The Germans, who are normally quite astute about the lessons of history, are now acting against Greece with what looks like a vindictive intransigence that would have made Allied negotiators at Versailles nod approvingly. The Greek’s choice now appears to be between another bailout and continued harsh austerity, or default and financial collapse. Who in Europe believes that pushing Greece into desperate economic straits is good for their stability? Will it take the rise of someone much more extreme than Tsipras to make the Germans, French, and others understand what they are really getting in exchange for avoiding another haircut on the loans, and accepting any responsibility for the bad judgments of the lenders as well as the borrowers?
Greece may have another choice. Two choices, actually: an economic choice and a political choice.
The economic choice, under a rational leadership, may enable Greece to default on their outstanding debt and quickly resurrect their access to global capital markets at reasonable rates. This choice would merely require a couple of changes in their constitution. It has been done before. To see how, we need to step further into history.
In the early U.S., although the states were considered sovereign in a number of ways, they were joined in a sort of currency union, i.e., the gold standard. In principle, the states would have adopted any fiat standard created by the Federal government, but such an alternative was, at the time, extremely controversial. In fact, President Jackson shut down the Second Bank of the United States in the 1830s, believing that central banks were corrupt organizations designed to protect the privileged [insert wry comment here]. In the aftermath of Jackson’s fateful decision, the states were left to pick up the slack in creating credit for an expanding nation. During this period, at the dawn of American democracy, state legislatures still had two inherited powers by virtue of their limited sovereignty: (a) the power to take on unlimited debt with a mere show of hands, and (b) the power to charter corporations–something exercised almost exclusively at the state level after the demise of the Second Bank.
Under these circumstances, many of the states developed something called taxless finance—a fancy term for borrowing against the stock of corporations, with recourse to future general tax revenues if those corporations defaulted. If that sounds a little Enronesque, you’re already ahead of the story.
What followed was a chartering and borrowing spree that went on until a financial crisis hit in 1837, triggering a five-year economic downturn. By 1842, nine of the 28 U.S. states had defaulted on part or all of their loans, and three more states barely averted going over the edge. The bankrupt states were now faced with being shut out of the credit markets (which, at that time, were still largely foreign) at the same time that they faced a steep decline in revenues. A bailout was out of the question. (Even then, the Dutch were not in a forgiving mood.)
Desperate to regain access to capital, they sought a response that would be credible to lenders, and adopted a set of reforms that included:
(a) Requiring each new bond issued by a state to be separately put to a general vote in a referendum, which meant having to sell each tranche of new debt to the people;
(b) Specifying the taxes that would be dedicated to servicing the debt, which would provide greater assurance to the lenders; and
(c) Taking the legislature out of the business of chartering corporations by, instead, making corporate charters universally accessible via an administrative process (i.e., how its done today), substantially eliminating the corrupt relationship between legislators and corporations, and forcing each corporation to stand on its own credit.
These reforms were credible because they were built into the states’ respective constitutions. That credibility helped restore their access to the capital markets. Since then, about 175 years on, no American state has gone bankrupt, and U.S. state-issued bonds have been among the safest investments on the planet.
If Greece is able to adopt constitutional limits on how, if not how much, they can borrow, plus other structural reforms they need to adopt anyway, it would increase its bargaining position with respect to its indebtedness, even to the point of risking a repudiation of its old debts, and exchanging its current bondage for a more sustainable level. Since any repudiation would almost certainly get Greece kicked out of the Eurozone, this gambit would work only to the extent that the increased inflation risk posed by re-adoption of the drachma could overcome the reduced default risk created by their constitutional constraints. But the upside of this gambit will become more compelling over time if the new regime of full austerity without debt relief does not work, and their economy cannot pull out of its dive in time for another crash. At that point, a firm majority of Greeks may become irresistibly drawn to the prospect of regaining their full sovereignty, with stronger internal incentives for responsible borrowing instead of the humiliation of ongoing European oversight of their domestic fiscal policy.
The political choice is more stark. Just as Germany was forced to accept the terms of June 1919, Greece may not have a choice with respect to the current European plan. But the Greeks still have a choice of who they elect, and what their constitution looks like. The most positive exercise of their political choices will be to mimic the American states in adopting constitutional constraints that bind future governments. They will do this only when the leadership agrees that having the people bind the government with respect to new debt is preferable to having the government continuing to bind the people in unconstrained borrowing.
On the other hand, if the Greeks suffer continued hardship under the austerity regime with no prospect for improvement, the political instability that created Syriza will become amplified, almost certainly resulting in more extreme parties. Then we should hope that the radical government they end up with stops at repudiating the debt before engaging in other distractions that will make the foregone trade-offs of today, such as additional haircuts on the loans, look like wonderful alternatives.