Austerity or Debt Relief? What we can learn from the Odyssey
Is there a better way to explain the Eurozone crisis than with Greek Mythology? Probably not, as Odysseus' choice between Scylla and Charybdis offers a particularly neat analogy for the current situation in Europe.
"To choose between Scylla and Charybdis" means to choose between two very bad options. The two main options crystalizing from the never-ending Eurozone crisis has been debt-relief or austerity measures. Mainstream economists from the Anglo-Saxon countries predominantly advocate another generous bailout program for Greece paired with debt relief.
Let's call this option Scylla.
Scylla might help the Greek economy to finally start its recovery, but it will also reward fiscal irresponsibility. Other Eurozone governments who received bailouts would demand debt relief too. Otherwise, they risk being replaced by more radical governments that promise their voters to take up the same fight as the Greek government.
Scylla could tear the Eurozone apart in the long-run.
Bearing this in mind, some countries in the Eurozone, most prominently Germany, favor a bailout program paired with strangulating austerity measures and no perspective on meaningful debt relief.
Let's call this one Charybdis.
Charybdis will punish fiscal irresponsibility and, hence, might impose discipline on Greece and other governments. But burdened by enormous amounts of debt, the Greek economy will not recover, unemployment will remain high, and radical parties will continue their ascent.
Charybdis will eventually prove just as deadly for the Eurozone as Scylla.
Why facing Scylla and Charybdis?
In the epic poem, Odysseus had to face one of the two sea monsters when he passed a narrow channel. He was portrayed by Homer as a man with great wits, so he must have been pretty sure that he had no other choice before he sailed into the channel. For Odysseus it was clear that this was his only way home.
Did the Eurozone leaders do enough due diligence before approaching the two monsters?
Maybe, there was another way that would not have implied entering the narrow channel at all. In other words, the European Central Bank and the Eurozone governments could have decided to not distribute any bailout money in the first place. In this case, Greece and potentially other peripheral governments might have defaulted. What would have been the consequences for the defaulting governments without bailouts?
On the one side, a defaulting government would have lost access to capital markets; it would have found itself unable to borrow money. The threat of a default and the corresponding loss of funding sources would have imposed fiscal discipline. On the other side, a defaulting government would have been able to unilaterally impose haircuts on its outstanding debt. This would have relieved the debt burden and allowed an economic recovery.
Compared to Scylla and Charybdis that perpetuate either fiscal irresponsibility or economic depression, avoiding both seems to be clearly the sanest option.
So why did the Eurozone nonetheless sail straight into Scylla and Charybdis? Why did they not abstain from entering the narrow channel by providing a bailout program of hundreds of billions of Euros? Why did they not allow Greece to default and recover?
A bigger monster was looming
A popular term to describe the ongoing Greek tragedy is „sovereign debt crisis," which is a truly misleading term. The fundamental problem has never been the concern that peripheral governments would be forced to run a primary surplus. No, the fundamental problem has always been on the creditor side, as the main creditors were banks.
Banks are – motivated by capital requirements that reward holding government bonds – major creditors of governments. They also enjoy unlimited government guarantees, which make them quite agnostic towards risk (but not toward returns). Before the first bailout program – before the Eurozone decided to sail straight into the narrow channel – banks around the world held an estimated €170 billion of Greek government debt.
In addition, banks also hold a lot of government debt of other peripheral governments. A default of one government could have depressed government debt of others, which could have quickly escalated in a large scale banking panic across Europe. Back then, the experience with Lehman Brothers was still in mind, so politicians knew how quickly things can spiral out of control when banking institutions fail.
The true winner of the bailouts
Banking was an even bigger monster on the open sea that forced the Eurozone to sail straight into Scylla and Charybdis. Banking made Scylla and Charybdis look like cute pets.
As such, the Greek government was given bailout money. Core Eurozone countries such as Germany – and not the Anglo-Saxon mainstream economists – were the main creditors for the bailout programs. As a result, it was decided to sail closer to Charybdis, the monster with the austerity measures.
Meanwhile, on the deck of the Eurozone ship, people are arguing on what is the lesser of two evils: Scylla or Charybdis? This choice essentially boils down to one simple question: Who should pay and suffer most for bailing out the banking system? The taxpayers of peripheral or core Eurozone member states?
The argument escalated over the past weekend with grotesque references to European history. In the end, this conflict only disguises the underlying and prevailing problem. As long as the big monster banking is looming, the Eurozone cannot exit the narrow channel. At the end of the day, one or the other monster will wreck the entire Eurozone ship. The choice between Scylla and Charybdis is merely a choice of who is getting hurt first.
No Euro with Banking
The only way out is to leave the narrow channel and to take up the big monster banking in the open sea. The Eurozone has to embrace radical solutions to overcome the dilemma between Scylla and Charybdis. Only by establishing a financial system without banking, the Euro stands a chance to survive future fiscal turmoil.
What would change without banking?
First, lending would only be undertaken by individuals and institutions who take full responsibility for their decisions, and not by banking institution that will need bailouts if their borrowers do not repay. As a result, nepotistic and inefficient governments – and it is not unfair to put the Greek government in this category– will find it much harder to find willing lenders.
Second, a defaulting government will no longer threaten financial stability. We would finally have a Eurozone that could credibly treat government default in line with European treaties: No Bailouts.