i

THE POSSIBILITY OF A HELLENIC EXIT FROM THE

EUROZONE

The Plan B

ERASMUS UNIVERSITY ROTTERDAM

ERASMUS SCHOOL OF ECONOMICS

MSc Economics & Business

Master Specialisation Financial Economics

Author: I.A. Athanasiadis

Student number: 365610

Thesis supervisor: Dr. J.J.G. Lemmen

Second reader: Dr. M.P. Bloem

Finish date: October 2013

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PREFACE AND ACKNOWLEDGEMENTS

I would like to thank my father who inspired me and helped me choose the topic and my friend

Antonis Theodorakis who supplied me with the data for the regression analyses.

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NON-PLAGIARISM STATEMENT

By submitting this thesis the author declares to have written this thesis completely by himself/herself, and not to

have used sources or resources other than the ones mentioned. All sources used, quotes and citations that were

literally taken from publications, or that were in close accordance with the meaning of those publications, are

indicated as such.

COPYRIGHT STATEMENT

The author has copyright of this thesis, but also acknowledges the intellectual copyright of contributions made by

the thesis supervisor, which may include important research ideas and data. Author and thesis supervisor will have

made clear agreements about issues such as confidentiality.

Electronic versions of the thesis are in principle available for inclusion in any EUR thesis database and repository,

such as the Master Thesis Repository of the Erasmus University Rotterdam

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ABSTRACT

After 2010 and the Greek economic crisis, a major concern of the Eurozone was what will happen

with the country’s membership. There were several opinions about what Greece should do; many

economists believed that leaving the Euro could lead to the collapse of the whole union in a chain

reaction, others however believed that Greece could only be saved if it left the union and tried to

achieve external devaluation with its own new national currency. Greece asked for help from the

IMF and tried to comply with the austerity measures in order to achieve internal devaluation and

finally improve competitiveness. In this dissertation paper I examined several other union breakups

in order to draw some lessons; in most cases exiting a union was encouraging for the economies

leaving the unions. Furthermore, I ran regression analyses to see how the Greek bond yields, bond

spreads and CDS spreads are affected by the situation and also how the borrowing costs of Greece

along with the risk of investing in Greek sovereign debt titles is affected by the credit rating of

Greece set by the three credit rating agencies. Moreover, after comparing the expectations of the

Troika to the real data after the implementation of the Troika’s program I found out that the Troika

greatly underestimated the negative impacts of its policies and that after three years of austerity

policy, the Hellenic economy was not able to recover. Considering that the only other solution for

Hellas, is leaving the Eurozone, I constructed a Plan B, indicating the steps that the Greek

government should follow after a Hellexit.

Keywords:

European Union, Autarky, Monetary Union, Currency Substitution, ECU, EMU, International Monetary

Fund

JEL classification numbers: G01, E42, F33, F34

Author email address: yiannathan@gmail.com

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Contents

PREFACE AND ACKNOWLEDGEMENTS .......................................................................... ii

ABSTRACT ............................................................................................................................. iv

LIST OF TABLES ................................................................................................................... vi

LIST OF FIGURES ................................................................................................................. vii

CHAPTER 1 Introduction ......................................................................................................... 1

CHAPTER 2 Literature review ................................................................................................. 3

CHAPTER 3 Historical Parallels .............................................................................................. 8

3.1 Austro-Hungarian Empire ................................................................................................... 8

3.1.1 Lessons to be drawn from the Breakup of the Austro-Hungarian Empire ................. 12

3.2 Czechoslovakia (1993) ...................................................................................................... 12

3.2.1 Lessons to be drawn from the Breakup of Czechoslovakia ....................................... 14

3.3 The Soviet Union ............................................................................................................... 14

3.3.1 Lessons to be drawn from the Breakup of the Ruble-zone ........................................ 17

3.4 United States of America 1930s ........................................................................................ 18

3.4.1 Lessons to be drawn from the drop of the Golden Standard ...................................... 22

3.5 Argentina 1999-2002 ......................................................................................................... 22

3.5.1 Lessons to be drawn from the drop of the Dollar Peg ................................................ 25

3.6 Icelandic Crisis of 2008 .................................................................................................... 26

3.6.1 Lessons to be drawn from the Icelandic Incident ....................................................... 27

3.7 Meta-summary of historical parallels ............................................................................... 28

CHAPTER 4 The Hellenic Crisis and the Troika ................................................................... 30

4.1 The Hellenic Crisis ............................................................................................................ 30

4.2 Data and Methodology ...................................................................................................... 33

4.3 Results ............................................................................................................................... 37

4.4 Basic Indicators of the Greek Economy ............................................................................ 47

4.5 Will the Troika succeed? ................................................................................................... 50

4.5.1 A mathematical scenario ............................................................................................ 57

4.5.2 How probable is the exit? ........................................................................................... 58

Chapter 5 Plan B ..................................................................................................................... 61

CHAPTER 6 Discussion and Conclusions .............................................................................. 69

REFERENCES ........................................................................................................................ 72

APPENDIX A DEFINITIONS ............................................................................................... 80

APPENDIX B STATA RESULTS ......................................................................................... 82

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LIST OF TABLES

Table 1. Results of the Liquidation of the Austro-Hungarian Bank 10

Table 2. Financial Statistics for the Soviet Economy 17

Table 3. Meta-Data summary table 28

Table 4. Regression analysis of Greek and German 10yr bonds Yield to Maturity 37

Table 5. Regression analysis of Greek yield spreads to Greek debt 40

Table 6. Regression analysis of Greek CDS spreads to Open Market Operations, Greek debt

and the German CDS spreads 41

Table 7. Regression analysis of % change of unemployment to % change of GDP 42

Table 8. Regression analysis of Greek bond yields to Moody’s credit rating 43

Table 9. Regression analysis of Greek bond yields to S&P’s credit rating 43

Table 10. Regression analysis of Greek bond yields to Fitch’s credit rating 44

Table 11. Regression analysis of Greek CDS spreads to Moody’s credit rating 45

Table 12. Regression analysis of Greek CDS spreads to S&P’s credit rating 45

Table 13. Regression analysis of Greek CDS spreads to Fitch’s credit rating 46

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LIST OF FIGURES

Figure 1 U.S. Gross Domestic Product 20

Figure 2 U.S. Average Rate of Unemployment 21

Figure 3 U.S. Government Expenditures and Investments 21

Figure 4 Argentine Unemployment Rate and Inflation 24

Figure 5 Argentine Real GDP Growth Rate 25

Figure 6 Top bondholders of Greek government bonds (percentage of bonds) 33

Figure 7 Regression Analysis Scatterplot 39

Figure 8 10 year Greek and German bond Yield to Maturity 39

Figure 9 Greek over German yield spreads 41

Figure 10 GeneralGovernment Government Revenue and Expenditure as % of GDP 47

Figure 11 Net external debt in % GDP (quarterly data) 47

Figure 12 % change in Unit Labour Costs 47

Figure 13 Greek Government Budget Deficit as % of GDP 47

Figure 14 Phillips curve of the Greek economy 48

Figure 15 General government gross debt to GDP ratio 49

Figure 16 Greek real GDP growth rate 50

Figure 17 Greek unemployment rate 51

Figure 18 Greek real GDP growth rate 52

Figure 19 Greek unemployment rate 52

Figure 20 Greek annual % change of exports of goods and services 53

Figure 21 Greek annual % change of exports of goods and services 53

Figure 22 PPP conversion factor (GDP) to market exchange ratio in Greece 56

Figure 23 Election poll 2013 for Greece 58

Figure 24 Imports vs foreign exchange reserves 59

Figure 25 Import coverage for Greece 60

Figure 26 Consumer’s confidence for Greece 60

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1

CHAPTER 1 Introduction The financial crisis of 2007-2008 started in the United States of America as a consequence of years of

deregulation and excessive risk taking and careless lending by the banks. This crisis eventually led to the

later Eurozone crisis. The Eurozone crisis started in late 2009 and was a mixture of sovereign debt crisis,

banking crisis, growth and competitiveness crisis. The situation was more difficult in some countries

because of the accumulation of large amounts of sovereign debt. Portugal, Ireland, Italy, Spain and Greece

faced the biggest problems. Greece’s sovereign debt increased to €262 billion in 2009 from €168 billion in

2004. Currently the Greek debt reaches €378 billion, or 199% of its GDP (including the last loans).

The then Prime Minister George Papandreou, after worsening the situation for Greece and increasing the

spreads by making careless public announcements –in which he talked about a country of corruption- along

with the public announcement of the then minister of economics G. Papaconstantinou, in which he

compared Greece to the Titanic, he decided to ask for help from the International Monetary Fund (IMF).

