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Greek Un-Disaster: The Big Choice

Disaster in the Eurozone, or raging success inside it as well...?
The GREEK government defaulted on its payment to the IMF, with wild popular support confirmed by a referendum, writes Nathan Lewis of New World Economics in this article first published at Forbes.
Huh? Isn't default supposed to be a bad thing?
Ecuador's government defaulted on its sovereign debt in December 2008. President Rafael Correa, formerly Ecuador's finance minister and who holds a PhD in Economics from the University of Illinois, declared Ecuador's debt "odious debt".
Only four months after the default, in April 2009, he was re-elected with 51.9% of the vote, the first time in thirty years a president had been re-elected in the first round.
Did economic disaster follow? Ecuador's GDP growth rate in 2009 was 1.16% above the global average.
Next for Greece is the bank workout. Initial indications are that a 30% loss on deposits above €8,000 would restore Greek banks to financial health, making them perhaps among the healthiest banks in Europe.
This should be done, and it should be done quickly, so that the banking system can get up and running again. Depositors should be senior to all other creditors, including derivatives liabilities, who would get a total loss. There is no need to sell the banks or sell the banks' assets. It is just an adjustment of liabilities. Existing shareholders would be wiped out; depositors would get a debt/equity swap, for example one share of equity for each €100 of debt converted, and thus become the new owners of the bank.
Of course this would involve some discomfort, but a 30% loss on deposits – with equity in trade – is hardly the worst thing that could happen. Also, Greek people implicitly supported such a path with their rejection of all EU borrowing in the recent referendum. Since the Greek government is in no position to recapitalize banks (again) with a "bail-out", a creditor writedown is the logical next option.
Then what? Then comes the Magic Formula. Low Taxes and Stable Money.
The worst thing that could happen is for a currency disaster to be piled upon all the other problems of default, bank restructuring, and various spending reforms – as Argentina experienced in 2001. That's why I insist on Stable Money. Argentina had been using a Dollar currency board, and many advisors begged the government to Dollarize completely, as Ecuador had done a year earlier, rather than devaluing the currency in an effort to prop up insolvent banks. Argentina didn't Dollarize, and you can compare their results to Ecuador's. (The Argentine Peso fell from 1:1 to the Dollar in 2000 to 9.14 per Dollar recently. Argentina's GDP, in nominal Dollar terms, fell more than 50% and took seven years to recover to its 2000 level.)
Technically speaking, Greece can certainly keep the Euro. Ecuador, which Dollarized in 2000, continues to use US Dollars to this day. Ten other small states and territories use the Euro exclusively, without being members of the Eurozone. If the European Union has a hissy fit, and somehow makes it difficult for Greek institutions to continue using the Euro, the next-best option would be a currency linked to the Euro with a currency board, such as is used by at least thirteen African countries with a combined population in excess of 109 million people.
Neighboring Bulgaria uses a highly reliable currency board linked with the Euro, so in a pinch, Bulgarian Levs could be used in Greece instead of Euros, until a domestic currency board could be established. The Lev has the advantage of being independent of the Greek government, and thus not in danger of being debauched by the government in a moment of weakness.
Keeping the Euro, or a currency linked to the Euro, is the best solution for maintaining Stable Money for at least the short term. The Euro itself might not be such a great long-term solution, particularly if Spain and Italy begin to follow Greece's example, but other arrangements can be worked out in the future.
And yet, all of this, added together, won't get Greece much beyond where it has been thus far – with 25% unemployment and 50% youth unemployment, a bloated and corrupt government burdened by a crippling legacy of entitlements, and an economy that has been in shrinkage since 2008. We could avoid disaster, but Greece would still be left with slow lingering decline, no better and possibly worse than today. How do we turn this around?
That's where we need the other half of the Magic Formula: Low Taxes. This could take many forms, but one excellent proposal was made by Steve Forbes, who suggested a flat individual and corporate income tax with a 10% top rate (the same as Bulgaria), a 10% payroll tax (instead of a 42% combined rate presently), and a 15% VAT (instead of 23% presently).
