Monday, May 3, 2010

Greece: Deja Vu Argentia 2001-2002?

The $146 billion rescue package for Greece over the weekend has given some folks hope that Greece and the Eurozone more broadly will survive in their current form. For these folks, this is the needed "shock and awe" package that will save the day. But is it? Peter Boone and Simon Johnson argue that to save the Eurozone not only are funds needed for Greece but also for Italy, Portugal and Spain over a three-year period. They estimate that such a package at a minimum would be around $1 trillion. Other observers are concerned about whether Greece can truly impose the savage austerity on the Greek people that is required by the bailout package. Here is Charles Wyplosz at Vox:
The plan will not work. Greece is supposed to reduce its deficit by 11% of GDP in three years. This would have been a tall order of requirement if the recovery was going to be strong. The drop in public spending, along with the psychological impact of the crisis, will provoke a profound recession that will deepen the deficit. This, along with the social and political impact of the crisis, will undoubtedly prevent the Greek government from delivering on its commitments.
This is beginning to sound a lot like Argentina in late 2001. It too had a sovereign debt problem, an overvalued real exchange rate, and was effectively part of a currency union (via a currency board) that did not meet the optimal currency area criteria. It also tried to cut wages and prices but found the deflationary price too high. Argentina ultimately defaulted on its debt in December 2001 which was just a few months after receiving a second IMF rescue package in August! In retrospect this second bailout from the IMF looks misguided--it only pushed back the inevitable default a few months but added more debt to the country. After defaulting in December 2001, the government of Argentina broke the the peso-dollar link in January 2002. It seems like, then, the Greek crisis is playing out just as it did in Argentina in 2001-2002. Of course, the implications are far bigger here: the crack up of the Eurozone versus the ending of the peso-dollar link for Argentina.

P.S. One of the best reads of the Argentinian crisis is Paul Blustein's "And the Money Kept Rolling In (And Out)." Blustein also had an enjoyable book on the emerging market crises of the late 1990s titled "The Chastening:Inside the Crisis the Rocked the Global Financial System and Humbled the IMF." Both of these books are informed but accessible to a wide audience. I hope he can find time to write a book on this current crisis. It would be a great public service.

Update: Martin Feldstein says Greece will default.

Update II: Maybe Paul Krugman is reading this blog.

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