So Greece started accepting rescue packages and imposing austerity measures dictated by the Troika (IMF,

European Central Bank (ECB) and European Commission (EC)). As it was mentioned before the greater

problem of countries like Greece was the excessive debt accumulation through the years. I will quote here

Karl Marx in a section taken by the Capital Vol. 1:

“National debts, i.e., the alienation of the state – whether despotic, constitutional or republican – marked

with its stamp the capitalistic era. The only part of the so-called national wealth that actually enters into

the collective possessions of modern peoples is their national debt. Hence, as a necessary consequence, the

modern doctrine that a nation becomes the richer the more deeply it is in debt. Public credit becomes the

credo of capital. And with the rise of national debt-making, want of faith in the national debt takes the place

of the blasphemy against the Holy Ghost, which may not be forgiven.

The public debt becomes one of the most powerful levers of primitive accumulation. As with the stroke of

an enchanter’s wand, it endows barren money with the power of breeding and thus turns it into capital,

without the necessity of its exposing itself to the troubles and risks inseparable from its employment in

industry or even in usury. The state-creditors actually give nothing away, for the sum lent is transformed

into public bonds, easily negotiable, which go on functioning in their hands just as so much hard cash

would. But further, apart from the class of lazy annuitants thus created, and from the improvised wealth of

the financiers, middlemen between the government and the nation-as also apart from the tax-farmers,

merchants, private manufacturers, to whom a good part of every national loan renders the service of a

capital fallen from heaven-the national debt has given rise to joint-stock companies, to dealings in

negotiable effects of all kinds, and to agiotage, in a word to stock-exchange gambling and the modern

bankocracy.”

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Marx plainly states here how public debt which on the one hand is a property of all is on the other hand the

main way to create capital from otherwise nonproductive money. So while all people are responsible for

their country’s debt as they have to pay higher taxes and comply with several austerity measures; banks,

creditors and speculators become richer. In this way the main cause of bankocracy is the money that public

creditors lend but never actually give. Karl Marx even in 1867 managed to understand and explain things

that today are apparent in our economies.

Greece right now continues its course indicated by the Troika, complying with the austerity measures in

order to achieve internal devaluation and become competitive. A pretty difficult course as its people have

to accept higher taxes, lower wages and unemployment. The strange thing though is that although everyone

seems to have a Plan B, indicating the way that a Greek exit from the Eurozone should happen, Greek

government does not even consider the exit as an option as they think that it would be catastrophic for the

country. It is noteworthy, that although the case of Greece is something new, as an exit from a monetary

union like the Eurozone never happened before, there are precedents that could be paralleled to the Greek

situation and it is possible to draw some important lessons from these breakups.

In this master’s thesis I will examine three previous incidents of monetary union breakups; the Austro-

Hungarian Empire, the case of Czechoslovakia and the breakup of the Soviet Union. I will also examine

the policies followed by F.D. Roosevelt in his hundred first days during the Great Depression, the case of

Argentina in 1999 and finally the Icelandic crisis of 2008, in order to find out if an exit will have the

expected results for Greece and also in order to draw some lessons. I will also try to conclude if the Troika’s

plan was successful, see how the whole situation in Europe and Germany affects Greece and the risk of the

Greek debt and I will also construct a complete exit plan for Greece.

The remainder of the thesis is organized as follows. Chapter 2 of this thesis includes an overview of the

literature related to topics such as the Euro-entry, the Euro-exit and the breakup of the Euro. Chapter 3

includes the examination and parallelism of the precedents. Chapter 4 includes the empirical analysis and

an overview of several basic indicators of the Greek economy along with the comparison of the expectations

of the Troika and the realizations. Chapter 5 includes the Plan B for Greece. And finally, chapter 6

summarizes and concludes.

In the next section there will be a brief analysis of the related literature, taking into account both views-

staying into Eurozone and stepping out from it.

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CHAPTER 2 Literature review Greece became a part of the Eurozone in January 2001, and eight years later the problems started. A quick

look at Greece’s financials is enough to find out that Greece, was always, in terms of public debt, an

indebted economy, with a far larger debt than that of its European counterparts. It was a vicious circle,

where debt was followed by investments and development and even more debt, something like a fake

development; a development that was not organic. The question is why Greek crisis happened now? Maybe

the main reason was the outbreak of the credit crisis a couple of years earlier and the systemic risk it created.

There were many suggestions from several economists around the world about what Greece should do.

Liberal and monetarist economists suggested that Greece should stay in the Eurozone and accept help from

the IMF and comply with the austerity measures dictated by the Troika (EC, ECB, IMF). Other economists

suggested that Greece should leave the Eurozone, and perhaps Europe, introduce a new national currency

and regain its ability of exercising monetary policy, and protecting its domestic market. However, it should

be noted that skepticism about the Eurozone is not something new, and it is for sure not a consequence of

the crisis. Long before the creation of the European Union (EU), many believed that this was a great

mistake.

Ralf Dahrendorf wrote for example in an article published in the “New Statesman” (1998) that European

Monetary Union (EMU) is a project dreamed up by politicians with more faith in political will than

economic sense. He believed that the euro would divide Europe like nothing else since 1945. Paul Krugman

also wrote in 2012 that the America’s and the United Kingdom’s unions are and will be the only functional

unions because they coincide with one nation, one government, a common language and culture, while

Europe is nothing like that. Many of the critics of EU justified their concerns about its success based on the

lack of a political union. By examining if the Eurozone meets all the criteria of the optimum currency area

theory academics found out that it surely does not, and as Gottfried Haberler (1979) stressed, it is important

that all the member-countries are governed by the same political beliefs for a union to succeed. Political

consolidation after all is the only way to economic convergence. Emeritus professor of the London School

of Economics and Political Science, Paul de Grauwe (2010), concludes that the only way for the Eurozone

to survive is the ability to embed itself into a political union; and by this he means that there must be some

transfer of sovereignty in the conduct of macroeconomic policies other than monetary policies from the

members to the union. Nevertheless, there are still some people who believe that a European political

integration is not the solution. Professor Simon Wren-Lewis (2013) of Oxford University disputes this idea,

arguing that we should be cautious about forming concrete conclusions from a single observation. He states

that the Eurozone crisis does not necessarily prove that a monetary union also requires a fiscal-political

union; he even supports the idea that the consequences of a bad political union could be even more

catastrophic than the consequences of a badly designed monetary union. The situation in the Eurozone

would be better if the ECB was acting more like the US Federal Reserve (FED) and if Germany and other

fiscally untroubled economies were less obsessed with austerity. Notable is also the view of Naomi Klein

4

(2013) who says that what countries that became members of EU do not understand, is that they handed

part of their sovereignty and their ability to affect their economy. For Naomi Klein, the EU and the

Eurozone is a prison and the whole crisis and its transfer from Wall Street to the different economies across

the world and innocent people is part of a shock therapy.

On the other hand, people who think that Greece should stay in the Eurozone believe that an exit would be

catastrophic for Europe; as Fabio Riccelli, manager of the Luxembourg-domiciled Fidelity European

Dynamic Growth fund said, a Grexit could cause contagion; contagion here is defined as a significant

increase in cross-market linkages after a shock to one country or a group of countries. Furthermore, the

pressure to the other weak European economies would be unbearable as interdependence of Greece is large,

i.e. Greece has strong relations with other European economies in all states of the world, such as trade

linkages and financial linkages (Cyprus is the obvious example of these linkages). Of course things would

not be the same if Greece were forced to leave the Union. As “The Economist” mentions in the article

“Exodus chapter 1”, a Greek exit and a disorderly bankruptcy would surely lead to contagion as the Greek

Central Bank owes over €100bn to the other central banks of the countries that are members of the Euro,

something that could surely harm European taxpayers. Germany, Britain, France and the IMF would bear

the largest losses. Stephane Deo, Paul Donovan and Larry Hatheway conclude in their UBS report, “a brief

history of breakups” (2011) that the economic and political consequences of a monetary union break up are

so severe, as to deter all but the most determined, or to deter all but those already suffering extraordinary

economic distress. Some of the greatest problems that Greece would face if it decided to exit the Euro

would be: collapse of the European Monetary Union payments system, hyperinflation, capital flight and

also the exit could hurt Europe’s trust in Greece (Anders Aslund, 2012). As Anders Aslund points out a

Eurozone exit might mean an exit from Europe as well, and this also means that Greece would lose any

advantages from being a member of Europe such as agricultural subsidies and other grants, exclusion from

the customs union and thus trade discrimination and finally exclusion from the Schengen visa area; with

the later having terrible impact on Greece’s tourism. And these are the impacts on Greece alone; Critics of

a Grexit such as Aslund believe that the exit would hurt Europe as well, creating a bank crisis, a bond crisis

and a trade slowdown. In addition to these three effects, Europe might face a chain of other countries’

defaults. The Institute of International Finance (IIF) calculates the costs of a disorderly Greek default above

€1 trillion taking into account the spillover effect. Raoul Ruparel and Mats Persson (2012) believe that the

costs from a Greek exit would outweigh the benefits. Finally, on their D&B special report the authors

conclude that impacts of a Greek exit would be so severe to the banking and the business sector that they

recommend that investors - based on their risk aversion - withdraw their money from the Greek market.

