Greece Can Be Saved By the Dark Arts of Investment Banking

The Greek government’s eleventh-hour payment of €750 million to the International Monetary Fund on the 11 May illustrates the brinkmanship and grand-standing of national electorates that are making the drama of debt negotiations into a crisis. The actual repayment is a mere pin-prick compared to the estimated €323 billion of total government debt and the €6.6 billion due to be repaid in June.

The real test of the crisis are not the numbers, nor even the insistence on debt cancellation by hard-line sections of Greece’s Syriza ruling party, and its counterpart in the German Finance Minister Wolfgang Schauble who insists that all debts are paid in full. The key factor is whether the Greek government can pay its running costs (not including debt payments) from tax revenues, or what economist term having a primary balanced budget. This is crucial because it determines the balance of power in the debt negotiations.

If the government has a primary balance or a surplus, and can cover its non-financial obligations out of its current revenues then it is in a position to tell its creditors to wait for repayments or interest. As the Greek Finance Minister Yannis Varoufakis is said to have observed, ‘If I owe my bank €1,000 and I cannot pay it back, then I am in trouble. If I owe my bank €1 million and I cannot pay it back, then it is the bank that is in trouble’, because that €1 million will make more of a hole in the bank’s balance sheet than it will in the debtor’s reputation.

However, if the government has a primary deficit and cannot cover its day-to-day expenses out of its revenues, then it is truly the government that is in trouble. It cannot tell its creditors to whistle for their money, if it is going to have to ask them for more loans the following day.

As any remotely competent investment banker knows, debts need never be paid off

So the primary surplus or deficit determines where the risk lies in the negotiations, whether with the creditors who will have to whistle for their repayments (in the case of a primary surplus) or with the debtors, who will have to promise to satisfy every demand of the creditors in order to get new loans to make up a primary deficit.

In fact, at the start of 2015 the indications were that the Greek government was approaching a primary balance, so that Syriza may have inherited a strong position in its negotiations. Whether the primary balance is still there is another matter. The Greek economy is not recovering, and there is every sign that the austerity imposed on the Greek government is decimating its revenues, and widening the deficit in its social welfare budget, as contributing employees and their wages fall.

In this situation the only way out is through resort to the black arts of investment banking. As any remotely competent investment banker knows, debts need never be paid off, while ensuring that creditors get their money back on time. The trick here is refinancing: borrowing elsewhere to pay off due debts, in this way making your debts long-term commitments that may be passed around whoever is willing to hold them for however long they are willing to hold them.

Europe does need to learn fast the techniques of debt management

The IMF has a rule that it does do not lend to governments that are in arrears. And so, at the height of the Third World debt crisis in the 1980s, governments in arrears would negotiate a new loan from the IMF, that would not be disbursed as long as those governments were in arrears. With the new loan in sight, the governments would borrow from the Bank for International Settlements – a sort of global central bank based in Basel, Switzerland - to clear off the arrears and unlock new loans that would be used to repay the loan to the BIS. 

This ‘kicking the can down the road’ (as it is colloquially referred to in the financial markets) may come as a shock to thrifty Swabian housewives and Greek Trotskyists who believe that Germany should forgive the debt. Europe does not need to go as far as the largest debtor in the world, the US government, whose Department of Finance is a franchise of Goldman Sachs. But Europe does need to learn fast the techniques of debt management, and develop institutions for such management, that will allow its governments to focus on economic recovery before the European project collapses into xenophobia and mutual recriminations.

Jan Toporowski is Professor of Economics and Finance at the School of Oriental and African Studies, University of London

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