Why Does Greece Not Simply Default?
ECONOMICS, 1 Jun 2015
History has shown that countries that refuse to pay their debts fall harder but recover faster than those that do not. So why does Greece’s left-led government not simply get it over with?
Greek Prime Minister Alexis Tsipras | Photo: Reuters
20 May 2015 – As the Greek debt drama finally comes to a head these weeks, with the Syriza-led government quietly warning the U.S. Treasury Secretary and the chief of the International Monetary Fund that its last-remaining cash reserves are now all but depleted and the government will not be paying the Fund if it does not receive an infusion of new cash before early June, a critical question arises: why do the radical leftists not simply get it over with and declare a default on the outstanding debt? What do they care about their creditors?
The question may sound trite, but it becomes increasingly perplexing once we place Greece’s current crisis in historical perspective. During the Great Depression of the 1930s, Greece — along with most Eastern and Southern European countries and practically all of Latin America — responded to its fiscal troubles by forcefully suspending debt payments to foreign bondholders. Economic history is replete with such unilateral moratoriums. Default was simply part of the rules of the game.
A remarkable contrast
Take the first wave of sovereign defaults following the independence struggles of the Latin American countries in the 1820s. Between 1822 and 1825, London and Amsterdam-based financiers — blinded by the prospect of easy profits — gobbled up Latin American government bonds like hotcakes. Some European investors were even deceived by a legendary swindler into buying the bonds of the non-existent newly independent nation of Poyais. In those years, financial euphoria reigned supreme.
Yet the lenders’ fall was swift and painful. Lured by cheap credit, the new Latin American debtors massively over-borrowed, while the European creditors wildly overextended themselves. After the independence wars were over, nearly every newly independent government fell into default. As one of the leading historians of the episode noted, “during a quarter of a century most of the [Latin American borrowers] maintained an effective moratorium on their external debts, which indicated an appreciable degree of economic autonomy from the great powers of the day.”
It is not difficult to understand why sovereign borrowers would want to exert this autonomy to full effect. Economists have found that countries that defaulted in the 1930s, for instance, recovered faster than those that did not. The countries that repaid their debts were forced to carry out contractionary policies (i.e., austerity measures) in order to free up the currency reserves with which to pay their debts. Transferring these scarce resources abroad directly contributed to a deepening of the crisis.
Why, then, would Greece not simply go down the same path today? The country has spent about a half of its history in a formal state of default. It defaulted on its first independence war loans in the 1830s, along with the Latin American countries. It defaulted again in 1843, in 1860 and in 1893. After the latter episode, German bondholders demanded international control over Greek finances — which they obtained with the establishment of the International Committee for Greek Debt Management following the Greco-Turkish war of 1897. Still, Greece managed to default again during the 1930s. None of these defaults occurred under radical governments.
Yet today, even under an anti-austerity government led by the radical left Syriza party, whose ranks contain an array of old-school Marxists, Greece has been scrupulously obedient to the dictates of its foreign creditors. This is all the more remarkable because, in a previous election campaign just three years ago, the same party still pledged to unilaterally suspend debt payments and to hold an audit of the national debt with a view to repudiating all illegal and illegitimate obligations. While the Speaker of Parliament, Zoe Konstantopoulou, has since called into life such an audit committee, Prime Minister Tsipras has sworn not to take unilateral action.
So what’s really going on here…? If less radical governments defaulted one after another in previous eras, why does Europe’s most left-wing government in recent memory not simply do the same?
Structural changes in capitalism
The short version of the answer is that Syriza itself is hardly to blame for its forced compliance. In fact, the world has changed in dramatic ways since the mid-1970s. The kind of capitalism we have today is not like the capitalism of yore. It is not like the Keynesian compromise that reigned during the post-war decades and that formed the bedrock of the Bretton Woods regime and the social welfare state. Nor is it like the classical laissez-faire liberalism of the so-called “first wave of globalization” in the classical gold standard era, between 1880 and the start of World War I in 1914, when default was still widespread.
Unlike previous eras, today’s global capitalism has been thoroughly financialized. This, in turn, has had major consequences not only for the centrality of finance within the regime of accumulation; it has also affected the nature of the capitalist state and its relation to private creditors. To summarize a long and complicated story, we can identify at least three structural changes that have been seminal in shifting the loyalty of governments away from their domestic populations and towards international lenders and domestic elites.