One view that was extensively discussed within Europe was the introduction of the Eurobond. Some people,

like Jeffrey Frankel (2012) believe that this could be part of the solution to the euro problem. Market and

investors would gratefully accept Eurobonds to diversify their portfolios, especially if with Eurobonds, they

5

could achieve higher returns than by buying US treasury bills. George Soros (2013) writes in “The

Guardian” that a Eurobond is the best solution for Europe. As he sees it, the solution is countries which

abide by the fiscal covenant, to be allowed to convert their entire stock of government debt into Eurobonds.

Of course this is something that Germany would not like, as it believes that knowing that somebody else

will pay the bill would give the incentive to already indebted economies to spend even more making the

problem worse.

The IMF tends to use the same recipe again and again, even after a series of failures. A typical example is

the Asian crisis where the IMF’s policy advice to solve the Asian crisis of increasing interest rates and

decreasing government expenditures had adverse effects, mostly because many conditions were attached

to the IMF loans and as a result led to microeconomic impacts. Whoever knows the basics of economics

can understand that trying to fight crisis with austerity measures is an unorthodox policy. Paul Krugman

calls austerity a “zombie” economic policy because as zombies keep coming no matter how many times

you shoot them the same happens with austerity measures; after seeing that this policy is not successful

Germany and IMF keep using it. Nouriel Roubini (2012) writes in “The Guardian” that the Eurozone has

an austerity strategy but no growth strategy. And because of that all it has is a recession strategy that makes

austerity and reform self-defeating, if output contraction continues, deficit and debt ratios will inevitably

continue to increase to unsustainable levels. What Europe needs is a much easier monetary policy and a

less front-loaded mode of fiscal austerity. Otherwise, Europe should be ready to face a stronger Euro, a

lower external competitiveness and of course a deeper recession. An RMF (research on money and finance)

report written by Powel, Stenfors and Teles (2010) about the Eurozone’s austerity measures is quite

interesting and relative to the matter. The authors, state that the austerity strategy suffers from a deep flaw.

It is well known that one of the biggest problems of the Eurozone is the loss of competitiveness by the

periphery; by introducing austerity measures both in the periphery and the core, Europe cancels its own

policy, as the core has enjoyed sustained competitive gains due to the wage repression. As a matter of fact,

trying to increase competitiveness both in periphery and the core, sustains divergence in Europe. So what

Europe should do as Matthew O’Brien states in his article “why the euro is doomed in 4 steps” is forcing

the northern bloc to increase wages and deficits, to offset the demand destruction in the southern bloc. Some

other things that should change in order to avoid a Euro crash as Simon Tilford (2011) concludes are

increasing Germany’s domestic demand, make monetary policies more expansionary as they are too strict,

encourage financial markets to discipline governments to discourage them from taking more debt, and

finally avoiding an Italian exit because it could be disastrous for the Eurozone.

Mario Blejer, former governor of Argentina’s central bank, and director of the Centre for Central Banking

Studies at the Bank of England has a typical view of Europe’s way of dealing with this kind of problems.

He believes that the whole situation in Europe resembles a pyramid or a Ponzi scheme. The only difference

is that Europe’s Ponzi scheme is a public sector one; this means that it is more flexible and while in a private

6

scheme the pyramid collapses when there are not any new investors to pay the old ones, in a public scheme

things can theoretically go on forever. As long as the funding comes from public money, the peripheral

countries’ debt could continue to grow without a hypothetical limit.

There are some papers which support the idea that departures from monetary unions can lead to positive

results. Andrew K. Rose (2006) compared countries that left monetary unions to those which stayed within

the unions and found out that the leavers tend to be richer, larger and more democratic but they also tend

to have higher inflation. John Tepper mentions in his paper “A Primer on the Euro Breakup: Default, Exit

and Devaluation as the Optimal Solution” that exiting from the Euro would accelerate insolvencies, but

would provide a powerful policy tool via flexible exchange rates. The European periphery could then grow

again quickly with deleveraged balance sheets and more competitive exchange rates, much like many

emerging markets after recent defaults and devaluations (Asia 1997, Russia 1998, and Argentina 2002).

There are also more optimistic economists such as Costas Lapavitsas (June 2012) who as he writes in “Le

Monde Diplomatique” after Greece exits the Euro, the Eurozone periphery may follow; this can be a huge

change and a new start for Europe and will lead to a slow recovery for Greece. Other economists like Yianis

Varoufakis (November 2012, “The Modest Proposal for the Euro”) believe that Europe is about to dissolve,

and that the only way to save euro is to redesign it from the beginning. Johan Van Overtveldt thinks as he

writes in his book “The End of the Euro: The Uneasy Future of the European Union” that there is no other

solution for Greece than to leave Eurozone. In his book “the end of the Euro” he states that this is not the

best solution but it is the least bad option from a limited number of outlets.

In addition, there are economists that take a middle ground such as Prof. Hans-Werner Sinn (April 2013).

He thinks that it is clear that the austerity measures do not work at all, and as the opposite strategy -inflating

Germany- is impossible, a good solution would be Greece stepping out of the Eurozone but not

permanently. Greece could exit the Euro and be offered a return ticket; so that it will be able to enter again

the Eurozone after it meets again some appropriate criteria.

Roger Bootle (2012) has written a complete practical guide for a country leaving the Euro. In his paper

which won the Wolfson economic prize, he analyses what should be done and he gives recommendations

for the exit. However, he sees a complete euro break up, with all current members returning to their national

currencies unlikely because there is a strong desire in key countries to preserve the single currency idea.

That is why he believes that what is more likely, is a dissolution between a northern monetary union

centered on Germany and a southern one centered on France. The idea of a two-core Eurozone is not a new

one, it has been there from the beginning. Many believed that the differences in the economies of the two

cores are so great that a single monetary union would be difficult to exist. Today and after five years of

euro-crisis, this theory comes back to the fore. More specifically, Hans-Olaf Henkel (2011) talks about

splitting euro into two currencies, one for the creditor-countries and one for the indebted ones. He calls this

7

plan, “plan C”, but he sees the introduction of a nordeuro a bit unlikely. Of course, he understands that with

this plan Germany may face a decrease in its exports, but trying to save the Euro by bailing out economies

will have its cost too. Brigitte Granville, Stefan Kawalec and Hans-Olaf Henkel (2013), propose that the

Euro split-up should be designed and led by France, as France is one of the core countries which faces

economic difficulties too and was one of the creators of the Euro. After the rich countries leave the Euro,

the rest of the Eurozone could gain again its competitiveness and this can be the start of a new development.

Finally, Frédéric Lordon (2013) in his proposition for the Eurozone in “Monde Diplomatique” with the

original title “Sortir de l’euro?” (Leave the Euro?), suggests that the Eurozone should leave the Euro and

introduce a common currency with national representatives; such a currency would have different exchange

rates with foreign exchange currencies and between the members of the Eurozone could exist a special

exchange rate regime, with fixed exchange rates.

8

CHAPTER 3 Historical Parallels The following section consists of an overview of other currency unions and their dissolutions. The monetary

unions that will be examined were chosen because of their resemblance to the Eurozone. Of course no union

can be fully compared to the European one, but valuable lessons can be derived by looking at unions that

share some common characteristics with the current union. The unions that will be examined are: the

Austro-Hungarian Empire, the Czechoslovakian union, the United States and the golden standard

(1932/33), the Soviet Union (1992/93), the Argentina and the dollar peg, and finally there will be an

overview of the crisis in Iceland. Other monetary unions such as the Scandinavian, the Latin and the United

States 1861 are in purpose excluded because they share only a few common characteristics with the

Eurozone and only little conclusions would have been derived from a parallelism.

3.1 Austro-Hungarian Empire

Austro-Hungary also known as Austro-Hungarian Empire or Dual Monarchy was a dual constitutional

monarchic union consisting of the Crowns of the Austrian Empire and the Kingdom of Hungary and was

located in Central Europe from 1867 to 1918 when it dissolved. After World War I the empire’s regime

was overthrown and its land was splintered following international law conditions. As far as its monetary

union is concerned the Austro-Hungarian Empire was a fiat currency monetary union between Austria and

Hungary with a mutual central bank. The currency of the union was the Kronen. The currency was legal

tender within the whole empire and was also exchangeable and used in other parts of the empire. The case

of the dissolution of the Austro-Hungarian monetary union is considered to be one of the closest ones to a

possible break-up of the Eurozone, as in both cases we have to do with a currency union of different member

countries, with a one and only mutual strong central bank. Of course there are much more profound

differences; maybe the most important differences are the reasons of creation of the unions and the reasons

for dissolution, the size and differences in cultures of the members, and the fact that many member countries

of the Eurozone disobey its rules.

