Greece’s exit from the euro zone seems inevitable now that voters across the debt-troubled country made it clear over the weekend that they won’t accept austerity measures lenders want in exchange for further aid. Globally, markets have been tanking on the news, as the fate of Greece grows more uncertain by the day.
It also doesn’t help that German Chancellor Angela Merkel, who holds considerable influence in the eurozone, has made it clear that Germany does not approve of any further rescue packages for Greece. On Monday, she rejected any possibility of restructuring the country’s debt, regardless of whether Greece agrees to further reforms.
That seems highly irrational. One way to understand this is to look at the nature of debt, which is not very different from an insurance policy, where insurers charge premiums as payment for the risks of having to pay out policies at a later date. Similarly, debt always carries the risks of default, which is why lenders charge interest. If all goes well, insurers or lenders profit; if things go badly, they take a loss. In addition, in the case of sovereign debt, lenders have no collateral, which makes the whole transaction a simple exercise in risk versus reward.
Corporate lenders, especially those that are unsecured, know this, which is why they will usually (though not always) work with a company to restructure its debt instead of pushing it into bankruptcy. Similarly, a lender might force a company to sell off some assets and cut workers in order to save costs, but even these actions must be taken with prudence so that they don’t destroy the ability of the business to make money.
In the case of Greece, there are only two possible outcomes, and it should be obvious to Germany which one protects its interests more.
If the European Central Bank refuses to bail out Greece, the nation willlikely have to exit the eurozone. If that happens, in order for Greece to prop up its nearly insolvent banks, it will have to print a new currency, the drachma. That means Greece’s economy would suffer further from higher inflation and a slowdown of economic activity since the drachma would float against the euro and get devalued. As a result, Greece could stop repaying outside lenders, as the country would no longer have to rely on the ECB to support its banking system and can act independently.
That’s a terrible outcome for Germany, which may only recover a tiny fraction of the money that Greece owes if it’s lucky, or perhaps, in a worst-case scenario, none at all.
On the other hand, if Germany agreed to show Greece a bit more sympathy by forgiving some of its debt and restructuring its repayment terms for the rest, it might help Greece regain its own economic strength, and in turn, slowly pay off its lenders. The agreement should ask Greece to implement reasonable reforms but should also allow it to raise taxes, which the country needs to do in order to narrow its deficit, and offer additional aid to offset the immediate banking crisis.
True, this would require Germany to double down on its risk, but that’s only temporary. By helping Greece climb out of its financial abyss, Germany would also be potentially salvaging a larger portion of its own loan over the long-term, whereas a punitive solution could push Greece to default. Also, as the leading French economist, Thomas Piketty, has pointed out, Germany’s own post-war economic miracle was partly rooted in debt relief and so some clemency for Greece at this time isn’t too much to ask.
Finally, while it’s unlikely that a Greek exit will create a real eurozone crisis as some fear, according to The Washington Post, it’s still a big gamble to take. With 240 billion euros owed by the Greek government and 89 billion euros by its banks to international creditors, the shock waves of a default could still be significant.
It’s hard to say how much Greece’s debt to Germany really matters to Germany. Since 60% of Greece’s debt is owed to the ECB, with Germany being the largest creditor by far, according to The Telegraph and others, it can’t be a non-issue. But one thing is clear: Merkel is standing on principle here, refusing to bow to pressure from Greek voters on the issue of austerity and possibly afraid of setting a bad precedent that could embolden other financially troubled nations, such as Italy and Spain, to thumb their nose at the eurozone.
However, by doing so, she is also inadvertently violating a basic principle of capitalist philosophy, which demands maximizing returns in any given situation, regardless of moral absolutes. It doesn’t matter whether Germany is right or wrong; the only question Merkel should be asking is which approach better protects Germany’s loan and the eurozone’s future stability. Pushing Greece over the edge won’t achieve that.
S. Kumar is a tech and business commentator. He has worked in technology, media, and telecom investment banking.