Greece crisis and the best way to cook a lobster

  • 22 June 2011
  • From the section Business
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There's an old joke about politicians and the best way to cook a lobster.

The Conservative throws the animal, live, into a pot of a boiling water. The Marxist smashes it over the head with a hammer, then puts it in the boiling water. The Liberal puts the lobster into a pot of cold water, then slowly heats it up.

The international community's approach to the Greek crisis is starting to remind me of the third option.

I'm in Brazil today, and it's the kind of joke they used to tell here. Until recently, this was a continent that used to practise extreme economics. There were dramatic booms and busts, and not much in between.

This did not have a lot to recommend it. It's hard for businesses and economies to develop if the prospect of a national financial crisis is always just around the corner.

Short-lived pain

But, as Jonathan Anderson at UBS has pointed out (in a different context), emerging market crises do have one big advantage over crises in so-called mature economies: they are over quickly.

"In emerging markets... most crises in the past two decades have proven to be liberating events, with both a rapid recovery and a considerable trend increase in growth.

"How can this be? In our view, precisely because of the cathartic dual impact of bankrupting capacity and writing off debts."

When crises struck in Asia and parts of Latin America in the 80s and 90s, emerging markets didn't get given a lot of room for Keynesian stimulus or "kicking the can down the road".

Instead they went straight to "Austrian-style" deep cleansing: currencies collapsed, foreign money evaporated, and credit shortages forced large parts of the corporate sector out of business.

This is not fun. On average, the emerging market crises in the 90s involved a peak-to-trough decline of 12% of GDP in the space of a few quarters - roughly twice what happened in advanced economies in 2008-2009.

Also the exchange rate, on average, fell by 40% in real terms (meaning a much larger drop in the nominal exchange rate.) That's roughly twice the size of the fall that occurred in the UK, and we are on the extreme end of experience for developed country currencies.

Benefits of default

These, then, were cataclysmic events which no sane country would choose to suffer. More like an economic collapse than a recession. In Thailand and Indonesia, for example, construction fell by 45% in one year.

With all this came massive writing down of private (in Asia) and public debt (in Argentine, Russia and Ukraine). According to the IMF, the public debt ratio fell by nearly 80 percentage points in Argentina, 45 points in Russia and 30 points in Ukraine.

But there was an upside: within 12-18 months, the average crisis economy was already in a rapid recovery, and growth in each of the following 5 years was much faster than before the crisis.

Not exactly what we've seen recently in Japan and other advanced economies coming out of debt crises.

Interestingly, Mr Anderson believes the main factor supporting these recoveries wasn't the devaluation of the currency but the early and dramatic return of private credit, itself made possible by massive default and writing down of debt.

On average, credit grew by 15-20% a year in these countries after the crises. "This quite simply has no analogue whatsoever in major developed country experience, past or present," he said.

In his view, this was only possible because private businesses - and in some cases, governments - had the option to default. Or more precisely, they had that option because there were no other options available.

Limited options

Greece was saved from that calamity a year ago by the first EU-IMF bail-out. That 110bn euros was the reward for having joined the club of "serious" European economies a decade earlier (even though such safety nets were not strictly supposed to exist).

The chances are they will now get another one, conditional on further cuts and reforms.

Because they are supposed to be a serious economy, and because they chose to cement their new status by giving up their currency, they have this "rescue" option which emerging market economies don't get when they run up gargantuan debts.

But when Greece opened the door to a bail-out, they also closed several others.

Giving up the euro would be much harder for Greece than even Argentina's painful escape from its currency board 10 years ago.

Likewise it would almost certainly be more painful now - for Greece and the rest of the world - for Greece to go through an Argentine-style disorderly default on government debt.

Serious eurozone economies can't get thrown into boiling water when they misbehave. A year ago that may have seemed a blessing for Greece. It's starting to look like a curse.