After 1867, the Austrian central bank evolved to a shared institution with offices in both capitals and with

the significance of the Hungarian part increasing over time. A two-level fiscal system was used; one for the

government and the other for the confederation. Most of the confederation’s revenues were coming from

custom taxes and were used to cover union expenditures –mostly military costs. Every country had its own,

government, parliament and could issue its own national debt while both countries were sharing the army,

the legal system, the currency and the diplomatic service. The union government was not allowed to run

deficits. Problems started after 1890s, when both countries could not borrow anymore from international

creditors, as the rates were getting higher and higher. This was an era of great volatility for the Krone and

the lack of reserves by the central bank made matters worse. As a result, the two countries have adopted a

9

stricter and tightening fiscal policy. More specifically, from 1887 to 1896 the central bank was forced to

raise its reserves to 40% of paper notes issued, with both countries funding the program. At the same period

the two governments faced their highest deficits (a peak of 80% of debt to GDP ratio for Austria and of

120% for Hungary). In a later attempt of the two governments to stabilize their currency, they repurchased

pre-Compromise government notes for gold, and this helped the mutual central bank to raise its reserves.

The share of funding was 70-30 for Austria and Hungary respectively. It has to be noted that both

governments were competing with each other on gaining control of the central bank, and although Austria

was a larger country and a stronger economy, both governments had equal rights regarding the central bank;

it was a price Austrians did not mind to pay if this was the only way of sustaining a strong Austro-Hungarian

central bank and avoiding a possible separation. The process of sterilization of government paper turned

out to be successful and provided central bank with adequate reserves, more than enough for an effective

cover ratio. In 1896 the common currency was pegged to gold to protect the governments from the exchange

rate risk on their borrowings. The period the empire adopted the gold standard, Austria’s average per capita

growth rate was 1.49%, double its average per capita growth rate of the two decades following 1873 but

considerably lower than that of Germany’s at the same period.

The beginning of the end for the empire came on 23 July 1914 when Austria-Hungary started war against

Serbia; the situation caused great agony on the two countries’ stock exchanges. A couple of months later,

the situation got so worse, that the empire cut off the gold convertibility of the Krone, and the pretension

to hold 40% reserves as a cover; moreover, the central bank could now lend to the government. War was

mainly financed by the central bank by printing new money, and as a result inflation was skyrocketed. In

1918 empire was defeated, and was forced to separation. The successor states as they were called, were

Yugoslavia, Romania, Czechoslovakia, Austria and Hungary. The separation also meant separation of the

central bank into two national banks, and of course separation of the common currency.

In parallelism with the Eurozone the separation of the currency is maybe the most important part of the

story. It took place in two stages; the first stage consisted of the stamping of the old currency notes, and the

second stage consisted of the transition from them to the new national currencies. The peace treaties

indicated that every successor state should stamp the currency in its territory and after a year introduce its

own national currency, while the stamped notes were going to be destroyed. Of course the whole process

had its complications as different states were imposing different taxes over stamping or forced loans

something that led people to delay the stamping in order to stamp their notes in the best terms. It was not

impossible to move notes from one state to the other for stamping. For example when the stamping process

started in Austria people were not eager to hand their notes, as the stamping process had not started in

Hungary yet and the unstamped notes were still legal in Austria. Another problem was that the stamps could

be easily forged. This was the main reason why the Serb-Croat-Slovene State later proceeded to another

stamping process. In addition, another major problem was the simultaneous circulation of other national

10

currencies. It is for sure, difficult to gauge the cross-border flows of notes, but it is not impossible to have

some approximation. In a working paper of the IMF the authors use as a source a report by de Bordes

(1926). They find out that while 31% of the notes were circulating in Czechoslovakia, 21% in Austria, 18%

in Hungary, 12% in Yugoslavia and 5.2% in Transylvania, the amount of notes that were stamped in

Czechoslovakia was only 22% and in Austria was 18%, of the whole stock of Krone banknotes in

circulation. Even with these rough calculations it is clear that a large amount of banknotes was part of cross-

border flows. This gives a very clear picture of what could happen in a similar situation in the Eurozone

after a Greek exit. Therefore, it is important to plan the whole situation in secrecy and prevent money

outflows from the country.

The first state to start stamping was Czechoslovakia in 1919 and a year later Romania and Yugoslavia

followed. The last to start the process of stamping and exchanging were Austria and Hungary. The peace

treaties precisely required the successor states after collecting all the notes in their territories to hand them

to the liquidators of the Austro-Hungarian bank for accounting and destruction. Detailed explanation of the

liquidation of the Austro-Hungarian central bank will not be given as it has nothing to teach us about

Eurozone’s case. In short, the central bank had two departments, the mortgage and the deposits, that were

liquidated. The liquidation of the first department was made by converting the claims into Austrian crowns,

and then the paying off was made with bank assets. As far as the deposits department is concerned, small

deposits were withdrawn while the rest of the department were moved wholesale to the Vienna Postal

Savings Bank. Shareholders were denied their claims to the bank; what they got was a residual share of the

bank’s net assets, some of its Austrian property and the printing press. Most of the bank’s gold reserves

were distributed to the states. Regarding the bank’s liabilities, a classification of the pre-war debt took place

as secured or unsecured. The secured debt was transferred to the state that the security was its property,

while unsecured debt was proportionately distributed among the states.

Table 1. Results of the Liquidation of the Austro-Hungarian Bank (Million gold kronen)

Total

distribution

Gold Property Other Assets

Austria 25.2 19.7 5.5 -

Hungary 25.2 19.7 5.5 -

Czechoslovakia 44.4 36.0 6.3 2.1

Yugoslavia 30.3 27.4 2.8 0.1

Romania 43.6 41.0 2.6 0.0

Italy 17.8 17.3 - 0.5

Poland 15.2 12.4 2.8 0.0

11

Total 201.7 173.5 25.4 2.8

Source: Zeuceanu (1924) pp.454-456

The next years both Austria and Hungary, after consecutive increases of the supply of money to finance

their deficits, faced hyperinflations. More specifically, in Austria loans to the government increased

multiple times and the increase reached a peak of 1,586% in 1922; at the same period the loans to the private

sector increased to unprecedented levels (from 424m Kronen at the end of 1920 to 781.8bn Kronen at the

end of 1922)1. Furthermore, Austria faced great increases in its retail prices (1,748% from December 1921

to December 1922). Situation was not any different in Hungary, which faced an increase in its loans to the

government of 834% in 1922 and an increase of 2,156% in 1923. A similar increase was noticed at the

commercial loans with increases of 663% in 1922 and 1,788% in 1923. It has to be noted that all the above

increases in loans were fueled by enormous increases of the supply of notes in circulation. On the contrary,

situation in Czechoslovakia was not the same at all. Czechoslovakians prohibited any monetary financing

of the deficit i.e. banking office lending to the government. However, the same could not be done with the

commercial loans which faced a raise of 2,432% in 1920; commercial loans were only a small proportion

of total assets though. So situation for Czechoslovakia was completely the opposite. The following years

total credit decreased and the same happened to the bulk of notes in circulation. Czechoslovakia also tried

to restore the exchange rate of the Kronen to its pre-war levels, but after facing a significant appreciation

which led to numerous problems including a rise in unemployment it gave up the idea.

The stabilization process for Austria started with the help of the League of Nations. A number of strategies

were adapted for the stabilization of the Austrian Kronen such as suspension of borrowing from the Austrian

section, capital controls and credit rationing. Austria in order to cover its deficits had to borrow money

from the League of Nations; of course in order to borrow the money it had to agree to a number of measures.

After that, national bank regained its strength and also people regained confidence in the Austrian Kronen,

and as a result a lot of capital returned to the country. Finally, on March 1 1925, Austria introduced a new

currency named the Schilling (1 Schilling=10,000 Kronen). Stabilization in Hungary was not any different,

as it had also to borrow from the League of Nations to cover its large deficits and also agreed to a financial

program. Before the two countries could sign for the loans, they had to meet some requirements; the

agreements were formalized in protocols signed in Geneva. One of the conditions of the program was that

the League of Nations would have the control over the execution of the program, something that is not far

from the situation in the countries under crisis in the Eurozone.

1 All statistics are taken from the IMF report “the dissolution of the Austro-Hungarian Empire” that used as its source the League of Nations

12

3.1.1 Lessons to be drawn from the Breakup of the Austro-Hungarian Empire

Unfortunately, the incident of the breakup of the Austro-Hungarian currency union is not encouraging, as

both countries after the breakup suffered from hyperinflations, great capital flight, and they had to agree

for help with the League of Nations. On the other hand, one could argue that this monetary union was a

successful one because it only consisted of two countries with limited differences in culture and geography,

and surely the union was more politically integrated. A main problem of the Eurozone in contrast to the

Austro-Hungarian monetary union is that although its members are constrained not only by the expectations

of the markets but also formally by the Stability and Growth Pact (SGP), only a few countries remained

obedient to the rules. It has to be noted that two of the first countries to disobey the deficit conditions were

France and Germany. However, this precedent can be used to draw lessons for a similar situation in the

Eurozone and a possible Grexit. First of all, the whole planning of the breakup should be done in complete

secrecy to avoid the problems of capital flight and massive deposits withdrawals. For the first months maybe

it would be wise to introduce some capital controls, and prohibit people from transferring money to other

countries even through the borders. Another problem that faced the empire was that the stamping, could be

easily forged; this is a problem that can be avoided today by using credit cards, at least until the new national

currency is printed. Regarding the hyperinflation issue, it is a problem that may be caused by the reckless

printing of new money to cover deficits and expenditures. However, surveys have shown that a devaluation

of 50% will lead to an imported inflation of about 10%, therefore inflation is a necessary evil; an evil that

can be moderated if government stops relying forever on the central bank for loans.

