending cuts and higher taxes. That is exactly what happened in Greece. But there was a difference. In most cases, the traditional IMF medicine counter-balances fiscal tightening with a devaluation of the exchange rate. The idea is that as the fiscal tightening squeezes domestic demand and threatens to cause higher unemployment, then a more competitive currency encourages net exports. Essentially, exports fill the hole left by the retreating government. But this was not possible in the Greek case because the country does not have its own currency – because it joined the euro. The only way of compensating for this absence was to allow domestic deflation of prices to produce an “internal devaluation”. What a laugh! We learned in the 1930s that this does not work. Deflation is extremely slow and painful and, even if it succeeded in improving competitiveness, it would worsen the debt ratio because it reduces the money value of GDP (the denominator of the ratio). The result is that Greece is on the road to misery, with no obvious escape.

Why don’t the Germans understand the logic of this argument? They tend to look at matters with regard to debt – and economic policy more generally – moralistically: "The Greek public sector has been wasteful in the extreme and Greek taxpayers have treated paying tax as near-voluntary. Accordingly, they have had it coming to them. When they reform themselves, then the economy will bounce back..." I am speechless at this attitude. Yes, the Greek public sector has been appallingly wasteful and making it less so is an important part of boosting Greece’s sustainable growth rate. But the current priority is not that, but boosting Greece’s actual growth rate now – and that is all about demand. There is no such thing as a free spending cut. Even tax evaders and under-employed public servants go shopping.

Why do the IMF and the other lenders persevere with this destructive path? The answer is IMP: “It’s mostly political.” That is to say, it is driven by the overriding will to keep the euro on the road. By now you should know my answer. Greece should come out of the euro and allow its new currency to depreciate sharply, perhaps by 30pc to 40pc.

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