RESEARCH:Fisher Capital Management Strategies: Greek Day of Reckoning Looms in Ponzi Europe: Mario I. Blejer

May 31, 2011 — Dirk Faltin, a senior economist at UBS AG, talks about Greece’s debt crisis and bond yields. He speaks from Zurich with Francine Lacqua on Bloomberg Television’s “The Pulse.” (Source: Bloomberg)

One of the undeniable features of the European debt crisis is the tendency to obscure, verbally and politically, the real issues at play. Euphemisms, statistical gimmicks, meaningless institutional squabbling, undecipherable acronyms, and plain double talk proliferate as part of the debate.

In my experience as central-bank governor in Argentina during the worst financial crisis in our history, at the beginning of this century, I learned how useful it is to cut through the fog in order to rebuild credibility and to allow a more lucid evaluation of the outlook. While there are few similarities between Greece’s present debt situation and Argentina’s in 2002, it is possible to reduce the recent talk of a default to four basic issues and make some predictions.

The nature of the debt problem in peripheral Europe is structural. Since it doesn’t reflect a temporary liquidity squeeze, the approach adopted so far can’t resolve it. The strategy in progress has been to pile new debt upon the existing stock. New loans are used to pay old debt, in addition to financing remaining fiscal gaps. This is why the Ponzi scheme analogy is appropriate. And while the pyramid is growing, the share of peripheral debt held by state-owned institutions also keeps getting bigger. This means that when it all finally collapses, it is the taxpayers of Europe, and the world, that will bear the full cost.

Growing Pyramid

The pyramid may continue to grow for a while, particularly if the cement used is public funds. But it is an unstable construction because European bailouts are becoming politically questionable and because throwing International Monetary Fund money into the Ponzi scheme is raising objections. This strategy is only making the situation worse.

The IMF has performed badly in this crisis. Its programs are bound to fail because their design is profoundly flawed. They contain two basic blunders. First, they have wrongly assumed that peripheral countries could return to the voluntary capital market next year. Today we know that Greece’s ability to borrow 30 billion euros ($43 billion) in 2012 is nothing but a fantasy. The programs, therefore, remain unfinanced. And the situation promises to be even more difficult in 2013 if the perverse permanent-bailout mechanism being designed is adopted.

Second, programs have been based on dreamy debt sustainability scenarios in which countries outgrow their debt under severe fiscal tightening. But since these austerity plans cause deep recessions, the debt/gross-domestic-product ratios increase over time in all peripheral nations. How this squares with sustainability, and how the macroeconomics add up, is hard to comprehend.