3.2 Czechoslovakia (1993)

Czechoslovakia was a sovereign state of the Central Europe which consisted of the present states of Czech

and Slovakia. Before World War II a small part of Ukraine also belonged to Czechoslovakia. The state of

Czechoslovakia was formed in 1919 and in 1939 was conquered by the Germans. Its liberation took place

in 1945, but Czechoslovakia was under the influence of Russia, which also secured its unity; it was not

until 1989 when Czechoslovakia returned to democracy.

The breakup of Czechoslovakia started in 1993 and was a two-staged process. At first, the dissolution

concerned only its political union, and the initial plan was, if the two governments agreed, to sustain the

economic and monetary union. It is a fact that the unity of the two states was never strong, but the pretext

was the elections of 1992, when the Czechs elected a coalition of three right-of-center parties while the

Slovaks elected a left-wing nationalist party. As the two parties could not agree about the distribution of

power across the federation they agreed to dissolve, and create two independent countries. In order to

moderate the economic consequences of the demise of the federation the two countries decided to retain

13

the monetary union at least temporarily and also retain the customs union and free movement of labor

permanently. After dismantling, both countries established their own central banks; however, a Monetary

Committee was also established for the design of the common monetary policy. Soon, the first problems

appeared, when foreign exchange reserves started to decline and the credibility of the Monetary Committee

was at stake. It became clear that sooner or later the monetary union would dissolve as well, so many

Slovaks and even Slovak firms started to transfer money to Czech banks, as they believed that Czech

economy was stronger and more stable and they were afraid of a devaluation in Slovakia. Expectations of

a future Slovak devaluation made Slovak importers to repay their debts before it was too late, while the

opposite happened with the Czech importers. The same period Czech exports to Slovakia skyrocketed. It is

obvious that a great outflow of funds took place once more on the anticipation of a breakup of a monetary

union. In an attempt to offset this outflow State Bank of Czechoslovakia started giving loans to Slovak

banks. The final breakup of the monetary union was decided to take place on January 1993.

The whole process was planned in complete secrecy to avoid more problems. The measures taken to

complete the separation of the currency can of course make up for an example of a possible Grexit or even

a complete breakup of the Eurozone. The most notable measures taken were, border controls, cessation of

all payments between the two countries. The process completed pretty quickly, it only lasted three days,

and within these three days all the old currency was stamped. The governments put a limit to the amount

of cash that could be stamped and so they encouraged deposits to banks; of course coins and banknotes of

smaller value were circulating and were valid for several months. The impact of the breakup was mostly

negative in the short term, as trade between the countries declined, the separation of the currency and the

introduction of new currencies created one-time costs for both economies; estimations reveal that Czech

GDP declined by 1% while the decline for the Slovak GDP was even higher, about 4%. The distribution of

the movable assets and reserves of the common central bank was done in proportion to the two countries

population (2:1); immovable assets came to the property of the country in which they were located. Jan

Fidrmuc and Hovarth (1998) analyze economic background of the breakup from the perspective of the

optimum currency area literature and they find out that negative impacts of the dissolution could have been

reduced if governments had taken measures to increase labor mobility, by increasing fiscal transfers or by

region specific policies. Short-term negative impacts were far more severe for Slovakia as it was a weaker

economy and things got even worse because of the lack of fiscal transfers which helped the equalization of

per capita income. Finally, situation for Slovakia improved after a devaluation of 10% on its currency.

Although the breakup had some negative impacts on the short run, the two economies managed to recover

pretty fast, as one year later both economies returned to growth. The decline of trade between the two

countries was offset by the increase in trade with other economies.

14

3.2.1 Lessons to be drawn from the Breakup of Czechoslovakia

One important characteristic of the break-up of Czechoslovakia is the great difference in the economies of

the two members. On the one hand Czech had a more stable and strong economy, on the other hand Slovakia

had a weaker economy apt to devaluations. Situation can be paralleled to the Eurozone’s where the core

countries have strong, stable, exporting economies while the periphery consists of more unstable, importing

economies with large deficits. In economies with such differences the existence of asymmetric shocks can

incommode even more the convergence efforts, especially when there is lack of fiscal transfers and labor

mobility. Labor mobility in Europe is lower than 0.1%, and fiscal transfers are questionable. So this is

surely a problem of the Eurozone as well. Another lesson that can be drawn from the precedent of

Czechoslovakia is that lack of a political union makes things a lot more difficult for the currency union.

The currency union of Czechoslovakia could not last more than six weeks after the political breakup. Of

course there are a lot of differences between Czechoslovakia and the Eurozone. Once again the size of the

considered union is much smaller than the Eurozone’s; but if it was difficult for a two member union to

sustain its unity, how difficult should it be for a 17-member union? Furthermore Czechoslovakia consisted

of two cultures characterized by much more common characteristics than the people of the Eurozone.

Another great difference of the two unions is that although the Eurozone has a central monetary authority

for the designing and planning of the common monetary policy that is strong and creditworthy, the same

was not true for Czechoslovakia where the central authority was the Monetary Committee. Conclusively,

we could agree that the example of the break-up of Czechoslovakia is an optimistic one, considering the

speed with which the two economies managed to complete the disintegration, the introduction of the new

national currencies and also the speed with which the two economies managed to recover after the demise

of the federation. Fidrmuc and Horvath (1998) state that it is crucial for two economies after the break-up

to sustain the customs union and the labor mobility; however my concerns on a Grexit are related to how

and if a customs union and a common agricultural policy can help the exited economy on its first steps.

3.3 The Soviet Union

The Union of Soviet Socialist Republics (USSR) or the Soviet Union was a state located in East Europe

and North Asia, and was the largest state in the world. Its capital was Moscow. The Soviet Union was the

first socialist state in worldwide history, it was established in 1922 and dissolved in 1991. With the

dissolution of the Soviet Union, 15 new successor states were established. The collapse of the Soviet Union

in 1991 was followed by the disintegration of the Ruble-zone in December of the same year.

The common currency of the Soviet Union was the Ruble which is also the reason why the union is known

as the Ruble-zone. Ruble banknotes were legal tender across the whole union and were also exchangeable

to foreign currencies at fixed rates, of course with the corresponding conditions and restrictions. Soviet

15

fiscal deficits were financed through seigniorage and borrowing from the private sector. The union was

highly dependent on inter-republic trade; Russia was subsidizing the other republics through trade and it

gained rents from those countries seignorages. Although this resulted in Russia losing money, it was

increasing its influence over the other republics. Production was structured in such a way, so that the union

could sufficiently supply producers as well as consumers across the union. It is notable that the locations

of the factories were chosen not by taking account the minimization of costs but the equation and

convergence of the republics’ economies. The monetary authority of the union and also the one and only

bank was the Gosbank, which had the task of providing the union with additional currency when there was

increased demand. What is also worth-mentioning is the payment system the union used. When an

enterprise had to make a payment, it presented the invoice to the Gosbank and the latter made a transfer of

money from the recipient’s account to the supplier’s account; when the money in the recipient’s account

were insufficient to cover the whole payment to the supplier, Gosbank supplemented the residual by giving

credit to the recipient. This credit would be paid by the recipient after he would receive the money from his

sales. If the recipient would not cover the credit until the end of the plan period, Gosbank wrote off the

debt. Household payments consisted mostly of cash transactions while enterprise payments consisted of

accounting transactions. Union received taxes from households and enterprises to cover any social

payments and pensions, and in the case of deficits, Gosbank covered the amount needed with credit to the

government.

Problems for the Soviet Union started during the last years of its life, when the increased deficits were

mostly financed by foreign borrowing and seigniorage. The excessive creation of money increased demand

for goods and services in unprecedented levels, and this created shortages. Things got even worse after the

failed attempt of Gorbachev’s Perestroika in 1986. Although, Gorbachev’s reforms were an effort to

improve things and their purpose was noble, it had negative consequences on output. Situation got even

worse when Perestroika aggravated social and economic tensions and nationalism and the same period

Soviet Union’s deficit reached 26% of its Gross Domestic Product (GDP); further data can be seen in table

2 of the section where we can clearly see how the public debt was increasing as the collapse were coming.

