Greece: Death spiral ahead

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Greece: Death spiral ahead

Post by Admin on Tue Jul 21, 2015 8:38 am

The Greek Parliament has now voted to surrender control of the Greek state to platoons of bureaucrats from Brussels, Frankfurt and Berlin, who will now re-impose the full policy regime against which Greeks rebelled in January 2015 – and which they again rejected, by overwhelming majority, in the referendum of July 5.
The orders from Brussels will impose strict new rules on the Greek people in the supposed interest of paying down Greece's debt. In return, the Europeans and the IMF will put up enough new money so that they themselves can appear to be repaid on schedule–thus increasing Greece's debt–and the European Central Bank will continue to prop up the Greek banking system.
A hitch has already appeared in the plan: the International Monetary Fund, whose approval is required, has pointed out—correctly— that the Greek debt cannot be paid, and so the Fund cannot participate unless the debt is restructured. Now Germany, Greece’s main creditor, faces a new decision: either grant debt relief, or force Greece into formal default, which would cause the ECB to collapse Greece's banks and force the Greeks out of the Euro.
There are many ways to rewrite debt, and let's suppose the Germans find one they can live with. The question arises: What then?
An end to the immediate crisis is likely to have some good near-term effect. The Greek banks will “reopen,” likely on Monday, and the European Central Bank will raise the ceiling on the liquidity assistance on which they rely for survival.  The ATMs will be filled, although limits on cash withdrawals and on electronic transfers out of the country will likely remain.  There will be some talk of new public investment, funded by the European Union; perhaps some stalled road projects will restart.
With these measures, it is not impossible that the weeks ahead will see a small uptick of economic life, and certainly, any such will make big news.  It's also possible that even without good news, Greece may limp along in stagnation, within the Euro.
But if you walk through the requirements of Greece's new program, there is another possibility.  That possibility is an economic death spiral – contraction leading to banking failure, banking failure leading to contraction – first in Greece and, later on, elsewhere in Europe. 
Here's what that would look like:
Value-added tax rates – your basic regressive sales tax – will jump by ten percentage points or more, to 23 percent, including for hotels and restaurants and including on the Greek islands. This will divert tourists to Turkey and elsewhere, damping Greece's largest industry. Also, it will drive small businesses even further to cash and tax evasion. This means other tax revenues will also fall.
Tax revenues will rise at first, but then they will fall short of targets, both because economic activity falls and evasion rises. As this happens, the new program requires that public spending be cut automatically. Since most public spending goes for pensions and wages, this means that pensions and wages will be cut. Since pensioners and civil servants live on these payments, they will cut their spending – and tax revenues will fall further.
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