First, peripheral countries have grown more dependent than ever on foreign credit and international investment for their own growth prospects. Second, a host of international financial institutions have been created, most importantly the IMF and the ECB, which can jump whenever a debtor is in distress to provide emergency loans (under strict policy conditionality) so the debts can be repaid. Third, financialization has contributed to the entrenchment of a state-finance nexus to a point where national governments and economies have become increasingly dependent on central banks and on domestic, privately-controlled banking systems. As a result, bankers have obtained vast leverage over economic policy, even when they (or their friends) are not in government themselves.
These three changes have been foundational to the generalized move away from widespread default, as it existed prior to World War II, and towards the incredible track record of debtor compliance that has been established under the neoliberal regime of financialization. Ever since the Mexican debt crisis of 1982 — and the Latin American and Third World debt crises that followed in its wake — governments have generally tried to avoid a suspension of payments at all costs. As David Harvey has put it:
“What the Mexico case demonstrated was one key difference between liberalism and neoliberalism: under the former lenders take the losses that arise from bad investment decisions while under the latter the borrowers are forced by state and international powers to take on board the cost of debt repayment no matter what the consequences for the livelihood and well-being of the local population.”
Of course there have been exceptions. Russia defaulted in 1998, although the fallout was limited mostly to domestic creditors and a major speculative hedge fund in the US. The Argentine crisis briefly punctuated the aura of neoliberal invincibility in late 2001, but as I have argued in a previous column, a closer look reveals that the country’s default was in fact triggered by deliberate actions on the part of the Wall Street-IMF-Treasury complex. This leaves Ecuador as the only country to have imposed a unilateral default in recent decades — but even Ecuador did not do so in the outright fashion of the 1930s.
The structural power of the creditors
By and large, it is therefore safe to say that the overarching rule governing international finance today is that countries will repay even under the harshest of circumstances, and will rarely – if ever – default on their external obligations. This has led to a bizarre situation in which Yanis Varoufakis, the fervid Greek finance minister, has pledged to “repay private creditors to the last penny,” even promising to “squeeze blood out of a stone” to repay the IMF. These statements are patently absurd, as it was Varoufakis himself who, prior to taking office, claimed that the debt cannotbe paid and argued that Greece should have “given the finger” to Germany and defaulted a long time ago.
Still, it should be clear by now that Syriza’s backtracking and Varoufakis’ wavering statements on whether or not the debt can and should be repaid are not the result of some personal disloyalty to the cause, nor of some grand scheme of betrayal playing out between Syriza and its supporters. Instead, what has happened is that the Greek government has run headlong into the structural power of its official creditors. This power revolves around the fact that the IMF, the ECB and the Eurogroup — which now collectively hold about 80 percent of the Greek debt — are the only ones capable of providing Greece with what it so urgently needs: cash.
After all, governments will stand or fall by the soundness of their finances. What matters is whether they can pay public sector wages and pensioners — and, ultimately, police and the army. What matters, in addition, is that credit keeps circulating through the domestic economy and that cash keeps coming out of ATMs when people withdraw funds from their accounts. If, within this complex system of credit circulation, there is a sudden hick-up or a systemic blockage — if the state can no longer pay its employees, or if the banks are forced to close doors and private businesses can no longer obtain trade credit — the whole whole system literally grinds to a halt.
The result of such an economic freeze-up, history tells us, are usually not very pretty for those in power. Argentina’s implosion following its record default in December 2001 is a case in point. Similar revolts took place during public debt crises in early-modern Europe, like when the wool carders of Florence rose up in the Ciompi revolt of 1378, or when the working classes and bourgeoisie of Paris rose up against Louis XIV in France. Just a few days ago, a Bank of Greece official warned that a bank closure might have similar consequences in Greece today: “We would see the revolt that this crisis has not yet produced. There would be blood in the streets.”
Spillover costs of default
In the past, defaulting governments were able to avoid such “spillover costs” by defaulting only on foreign lenders. In the process, the costs of adjustment were effectively shifted onto private bondholders in the creditor countries, and scarce resources could be reinvested domestically in order to dampen the social consequences of the crisis and hasten the recovery. But in the complex and highly intertwined financial markets of our day and age, such discrimination between externally and domestically held debt is no longer possible. Default on one becomes default on all.
The result is to make a suspension of payments very costly in the short term. In addition to the oft-repeated “calamity” of being forced out of the Eurozone by the ECB, the spillover effects of default would extend all the way down into the domestic economy and would ripple out into the social fabric, threatening political stability. No democratically elected government would like to take responsibility for triggering (let alone putting down) a popular revolt over disappeared savings and wages.
