Greeks in the Streets Are Right, EU Economists Have It Wrong

The agreement by the European Union and the International Monetary Fund
to provide up to $960 billion of support to the Continent's weaker
economies, as well as to financial markets, has appeared to calm
investors worldwide, for the moment.

But this does not resolve the underlying problem, even in the short run.

The problem is one of irrational economic policy. The Greek government
has reached an agreement with the E.U. authorities (which include the
European Commission and the European Central Bank), and the I.M.F. that
will make the current economic problems even worse.

This is known to economists, including the ones at the E.U. and I.M.F.
who negotiated the agreement. The projections show that if their program
"works," Greece's debt will rise from 115 percent of gross domestic
product today to 149 percent in 2013. This means that in less than three
years, and most likely sooner, Greece will be facing the same crisis
that it faces today.

Furthermore, the Greek Finance Ministry now projects a decline of 4
percent in G.D.P. this year, down from less than 1 percent last year.
However that projection is likely to prove overly optimistic. In other
words, the Greek people will go through a lot of suffering, their
economy will shrink and their debt burden will grow, and then they will
very likely face the same choice of debt rescheduling, restructuring, or
default - and/or leaving the Euro.

There are lessons to be learned from this debacle. First, no government
should sign an agreement that guarantees an open-ended recession, and
leaves it to the world economy to eventually pull them out of it. This
process of "internal devaluation" - whereby unemployment is deliberately
driven to high levels in order to drive down wages and prices while
keeping the nominal exchange rate fixed - is not only unjust, it is
unviable. This is even more true for Greece, given its initial debt
burden.

The tens of thousands of Greeks in the streets have it right, and the
E.U. economists have it wrong. You cannot shrink your way out of
recession; you have to grow your way out, as the United States is doing
(albeit too slowly).

If the E.U. and the I.M.F. will not offer a growth option to Greece, the
country would be better off leaving the Euro and renegotiating its
debt.

Argentina tried the "internal devaluation" strategy from mid-1998 to the
end of 2001, suffering through a depression that pushed half the
country into poverty. It then dropped its peg to the dollar and
defaulted on its debt. The economy shrank for just one more quarter and
then had a robust recovery, growing 63 percent over the next six years.

(By contrast, the "internal devaluation" process promises not only
indefinite recession, but a long, very slow recovery if it "works" - as
we can see from the I.M.F.'s projections for Latvia and Estonia. Both of
these countries are projected to take 8 or 9 years to reach their
pre-recession levels of output.)

The E.U. authorities sent markets crashing last Thursday by saying that
they had not discussed using "quantitative easing" (i.e., the creation
of money, as the U.S. Federal Reserve has done to the tune of $1.5
trillion in the last couple of years) to help resolve the situation.

E.U. officials also made statements that more deficit reduction is
needed by countries that are still in recession or barely recovering.
The new agreement reached over the weekend partially reverses these
statements, but not enough.

The pundits are quick to blame Greece and the other weaker European
economies - Portugal, Italy, Ireland and Spain - for their problems.
Although, like most of the world, these countries did have asset bubbles
and other excesses during the boom years, they didn't cause the world
recession that sent their deficits skyrocketing.

Most importantly, the real problem now is that the E.U. and the I.M.F.
are still offering them the medieval medicine of bleeding the patient.
Until that changes, expect a lot more trouble ahead.