In 1998, Bulgaria had a corporate tax rate of 40%, and a top personal income tax rate of 50%. The VAT rate has been unchanged since that time, while the payroll tax rate has been reduced by a whopping twelve percentage points. The result? Total tax revenue, as a percentage of GDP, was 34.6% in 1998, and 35.8% in 2014. Needless to say, these business-friendly tax rates have allowed Bulgaria's economy to grow, in part because of a flood of Greek businessmen seeking a better environment. A stable revenue/GDP ratio, multiplied by much larger nominal GDP, means more tax revenue, not less.
I might suggest an even more aggressive proposal: a tax system based only on indirect taxes, something like the "fair tax" ideas floating around in the US. This can work well, but only when government expenditures are fairly reasonable, for example around 15% of GDP. That is more than enough for a wide range of government services, including universal healthcare. The Greek tax system could consist of the present 23% VAT, perhaps the existing local property tax, a few excise taxes on things like gasoline and tobacco, and nothing else. This might seem politically improbable at this time, but people can be inspired by such visions, and when they are inspired, great things can happen.
Even the lefty-as-possible Syriza government – some actually call themselves "communists" – is now adamant that higher taxes ("austerity") are a disaster. If that's the case, would lower tax rates be an un-disaster? An un-disaster is exactly what Greece needs, right here and now. Maybe, as big an un-disaster as you can make.
Once all these things are in place – sovereign default, bank restructuring, a reliable currency arrangement, and big tax reforms – then a reform of public spending would be much easier. Everybody in Greece knows that things need to be fixed. What they don't want is for Greek people to make concession after concession while foreign debt tyrants get paid back 100% – especially since the "troika" loans to the Greek government were mostly to bail out foreign banks to begin with. The concessions come after the default – just as is the case with corporate employment and pension agreements, or municipal bankruptcies in the United States.
The tax reforms also need to come before, or at least concurrently with, the spending reforms. If thousands of excess government employees, thousands of pensioners under 65, and hundreds of crony businesses are going to be kicked out of the government feeding trough – as everyone knows they should be – they need to have a healthy private economy as a viable alternative. The tax reforms make that possible.
You could make a list of a hundred other reforms, such as the ease of setting up businesses or a relaxation of labor laws. Go ahead and do those too. But, they won't be very effective by themselves. You need the tax reforms. Would you set up a business in Greece today? Since the answer is already "no," who cares what the other details are. And if the answer is "yes," then you will try to make it happen, even if there are obstacles, although it would be better if there weren't.
That is quite an agenda. But, all the alternatives are worse. Even the IMF – one of the Greek government's major creditors – says that the Greek government needs a debt restructuring. Just piling on more debt is not a viable solution. Nor is trying to make-believe that banks are healthy, even with a further "bail-out", whose financing seems very unlikely. And printing money/devaluing the currency to make it all better? This is a popular sort of notion today, which just goes to show how few supposed experts know what happens to places like Argentina that actually try it.
I think Greece could be wealthier than Germany in twenty years. With visionary leadership, of the sort that Lee Kuan Yew showed in Singapore (14.2% tax revenue/GDP) or John Cowperthwaite showed in Hong Kong (13.0% tax revenue/GDP), it might take less than ten. Or, you could have one heck of a disaster. I suggest taking the road to prosperity.

Formerly a chief economist providing advice to institutional investors, Nathan Lewis now runs a private investing partnership in New York state. Published in the Financial Times, Asian Wall Street Journal, Huffington Post, Daily Yomiuri, The Daily Reckoning, Pravda, Forbes magazine, and by Dow Jones Newswires, he is also the author – with Addison Wiggin – of Gold: The Once and Future Money (John Wiley & Sons, 2007), as well as the essays and thoughts at New World Economics.

See the full archive of Nathan Lewis articles.

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