Greek Default = Eurozone collapse = Great Recession Once More

Original caption: I decided to see if I could ...Image via Wikipedia
The domino effect of a possible (probable?) Greek default is with us.

First Greece defaults on its debt, next the European banks, foremost among them the French and German banks but also the European Central Bank, are hit.

Next in line, the other insolvent countries in the Eurozone: Ireland, Portugal, Spain and, yes, Italy too.

Finally, through the holdings of American banks in Europe coupled with the business of derivatives and credit swaps (intended to provide insurance against sovereign debt defaults, starting with Greece), the financial tsunami  hits the American shores.

This can mean only one thing: a return of the Great Recession. The feared "second dip" becomes reality.

This nightmare scenario is not a figment of my imagination. Unfortunately, it is very real - and explains why the Eurozone finance ministers , in their latest meeting in Luxembourg, have issued an ultimatum to Greece: austerity, or else no bailout money.

The requirements are tough: a five year plan of spending cuts, tax increases and privatization.

Something Antonis Samaras, the leader of New Democracy, the main conservative opposition party in Greece, adamantly refuses to consider. George Papandreou, the Greek Prime Minister has reacted with a promise to drive the austerity measures through parliament by July 28 and with a government reshuffle. He has removed his finance minister and appointed instead his defense minister, Evangelos Venizelos, to the post.Venizelos now now occupies both the position of deputy prime minister and finance minister.

He is clearly a heavyweight...But who is he and why the change? A professor of Constitutional Law and author of books, monographs and articles dealing with a range of political and social policy issues such as the future of the Greek university system, Venizelos at first sight wouldn't seem to be an appropriate choice as finance minister: he's not an economist and has no special knowledge of finance. Although a lawyer's background nowadays seems to be what is needed to reach any political post (for example Christine Lagarde's candidacy to the IMF or Sarkozy as President of France).
 Evangelos Venizelos, Minister for National DefenceEvangelos Venizelos Image via Wikipedia
So what has he got? First, a strong and varied political experience, starting in 1989 when he defended the current prime minister's father, Andreas Papandreou,  from corruption allegations. Impressed with his lawyer's talents, including a remarkable gift for oratory, Andreas Papandreou included him in his PASOK party. In 1993, when PASOK returned to power, Venizelos became the government's spokesman and thereafter occupied a succession of ministerial posts from 1993 to 2004: the press and media, transport and communications, justice, culture (twice) and development. In 2007, he tried to wrestle the PASOK leadership from George Papandreou and failed. Presumably, the two men cannot be close friends, and yet...

Venizelos is also reported to have a great ability for negotiation with trade unions and to be well respected by the Greek general public, who tend to trust him and see him as something of a political outsider. And that is important because the whole Greek political class, on the left and the right, suffers from a serious gap in confidence.

Politicians in Greece are universally considered as the culprits for the present catastrophic situation, and Andreas Papandreou in particular is seen as the main architect of the bloated public sector. Whether he is or not, I don't know, but there is little doubt that for decades democracy in Greece has been played out on the basis of a disarmingly simple equation: votes = government jobs = juicy pensions.

The public sector has become a behemoth eating up some 40 percent of GDP (although statistics are only a rough approximation: in such cases of rampant corruption and profligacy, there is no particular reason to trust them). That leaves 60 percent of the economy still in the private sector.

That would be a sizable amount if the private sector was healthy and willing to pay taxes. But confronted with a huge and manifestly unfair government machine, what would you do? Would you pay your taxes and feed the monster? Of course not. And that is exactly what has happened in Greece. Every business, from the largest (the shipping industry) to the smallest (the bar and hairdresser), is busy avoiding paying taxes. And those who can (the wealthy) are busy transferring their money out of the country. Once again, statistics are moot, but it is likely that some €50 billion in tax payments are evaded each year and possibly €30 billion of funds are exported and placed in safe havens abroad. I am not standing by these numbers, but you get the idea.

Result? The economy is on its knees, and that is a pity, considering that Greece had at least two cards to play (tourism and shipping) as well as one of the best banking systems in Europe. Greek banks survived the 2008 financial shock remarkably well, and if customers hadn't started to withdraw deposits and credit rating agencies had not downgraded Greek government debt to junk status (or thereabout), Greek banks would have no trouble functioning efficiently. But now, the only place where they can get the liquidity they need to finance the needs of their business clients is the European Central Bank. And the latter has joined the political chorus of European finance ministers and the IMF demanding additional austerity before releasing any more  funds.

So we are back to square one, where we were a year ago when the Greek debt crisis exploded. Greek business can't get the financing it needs from its banks, the economy is clearly on a downward spiral, with unemployment rising etc.

Is more austerity the answer? Even though austerity measures (budget cuts, tax increases, sale of state assets) justifiably aim at correcting the excesses of the public sector, they unfortunately also adversely affect the private sector. How come? Because in a downward spiral, the bailout money acts like good money chasing the bad. There is never enough of it if the economy keeps dipping. Now, as I am writing, Greek banks have almost ceased functioning, i.e. filling their main role as providers of  working funds to business. This coming summer they will be able to fulfill the business funding role only if the bailout money is provided.

The problem is that this is precisely the scenario that played out last year and yet didn't work. Everybody fears the new bailout will prove not to work again - to be simply a way to kick the can down the road. Why? Because there's more to it and it's not something the banks can solve on their own: the private sector has to start behaving appropriately vis à vis the public sector. This means it has to start paying taxes and refraining from exporting its profits abroad. Of course the government can pursue the tax evaders and slap on a series of anti-tax evasion measures (including a tax holiday to repatriate funds). And the government has already done some of  this, but there is little doubt that coercive measures can only do so much.

What is needed is a cultural change: a changeover in the Greek mindset. Greeks have to stop seeing their government as a repair of bandits and start trusting in its capacity to put its house in order. For this to happen, it is clear that the government has to very openly and efficiently apply the needed austerity measures. But it also has to convince Greek citizens that it is serious about this reform - that it means business. This is where Venizelos comes in, this is going to be his challenge: effectively apply the needed reforms and convince the Greek public that he is doing so.

Can he make it? The bets are open, but in my opinion, one thing is certain: if he can't, nobody can.

I would love to have your views, and in particular I would love to hear from my Greek readers out there...
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