The inability of households and private sector to meet their needs in goods and services forced them to

increase their deposits, a situation known as the “the Ruble overhang”. Finally, as Patrick Conway (1995)

mentions, in January 1991, the government announced that large-denomination banknotes were no longer

legal tender. People could exchange them for smaller bills up to a maximum amount. This of course had a

bad impact on the trust on the Ruble as a currency, and although it decreased the supply of money it

increased expenditure and consequently inflation. In mid-1993 some republics suffered from inflation rates

of 25% per month.

The breakup of the Soviet Union was a two-stage breakup, i.e. a political and an economic. In 1991, after

the collapse of the union, Gosbank dissolved in fifteen separate central banks, with each bank being

16

responsible for its own national financial system. The fifteen independent former members were still

sharing the same currency and the Central Bank of Russia (CBR) retained the right of printing money.

After the demise of the union, there was no official authority for the conducting of monetary policy, and

also the different central banks operated without any coordination; they may had not the right of printing

money but they could finance their deficits with bank credit (monetization of the budget deficits);

something that worsened the situation of the monetary union, by increasing demand but not supply. This

led to the creation of shortages and new increases in inflation. In 1992, administrative price controls were

removed and repressed inflation was released, pushing prices even higher. The absence of markets for the

sale of government bonds made financing more difficult and was forcing governments to rely even more

on credit from their central banks; it was a vicious circle. In addition, fiscal transfers that were used

previously by the union had stopped and the new tax systems were not as successful and effective as the

old one; the latter led to decreased tax revenues in a period of increased expenditures. The situation was

much worse for the non-Baltic economies with Georgia and Ukraine having the largest budget deficits.

As time was passing, things were not improving and by July 1993, seven out of fifteen members of the

Ruble area had retreated from the union and introduced their own national currencies. At the same period

the Russian government declared all the banknotes issued from 1961 to 1992 illegal, and took them out of

circulation. This happened pretty suddenly and without a warning to the other members. Many believe that

the most serious reason for the breakup of the Ruble-zone was the free rider problem, as member countries

could easily finance budget deficits with bank credit and then shift part of the inflationary consequences to

their neighbors. Georgia, Azerbaijan and Moldova started the necessary processes to introduce their own

national currency. Armenia raised its objection to Russia, as there was an agreement stating that six months

before any reform there should be a warning. Kazakhstan, Uzbekistan and Belarus were cooperative and

decided to stay within the Ruble zone; Tajikistan was the last to leave (1995) as it was torn by civil war.

Russia made it clear to the other members’ central banks that they either could agree to new measures for

reconstitution limiting in this way their rights for credit policy or they could be excluded from the union.

Notable is that before the disintegration of the union, IMF’s advice to the members was to remain within

the union. Nonetheless, IMF changed its advice after Estonia’s success regarding its new currency system.

Most of the former members after introducing their own national currency and conducting their own

monetary policy, suffered from high rates of inflation and depreciation of their currencies. International

financial markets did not show trust in their currencies. Baltic countries on the other hand managed to

annihilate their budget deficits and to fight inflation effectively and as a result they were accepted by

international markets.

17

Table 2. Financial Statistics for the Soviet Economy

Government Budget

Deficit

Government Debt Household Saving

Deposits

Year Billions of

Rubles

Percent of

GNP

Billions

of Rubles

Percent of

GNP

Billions of

Rubles

Percent of

GNP

1980 12 1.9 76 12.2 156.5 57.9

1981 9 1.4 85 13.1 165.7 57.9

1982 15 2.2 100 14.4 174.3 58.9

1983 10 1.4 110 15.1 186.9 61.1

1984 9 1.2 119 15.7 202.1 63.9

1985 14 1.8 133 17.1 220.8 68.0

1986 46 5.8 179 22.4 242.8 73.1

1987 52 6.3 231 28.0 266.9 78.2

1988 81 9.3 312 35.7 296.7 81.0

1989 92 6.9 404 43.4 337.7 83.7

Source: McKinnon, The Order of Economic Liberalization, table 11.1 (1991)

3.3.1 Lessons to be drawn from the Breakup of the Ruble-zone

The Ruble-zone was different from the Eurozone in so many ways but it also shared many common

characteristics. It is true to some point that a Euro breakup would be something entirely new, with no

precedent; but on the other hand by taking into account that the Ruble-zone was also a currency union of

fifteen members we could draw some valuable lessons from its dissolution. First of all we should highlight

the main differences of the two unions. The Ruble-zone’s dissolution was caused by the previous collapse

of the Soviet Union and not by economic problems. Another great difference is that the Soviet Union was

a socialist union, governed as a single party state, and even after the collapse and the independence of the

members, residues of socialism were evident. The fact that the two unions’ regimes are so different may of

course lead to different economic problems and decisions, after all we are talking about a political system

that has long disappeared. Another difference is that the free rider problem of the Ruble-zone cannot be a

problem of the Eurozone, as national central banks of its members do not have the right of financing their

governments with credit. The precedent of the Ruble-zone teaches us that even if the economic costs of a

breakup are high, this is not the reason why it should be avoided. Another lesson we can derive from the

disintegration of the Ruble-zone is that weaker economies may find difficulties in leaving the Eurozone, as

this would cause inflation after the devaluations; this would make debts impossible to be paid, and would

18

finally lead to default, something that would make it harder for the weaker economies to reenter

international financial markets. Of course someone could argue that some of these things are already evident

in the weaker economies of the Eurozone, as debts are too big to be repaid and international financial

markets have lost their trust in those countries. On the other hand, the breakup of the Ruble-zone is more

optimistic for stronger economies considering the course of the Baltic economies. Those countries after

leaving the Ruble-zone, were able to quickly stabilize their economies and fight inflation, and they were

able to finance their public and private debts through the international financial markets.

3.4 United States of America 1930s

The Great Depression was a severe economic crisis that started in 1929 and lasted even for ten years in

some countries. The cause of the crisis was the financial crash that started in 24 October 1929, a day also

known as black Thursday. The end of the depression for the United States of America came with the

development of the war economy of World War II ten years later. The consequences of the depression were

catastrophic both in developing and developed markets. Its negative impacts were apparent in international

trade, wages, tax revenues, prices and firms’ profits and unemployment. By the end of 1931 more than 2200

banks in the U.S. collapsed, and nothing was done by the FED to support them. In March 1933 Franklin

D. Roosevelt was elected president of the United States of America and his task would be difficult. In his

first hundred days president Roosevelt tried to fight depression with an economic program i.e. a series of

measures, known until today as the New Deal.

Franklin D. Roosevelt started the New Deal in 1933 and its cornerstone were the “3 Rs” i.e. Relief,

Recovery, and Reform. The program’s main purpose was to relieve the poor and unemployed, recover the

economy, and finally reform the whole system to prevent another incident. The New Deal was what the

Democratic Party thought was necessary for the economy at that time, but was criticized by a part of the

Republicans. Conservatives believed that this new program would hurt businesses and growth in general,

while Liberals believed that a part of the program was promising for a better future.

The first hundred days were decisive, as government took the most important measures. First of all, the

congress passed laws to protect all stock and bond holders. The measures were mostly a series of acts:

Emergency Banking Act, was a measure that gave the president the power to reopen any viable

banks and regulate banking,

Economy Act, was a measure focusing on cutting federal costs by reorganizing cuts in salaries and

veteran pensions,

Beer-Wine Revenue Act, was an act that was legalizing and taxing wine and beer; this act consisted

a huge blow for illegal trade and gangsters.

19

Civilian Conservation Corps (CCC) Act, this was a series of public works such as road building,

forestry labor, flood control etc., and their main purpose was to employ young men; with this act

three million men found work.

Federal Emergency Relief Act, with this act the Federal Emergency and Relief Administration

(FERA) was established and its main purpose was to distribute $500 million to different states.

FERA eventually spent $3 billion.

Agricultural Adjustment Act, the relative administration’s purpose was to decrease crop surpluses

by subsidies and destruction of crops. With the Thomas Amendment, President had the right to

inflate the currency using different ways.

Federal Securities Act, this act would toughen regulation of the securities business.

Tennessee Valley Authority Act, this was an act that gave the government the right to build power

plants and dams in the Tennessee Valley. Its purpose was to generate and sell power and to develop

the area.

The second hundred days the congress took another series of measures such as:

National Employment System Act, its purpose was the creation of the U.S. Employment Service

Home Owners Refinancing Act, this act established the Home Owners Loan Corporation. Its

purpose was to finance non-farm home mortgages.

Glass-Steagall Banking Act, this act was the stepping stone for the later Federal Bank Deposit

Insurance Corporation.

Farm Credit Act, with the purpose of refinancing farm mortgages

Emergency Railroad Transportation Act, to stiffen the regulation of railroads

National Industrial Recovery Act, which established the homonymous administration and the

Public Works Administration.

