Gunboat Diplomacy: The Greek Debt Deal

The Lehmann Letter (SM)

A century ago it was referred to as gunboat diplomacy: European, and sometimes American, warships visited a small, weak nation to ensure that it repaid its debts to European and American bondholders.

On occasion gunboat diplomacy involved North Africa or the eastern Mediterranean. Sometimes it was the Caribbean and Central America. The Europeans and Americans established a protectorate in the target country and seized the customs authority for a number of years. The European and American authorities could then skim the customs revenue in order to repay the bondholders. There were times when the occupiers left soon after the bondholders obtained satisfaction. There were other times when they remained longer. Bottom line: The small country lost its sovereignty for a while.

Articles in today's New York Times and Wall Street Journal regarding the Greek debt deal are reminiscent of those bygone days:

http://www.nytimes.com/2012/02/21/world/europe/agreement-close-on-a-bailout-for-greece-european-finance-ministers-say.html?_r=1&ref=todayspaper

http://online.wsj.com/article/SB10001424052970203358704577234560465582418.html?mod=ITP_pageone_0

There are no gunboats and no seizures of customs revenue, but Greece has compromised its sovereignty - by ceding control over its fiscal authority - in order to remain in good standing within the euro zone. It's part of a three-way deal: Greece must impose austerity measures in order to reduce its budget deficits, the bondholders take a loss with the write-down of Greek debt and the strong nations of Western Europe provide bailout funds.

There are risks. The bondholders know this. They will take a loss. The strong nations of Western Europe know this. They will provide the bailout funds. But the biggest risk revolves around the Greek austerity measures. Put simply: The Greek government must reduce its expenditures and increase its tax revenues. That will enable it to pay its debts. But reducing expenditures and raising tax revenues will have a contractionary impact on the Greek economy. Austerity will reduce Greek output and income, making it more difficult for the government to repay its debts. Why? Because a poorer nation demands more social services, raising government expense, and a poorer nation pays less taxes, reducing government revenue. Everyone hopes that the Greek government can clear this hurdle.

(To be fully informed visit http://www.beyourowneconomist.com/)

© 2012 Michael B. Lehmann