“A story is told of a man sentenced by his king to death. The latter tells him that he can keep his life if he teaches the monarch’s horse to talk within a year. The condemned man agrees. Asked why he did so, he answers that anything might happen: the king might die; he might die; and the horse might learn to talk. This has been the eurozone’s approach to the fiscal crises that have engulfed Greece, Ireland and Portugal, and threaten other member states”, writes Martin Wolf (Financial Times 10-5-11).
When on Friday evening Der Spiegel talked about a Greece return to dracma, euro went down to 1,43 dollars, the same fall which happened few hours before when was the dollar to rise, because of good news regarding employment. But, also because S&P and Moody’s ratings, in all Europe bank’s asset prices went down; what is a bit strange is the fact that Paris and Frankfurt loose less than Madrid and Milan. The strangeness is that Frances and German banks hold 160 billions of Greek bonds, much more than Spanish and Italian ones.   

Lorenzo Bini Smaghi, a member of the ECB board, produced several statements  (the last one on La Stampa, 10-5-11) with a full fledged defence of the official positions of European council and ECB. In short the statements are:
i) what many analysts don’t see is the impact of a default or debt restructuring on the same country.  Banks would lost the ability to get financing from the ECB, having no collateral  because of the losses on governmental bonds. And of course Greece cannot finance public expenditures printing money (like Argentina). It would be a complete disaster.
ii) Greece lost time considering this hypothesis for some months, because of bad advices by financial and lawyer operators, before realising that it was a tall story. So the reform process slowed, and after one year we have to put hands on the program, in order to get more guarantees. 

We may interpret these statements saying that EU doesn’t allow a default by a State member, even under the label of on ordered restructuring. EU is ready to lend whatever amount would be needed arriving eventually at the total financing of the Greek debt. But Greece has to adopt a extremely severe (actually unsustainable), economic policy. By the way Bini Smaghi revealed what could be called  a “Pulcinella’s secret”, that is that there the hypothesis of a debt restructuring has been presented by the Greek government,  but throw off by European authorities.

Is a orderly debt restructuring really so lethal to the Greek economy? Of course it implies an haircut to the bond value, but this is what the market already did: in one year Greek bonds lost 24,5% (two years), 39,8% (five years), 39,3% (ten years). While the loss is bearable for Frances and German banks, the stroke is very strong for Greek banks: on average a 36% of the tier 1 capital. It appears that several banks would have serious difficulties and same one would be virtually on default; only National Bank of Greece could afford the cut because of an higher capital.        

Now it is true that Greece gave up monetary sovereignty, in exchange of the cut of interest rates, and the honour of be a member of euro; Paul De Grauwe wrote an interesting paper  saying that “when entering a monetary union, member-countries change the nature of their sovereign debt in a fundamental way”. He shows how Spain, whose government debt is lower than the UK one, must bears an higher interest rate, just because of the loss of monetary sovereignty. De Grauwe’s thesis is that the eurozone should take care of this problem; a debt restructuring may even imply a default of some Greek bank, but EU and ECB may avoid a complete meltdown. There is plenty of banks ready to fill the void.

The true problem is that a debt restructuring imply that the debt burden is shared between the debtor and his creditors; the European official position is that the burden should entirely bear upon Greek citizens. Living aside the equitable aspects, the issue is on the sustainability of the medicines prescribed to the Greek economy. In 2010 the deficit was 10,5%, which is absolutely remarkable in respect of the 2009 deficit of 15,5%, bur still less then the target of 9,4%. The problem is that the fiscal revenue suffers from the recession brought about by the cut of public and private expenditures and the rise of taxes.

The selling of public assets and the liberalization of service sector may help to cut the deficit, and Greece must reach a realistic primary surplus, which can be sustainable over time. But if you try to reach a primary surplus historically unbelievable, the classic Keynesian multipliers will reproduce a new deficit in a vicious circle. A similar argument apply to the problem of busting export: a country with monetary sovereignty may devaluate, but a member of a monetary union has to cut wages and prices (which, by the way, is much more difficult and time consuming) with the result of increasing the debt-gdp ratio.