Benn Steil


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Greece Hurtles Toward Its Fiscal Cliff

by Benn Steil and Dinah Walker
November 27, 2012


The United States marches solemnly towards its fiscal cliff, awaiting only the command from the Goddess of Reason to halt. Unfortunately for Greece, that country plugged its ears back in March.

Like the United States, Greece made prior commitments on spending and taxation in order to bind itself to the mission of deficit reduction. Unlike the United States, Greece left itself little means to unbind itself. As shown in the graphic above, its massive debt restructuring in March only reduced its debt-to-GDP ratio from 170% to 150%, but in the process made further significant restructuring much more difficult.

Before the March restructuring, Greece owed private sector creditors €177 billion in obligations governed by Greek law and only €30 worth governed by international law, the latter being vastly more difficult to walk away from. After the restructuring, Greece owed private sector creditors only €86 billion, but all of it was now governed by international law (31.5%*177 + 30). And it also added €75 billion to its €124 billion stock of official sector (EU and IMF) obligations, bringing that total to a whopping €200 billion.

Though Greece desperately needs to shed more debt, it faces the problem that its private sector creditors are now all shielded by international law, and its public sector creditors are protected by the power to hurl it into unsplendid economic and political isolation.

This suggests strongly that Greece should simply have repudiated all its Greek-law private sector debt back in March, when it had the chance. Why didn’t it?

Many reasons, some of which flimsy – such as fears of triggering credit default swaps if the restructuring were “involuntary.” But the most pressing reason was to avoid crushing the Greek banking sector, which was exposed to Greek sovereign debt to the tune of about €50 billion. The €25 billion lent to Greece by the so-called European Financial Stability Facility (EFSF) in order to recapitalize its banks would then have to have been a much higher €50 billion. Still, Greece would be at considerably less risk of hurtling over the fiscal cliff today had it avoided taking on the additional €56 billion worth of nonrepudiable private sector IOUs in March.

In contrast, the United States can avoid its looming cliff by Congress and the president agreeing just to keep on adding to the prodigious national tab. It’s good to be the king of reserve-currency issuers – at least until the market cuts your head off.

European Financial Stability Fund: Questions and Answers
IMF: Greece’s Financial Position in the Fund as of Sept. 30
BIS: Consolidated Banking Statistics
Geo-Graphics: The IMF Is Shocked, Shocked at Greece’s Fiscal Failure. Should It Be?

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