Last week felt like deja vu. The European Union, European Central Bank, and International Monetary Fund demand Greece adopt a new set of deep austerity measures in terms for short-term aid. After a fair amount of posturing on both sides, Greece looks poised to acquiesce to the demands and its inevitable default is pushed out for a few more weeks.
We've seen this before, and playing this game over and over again has certainly bought some time for Europe. However, the austerity measures are just providing some short-term cover, not producing sustainable structural changes. In order for the long-term view for Greece to improve, Europe must sell structural changes to the Greeks or find a way to let the country leave the common currency.
Barring any last-minute derailing, the current plan should save Greece from an immediate default. In exchange for further cuts to the minimum wage, a decrease in the number of public-sector workers, and more pension reforms, Greece will be able to execute a bond swap with private creditors that will help reduce its total indebtedness to around 120% of gross domestic product. A staggering amount for sure but far less than the current 160% debt/GDP ratio. The deal will also release more cash to Greece so that the country can pay off a chunk of debt that is maturing in March.
Upon Closer Inspection
Although defusing the short-term time bomb is important, the structural changes included in the package will do next to nothing to actually improve Greece's economic standing and create a more stable economy. There is no question that Greece needs to radically overhaul its economic system. Tax evasion remains incredibly high, wages are too high, work rules are too restrictive, and pension benefits are too generous. In order for the country to return to sustainable economic growth, all of these issues and more will need to be tackled.
Simply legislating lower government spending is not going to be a magic potion that makes this happen. There needs to be real buy-in from both politicians and average Greeks that these are important issues, that the shared sacrifice is worth it, and that they will benefit in the end. Nothing we've seen so far in this process indicates that this is happening. The general strikes being called across the country are one indication of the disaffection with these policies, and the resignation of key ministers in the Greek government are another.
With an election scheduled to take place in the coming months, there is even less visibility into how the government is actually going to implement real reform. The government that is returned to Athens after elections is likely going to be even more hostile to further changes, and it could very well try to roll back some of the previously agreed changes or simply fail to implement them.
Now investors shouldn't be too blown away that the Greek people are resistant to implementing more radical reform. The country has been trying to cut back on spending in recent years, and the results have been continuous GDP contraction and skyrocketing unemployment--20% for the general population and nearly 50% for youth. Workers are none too keen to give up benefits they had been promised and were counting on. The reform doesn't offer a lot of short-term benefits to current workers, and political leaders aren't making the case that staying in the euro and the EU is worth the price.
Not Many Alternatives
Frankly, at the moment, the most important thing the austerity measures are doing is providing EU leaders political cover for releasing more money to Greece. The bailouts are becoming increasingly unpopular across Europe. But the EU is aware of the potentially negative consequences of an unplanned, chaotic Greek default, and EU officials want to keep providing liquidity until a long-term plan has been reached. Leaders need to be seen getting something in return for releasing more cash, and budget cuts are essentially the only thing Greece has to offer.
Now this isn't to say this short-term deal is all bad. It does defuse the ticking time bomb of the March debt maturity. And getting private creditors to accept that they are not going to receive 100 cents on the euro is an important first step to a managed default and lowering of the debt burden.
However, even with a lowered burden, if the Greek economy keeps shrinking, we will be right back to where we started. Europe's leaders need to step up and provide a credible, durable plan that will restore competitiveness to Greece, in a way that will be accepted (however begrudgingly) by the Greeks. If they can't do that, then Europe needs to admit Greece can't be fixed in the euro framework. European officials will need to find a graceful way to let Greece leave the euro and let a massive currency devaluation be the first step to nursing Greece back to health.
Neither of these are easy tasks, and they might in fact turn out to be impossible given the current political situation. But until one of those two things happens, the country will remain on edge, and uncertainty will reign. The world will be one domestic political crisis away from a disorderly default and the entire agreement falling apart. Even though we've had quite a bit of time to prepare for the country's collapse, it is still a giant unknown how it will affect Europe and what other nations would come tumbling down with it.
Bearemy Glaser is the worry-prone alter-ego of Morningstar markets editor Jeremy Glaser. Each week he shares his list of top worries and invites you to share yours in the comments box below.