Abandonment of the gold standard

The last measure is thought by some economists to be the most important measure that President Roosevelt

took during his presidency and maybe the main reason why the United States managed to recover. Back

then, and before the election of F. D. Roosevelt, the gold standard was a monetary system under which all

dollars were convertible to gold; in addition, banks were forced to accumulate large amounts of gold as

reserves. Banks were obligated to keep 40% of the currency in circulation as gold reserves, all this until 19

April, when the U.S.A. dropped the gold standard. Government announced that people should exchange all

of the gold they had (jewelry and gold teeth excepted) for paper money at a price of $20.67 per ounce;

however, this measure didn’t apply to foreign banks and investors. After the suspension of the gold

standard, convertibility of banknotes to gold would be impossible. Although the means used were cruel as

whoever was not exchanging his gold for money could be fined or even sentenced to prison, people did not

reacted as they have been told that this was a national emergency. Roosevelt managed to pass this measure

20

based on a 1917 act; the Trading with the Enemy Act, under which when nation was under war, president

had the right to prohibit people from “hoarding gold”. The main reasons that led to the decision for

suspension of the gold standard, was firstly, the deflation that prevailed in the U.S. with the wholesale

prices falling 37% and farm prices falling by 65% and secondly, the abandonment of the gold standard by

Britain in 1931 that led to a devaluation of the Pound of 30% and to a decrease of the competitiveness of

the U.S.. With the suspension of the gold standard the Dollar exchange rate with the other gold standard

currencies decreased by 11.5%. In 1933, government’s main purpose was reflation and to achieve that goal,

administration proceeded in several raises of the price of gold; the consequences for the dollar was

consecutive depreciations. The decisive move of the Congress to transfer to the government the title of gold

from the Federal Reserve, made things even easier for Roosevelt. He managed to increase the gold price to

$35 dollars per ounce, a measure that led to the devaluation of the dollar to 59.06% of the par of 1879. The

U.S. started to buy gold from different countries, and by 1935 $1.74 billion gold had been imported to the

country; Roosevelt continued this policy by also buying silver and increasing country’s reserves. This was

one of the greatest devaluations in the history of the U.S. which gave it a competitive advantage over the

other economies. Situation was so bad for the economies that were under the gold standard that they were

forced to drop the gold standard too.

0

50

100

150

200

250

1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939 1940 1941 1942 1943 1944 1945

U.S. GDP

US GDP (in billion current dollars)

Figure 1

21

It is clear from the above figures that the United States managed to recover under Roosevelt’s “New Deal”.

More specifically, after 1934, the U.S. domestic product started an increasing course which intensified

during the war when the country developed its war economy. During the same period and because of the

“New Deal”, government expenditures started increasing and reached to unprecedented levels in 1940s

because of war expenditures. In the late 1930s unemployment reached double digit levels which started

9.4 10 9.9 8.7 8.7 10.5 10.9 13.1 12.8 13.8 14.8 15

26.5

62.7

94.8

105.3

93

Government Expenditures and Investments

Government Expenditures and Investments(in billions current dollars)

0%

5%

10%

15%

20%

25%

1929 1930 1931 1932 1933 1934 1935 1936 1937 1938 1939

Average Rate of Unemployment

Average Rate of Unemployment

Figure 3

Figure 2

22

decreasing under the “New Deal”. The sudden increase in 1938 was due to a second depression that hit the

United States. What is also noteworthy is that every country that abandoned gold standard early, managed

to devalue its currency by around 40% and recover quickly while the countries that were the last to drop

the gold standard, were also the last to recover, namely France, Netherlands and Poland. Bernanke and

James (1991) find that countries like Spain that were not on the gold standard did not face any of the

deflation problems of the Great Depression. They also find that countries that abandoned earlier the gold

standard faced a growth of industrial production that averaged 7 percentage points a year better than the

countries remaining on the gold standard.

3.4.1 Lessons to be drawn from the drop of the Golden Standard

The case of the United States is more closely related to a Greek exit from the Eurozone as it conceals maybe

the main strategy that most supporters of a Grexit believe that Greece should follow after it leaves the Euro;

currency devaluation. F.D. Roosevelt, after the suspension of the gold standard, proceeded to a major

devaluation of the Dollar and managed to recover the economy. This is a very encouraging precedent for

Greece. However, someone can argue that there are major differences in the economies of the two countries.

On the one hand, the United States was the largest economy in the world back then and a major exporter.

On the other hand Greece today only accounts for the 2% of the EU GDP, and is mostly an importing

country with no industrial sector. However, a devaluation could be lifesaving for such an economy too, as

it could improve Greece’s terms of trade by increasing its exports and decreasing its imports, it could

increase Greece’s tourism and foreign direct investments, it could help Greece regain its domestic market

and finally develop again its agricultural sector. Another valuable lesson from the US incident is the way

F.D. Roosevelt proceeded to the suspension of the gold standard; he firstly declared bank holiday. A step

that Greek government should do before introducing the new currency to manage to prepare itself and limit

the panic. Finally, it has to be noted that Roosevelt followed a complete different strategy during the Great

depression; it was a Keynesian approach that in order to fight the negative consequences of the crisis he

increased public expenditures and raised wages. Furthermore, he supported workers and the unions against

capital. It may be a different situation for Greece but the policies the IMF uses are completely the opposite.

Recently in Greece, Prime Minister Antonis Samaras prohibited strikes using the law of mobilization

against the high schools teachers.

3.5 Argentina 1999-2002

The Argentine crisis was an economic decline that started in 1999 in Argentina. It was a chain of events

consisting of a great fall in Argentine GDP, rise in unemployment, fall of the government, riots, and the

end of the Peso’s peg to the Dollar, and default on the country’s foreign debt. The case of Argentina is the

23

most closely related to the case of Greece and can teach us valuable lessons regarding the “Plan B”.

Argentina had always a turbulent economy, but the main reasons of its economic crisis are three. The first

reason was the devaluation of the Brazilian Real which led to the fall of Argentina’s exports. Brazil

proceeded in devaluation of its currency to get out of the crisis in a period in which Latin America, Russia

and later Asia were facing economic problems. The second reason was the tax increases in 2000 and

Argentina’s high rate of unemployment. And finally, the third main reason was its extensive government

debt.

In 1999, Argentine deficit was 2.5% of GDP, and then-President De la Rúa believed that by reducing it, he

could inculcate confidence to the market and maybe reduce interest rates. De la Rúa knew that by reducing

taxes little could be achieved and he also did not wanted to drop the Peso’s peg to the dollar, a policy that

have been adopted in order to stabilize Argentina’s currency. Although it was difficult to attract funding

through the markets, a solution was found when the IMF signed a loan of $7.2 billion to Argentina.

Furthermore, government also proceeded to consecutive tax increases which made matters even worse as

the tax rates were already high.

During 2000 the decline of the economy kept on, and one year later, the new minister of economy tried to

reduce government expenditures, a move that infuriated the people and led to protests. After several

resignations of members of the coalition government and the new minister of economy, signing as successor

minister Domingo Cavallo for whom his stance against the convertibility law was known, led to bank runs.

Cavallo’s public statements regarding the convertibility law later led to the downgrade of Argentina’s credit

rating. Argentina’s government continued to finance its debt by borrowing at high interest rates, and it also

used debt swaps to transfer some payments into the future and reduce debt repayments in the short run.

Furthermore, it signed another loan of $22 billion with the IMF after agreeing in taking austerity measures,

and situation seemed to get even worse for its economy. In December 2001, Argentine banks froze deposits,

and Argentina was getting into a deep depression; people started demonstrations known as cacerolazos as

they were banging casserole pots and pans. Things were deteriorating as IMF stopped giving any further

installments of the loan as Argentina could not keep up with the appropriate measures of austerity and was

unable to attract funding from international markets as well.

The severity of the situation in Argentina was even reflected on the political field with several reshuffles;

eventually, President Adolfo Rodríguez Saá decided to default on the country’s public debt of $50 billion

to foreign investors. Following Rodríguez in presidency, President Duhalde, proceeded in a series of

measures after the default in an attempt to ease the situation. First and most importantly, Duhalde

abandoned the Peso’s peg to the Dollar, and as a consequence Peso devalued. After the end of the

convertibility system he proceeded to confiscation of Dollar reserves and to pesofication of the Dollar bank

deposits, loans and legal contracts; something that turned out to be beneficial for debtors but not for

24

creditors and people with savings. In addition, he introduced new taxes and also doubled penalties for

employers who fired employees.

The first two years after the reform were the most difficult for Argentina, as its GDP decreased by 5.5% in

2001 and by 10.9% in 2002. Unemployment reached to the unprecedented level of 23.6% and real wages

and sales declined as well (23.6% and 26% respectively) while at the same time inflation reached 41%.

Several companies declared bankruptcy, and others faced major problems, among them Aerolineas

Argentinas, Argentina’s largest airline company who was forced to cancel all international flights. Finally,

the pesofication affected mostly banks and financial institutions. However, economy was not the only sector

which suffered the terrible consequences of the crisis; people were starving as poverty rate had reached

58% in 2002 and they were protesting. It is noteworthy that Argentine agricultural products were not

accepted by some countries because of fears that they could be damaged because of the chaos.