The flip-side of the story, of course, is that such spillover costs generally turn out to be relatively short-lived, and may therefore end up paying off over the long-run — if the government is prepared for such an eventuality and manages to hold onto power, that is. Aided by good external conditions, Argentina’s recovery began after 6 months. Greece’s conditions may be less rosy, but there is nevertheless reason to believe that default and euro exit would lead to recovery within months. Obviously, the government would need to have a well thought-out Plan B that would allow it to bridge the difficult transition period.
This is why some of Syriza’s more radical factions are now urging the government to take this gamble and pursue a rupture with the creditors. The party’s moderate and euro-friendly leadership, however, does not appear to be willing to do so. While the divide between the two camps can partly be ascribed to ideological differences within Syriza and the fear of being punished by voters for crashing out of the Eurozone, it should be clear that the predominance of creditor-friendly solutions to international debt crises cannot be ascribed purely to a lack of “political willingness.” The spillover costs of default structurally limit the room for maneuver of heavily indebted peripheral states, compelling them to repay no matter who is in charge of the government and no matter how radical their ideas may be.
These limiting factors are related to the three structural changes mentioned before. In the case of Greece, the country remains dependent on foreign sources of credit — at least in the short-term — to pay pensions and wages. Since private investors have long since stopped buying Greek debt, the only ones capable of furnishing the Greek government with much-needed cash are the Eurogroup and the IMF. Both are currently withholding promised credit tranches and refusing to extend further loans unless the Syriza government surrender to the creditors’ dictates by effectively renouncing the anti-austerity and anti-reform platform on which it was elected.
Meanwhile, the Greek state and economy remain dependent on the functioning of the domestic credit system, which is currently kept alive with drip-feed infusions of emergency liquidity assistance (ELA) from the European Central Bank. The ECB sets the ceiling for the total amount of ELA that Greek banks are entitled to, raising this amount only marginally every two weeks. This is clearly a deliberate attempt to starve the Greek economy of liquidity and thereby put pressure on the government to surrender.
Unsurprisingly, in such a context of growing financial insecurity, ordinary Greeks fear that the government may soon impose capital controls to prevent a banking collapse, so they have begun to withdraw their bank deposits in droves: more than 35 billion euros has been withdrawn since December. If these trends continue, the banks may have to shut their doors within three weeks.
At the edge of a cliff
Yet for all the obvious drama, there is a grave irony in all of this. The structural power relations in today’s heavily financialized world economy may have succeeded in preventing the vast majority of borrowing countries from pursuing unilateral default in response to a sovereign crises. But at the same time the extreme stance of the creditors, in their insistence on full repayment even from a bankrupt country, is threatening to produce precisely that which it is supposed to prevent: a disorderly unilateral default.
At the moment, the Eurogroup seems blind to the fact that Tsipras and Varoufakis are probably the creditors’ most reliable allies in Greece today. Both are moderate reformists with widespread popular support who are actually willing to repay, even if they know they cannot. Ironically, it is precisely by forcing Syriza’s relatively pragmatic leadership into a humiliating defeat that the creditors may end up strengthening the hand of the pro-default radicals inside the government. By depriving the Greek government of the key resources on which it depends to survive, the creditors may actually end up maneuvering Tsipras and Varoufakis into the impossible position of having to bring a new reform package to Parliament in front of a hostile audience that will include their own fellow cabinet members.
Tsipras has already indicated that he would refuse to pass such an agreement with the support of the opposition. In other words: if his own internal opposition within Syriza refuses to sign the prime minister’s last-minute agreement with the creditors, he would rather reject the deal than break up his party and side with the ancien regime of PASOK and New Democracy, or so he says. This shows that even the most watertight regimes of financial control may end up backfiring into the faces of those who run them — and while there can be no guarantee that this will actually be the case for Greece, the creditors clearly cannot rest on their laurels just yet.
Yes, unilateral default has been largely banished from the global political economy in recent decades. And yes, national governments have long since been shackled to their creditors in an all-encompassing system of hyper-financialized capitalism. Standing at the edge of a cliff and faced with such a deeply entrenched and extreme power imbalance, we should not be surprised that a young left-led government like Greece’s is unwilling to jump off the cliff voluntarily. Still, no one can predict how they will react when they are pushed — whether by their creditors from above, or by the people from below. On June 5, when the next IMF payment is due, we should know.
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Jerome Roos is a PhD researcher in International Political Economy at the European University Institute, and founding editor of ROAR Magazine.
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