Monday, April 25, 2011

Do not blame the ‘herd’ for Greece’s high borrowing costs

by Desmond Lachman

Letter to Financial Times

April 25, 2011

Sir, Your editorial “Europe must use borrowed time well” (April 21) asserts that Greek solvency is still within reach and that Greece’s present high borrowing costs reflect, to an important degree, market herd behaviour. In so doing, your editorial glosses over several important facts on the ground that would suggest that a large writedown of Greece’s sovereign debt is almost inevitable.

Over the past six quarters, Greece’s gross domestic product has contracted by 8 per cent while retail sales are currently some 20 per cent below year-earlier levels. At the same time, rather than increasing by the 8 per cent programmed by the International Monetary Fund, Greek tax collections declined by well over 10 per cent in the first quarter of 2011. In the absence of a rebound in these collections, Greek tax revenues could be some $10bn below IMF-programmed levels in 2011.

Greece’s dismal economic performance to date under the IMF-European Union adjustment programme is validating the view of those who warned that draconian fiscal adjustment within the euro straitjacket was bound to lead to a collapse in the Greek economy, which would contribute to an increase in Greece’s public debt to GDP ratio well beyond the already high 160 per cent projected by the IMF programme. This experience would also suggest that the application of further severe budget tightening within the euro straitjacket now being prescribed by the IMF will lead only to a further collapse in the Greek economy that will make it even more difficult for Greece to service its debt.

Far from Greece’s currently high interest rates being the result of herd behaviour, it would seem to be reflecting the market’s accurate assessment that Greece has a fundamental solvency problem. To pretend otherwise only delays finding a solution to Greece’s very difficult economic problems.

Dr. Desmond Lachman
American Enterprise Institute
Washington, DC, US


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