Economy started recovering after 2002 as can be seen in figures 1 and 2. After Duhalde managed to stabilize

the situation he called for elections; the successor president was Néstor Kirchner. After all, the devaluation

of the currency succeeded in making imports expensive and exports cheap; Argentina was once again

competitive. It has to be noted that things also improved due to the excessive rise in the price of soy beans.

After the devaluation, government tried to support import substitution and improved its tax collection

system. Argentina quickly created a huge trade surplus that was the main reason for a great inflow of dollars

and a large increase in its foreign currency reserves. By trying to build again its foreign exchange reserves

by buying Dollars, Argentina could cause inflation; to stop this trend the central bank started to sell treasury

letters. Argentina, eventually, used the foreign exchange reserves it collected to repay the IMF in 2006.

-5.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

40.00%

45.00%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Argentinian Unemployment vs Inflation

Unemployment rate Inflation

Figure 4; Source: CIA World Factbook

25

As can be seen in figure 2, Argentina faced some economic problems during 2004, when the increased

industrial demand caused an energy crisis. However, it again managed to recover on the next year. Finally,

the world economic crisis of 2008 is apparent in both figures 1 and 2 as it is clear the increase in

unemployment rate and the decrease in Argentina’s growth rate, which reached 0.9% in 2009.

3.5.1 Lessons to be drawn from the drop of the Dollar Peg

The case of Argentina is surely a precedent that can teach us a lot of lessons about a possible exit of Greece

from the Eurozone. The two incidents share a lot in common. On the one hand Argentina, who had its

currency pegged to the Dollar, faced an economic crisis partly because of its outstanding debt (50.8% of

GDP) with severe consequences for the employment, the poverty and its growth. And on the other hand

Greece, which faces a crisis now that was triggered by the credit crisis of 2008; a crisis that was also caused

by Greece’s huge sovereign debt (189.48% of GDP) and led to large increases in unemployment and

negative growth rates. Greece has, just like Argentina, lost its ability to exercise monetary policy as it is a

member of a monetary union and it also tried to get help from the IMF just like Argentina did. After all, it

is not at all unrealistic to say that Argentina’s past could be Greece’s future. Although Greece faces a much

more severe crisis than Argentina, it could be the case, for Greece too, that by defaulting on its huge

sovereign debt and by getting out of the Eurozone and regaining its right of exercising monetary policy to

manage to create an export surplus and of course to become again competitive. Surely we have to keep in

mind the problems that Argentina faced after its devaluations. But maybe we should decide what kind of

-15.00%

-10.00%

-5.00%

0.00%

5.00%

10.00%

15.00%

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Argentinian Real GDP growth rate

Real GDP growth rate

Figure 5; Source: CIA world factbook

26

recovery we want to achieve. It is clear that the strategy of the IMF did not succeed in Argentina ten years

ago and made things even more difficult for the Argentines; and even if it would succeed this would not

happen as quickly as it happened after the devaluation but after years of austerity. There is some criticism

when people parallel the case of Argentina to that of Greece. People tend to be cautious because of the

differences the two countries have in their economies, as Argentina was a large exporting, developing

country while Greece is mostly an importer, and because of the differences of the economic environment

now and back then; we must not overlook the fact that Argentina managed to recover in a booming

economic environment, while Greece faces a crisis in an economic environment where most countries face

problems with their economies too. They are not few those who believe that if Greece would default on its

debt then it would surely damage the relations with its international and domestic creditors; but taking into

account that Argentina defaulted on its debt and after 4 years managed to receive some major loans from

the World Bank and the Inter-American Development Bank is encouraging. Perhaps paying off the IMF

played an important role for Argentina. The critics of a Grexit also use as an argument the huge inflation

that the introduction of a new currency and its devaluation would cause; but as we can see in the Argentina’s

case which had a more unstable economy than that of Greece’s, an “unorthodox” inflationary policy that

targets in growth may be more successful than any other policy. Of course, the first two years may be

difficult with a great inflation but after starting to recover, with the appropriate policies, a stabilization of

the economy is not impossible.

3.6 Icelandic Crisis of 2008

In 2008 Iceland, faced major problems with its economy. It was a banking crisis that led to the collapse of

the three largest privately owned commercial banks. Everything started because of the inability of the three

banks (Glitnir, Landbanki, and Kaupthing) to refinance their debts. The debt of the three banks amounted

to €50 billion, a number extremely high related to the Icelandic GDP of €8.5 billion. But how is it possible

the banks of a country of 321,857 people to swell to such an extent?

Because Iceland is a small economy, its banks had to sign loans on the interbank lending market and accept

deposits from other countries in order to expand. At the same period households also took large amounts

of debt, and the whole situation led to inflation. Inflation increased even more when the central bank of

Iceland tried to increase liquidity of the banks by printing new money and reached to 14% in the end of

2008. Consequently the central bank held interest rates high (15.5%), much higher than the interest rates in

the Eurozone, something that motivated investors from abroad to bring their deposits to Iceland. The

increase in the supply of the Icelandic Κrónur was huge and a bubble was created. Due to the credit crisis

of 2008, Icelandic banks found it difficult to make loans, a situation that made it difficult for them to meet

their obligations to their creditors. They also could not turn to the central bank as a lender of last resort

27

because Icelandic central bank was much smaller and it could not guarantee their payments. As a result the

only solution was to let banks collapse.

The immediate effect of the collapse was the job loss for all the bank employees, and the bankruptcy of

several firms. Things were also difficult for importers, as Icelandic government restricted foreign currency

for a variety of products. Iceland also faced a huge increase in its unemployment rate, from 1% in 2007 to

8% in 2009. Debt repayments became pretty difficult and costly, and as a result many people lost their

homes due to outstanding mortgages. Nevertheless, the crisis did not only affect Iceland; there were bad

consequences for the countries of the depositors as well.

In September 2009, Icesave bill 1 was the first plan between Iceland, the Netherlands and the Great Britain,

about the deposits, but finally it ended with the disagreement of the three parties and Britain’s and

Netherlands’ threat of blocking the IMF’s aid package. After that, Iceland voted for a 2nd plan, known as

Icesave bill 2; but President Ólafur Ragnar Grímsson declared that he would not sign for the bill and called

for a referendum. The referendum was held in Iceland in January 2010, to decide about the loan guarantees

to Britain and to the Netherlands (€3.8 billion); 98.10% of the people who voted, voted against the loan

guarantees. In short, people did not want to pay for the banks’ mistakes. Finally, a third proposition was

made under the name Icesave bill 3, and a second referendum rejected it again with 58.9% of votes against

it. Eventually the case was transferred to the courts, where EFTA court cleared Iceland of all the charges.

In the end of 2010 Iceland started recovering at a steady pace as it managed to decrease its unemployment

although not even closely to the pre-crisis levels, and have a positive growth rate. IMF which was

summoned from the start of the crisis claimed that the recovery was a result of its austerity measures and

successful policies. However, if we take a closer look at Iceland’s macroeconomic facts we will find out

that Iceland’s recovery is not as successful as IMF claims it is. After the collapse of the banks, Icelandic

government split the banks in national lines, something that left Iceland with banks unable to provide

banking services. Furthermore, Iceland keeps using capital controls that were implemented during the crisis

in order to sustain a stable exchange rate, and also the IMF’s policy of high interest rates severely contracted

private investment. Finally, Iceland faced an 11% GDP decrease after 2008, and saw its debt to increase at

unprecedented levels.

3.6.1 Lessons to be drawn from the Icelandic Incident

The Icelandic crisis of 2008 does not share much with the Greek crisis, as the main reasons of the two crises

are completely different. It could be stated that Iceland shares more in common to what happened recently

in Cyprus. However, we could derive some lessons from the situation in Iceland that could be useful for

28

the situation in Greece. Maybe one of the most wise decisions of the Icelandic government was to take into

account firstly the needs of its people and then of its creditors. Of course rejecting to guarantee the deposits

of foreign investors was a necessity but going into a referendum to decide the country’s course was a wise

decision. Another decision that helped the country to recover was the “nationalization” of the three

collapsed banks; it was not literally a nationalization but an emergency legislation as now two of the three

banks are private again. In contrast, in Greece, the total cost of aid and liquidity measures and the capital

received by the domestic banks from the Greek governments over the years amounts to €145 billion;

without of course any kind of nationalization. This is money that Greek people are required to pay as it is

charged to the public budget and increase public debt. In addition, the fund’s austerity measures had some

positive impacts on the Icelandic economy but this happened after only two years. After three years of far

more severe austerity measures, Greek economy did not show any signs of recovery and faces about 3 times

the unemployment of Iceland in 2008. So conclusively, the lessons we can derive from the Iceland’s

incident are basically four. Having a national currency is necessary, as its devaluation can revivify the

economy through exports. Secondly, letting banks fail and not transferring their bills on to the people may

turn out to be positive for the economy. Thirdly, using referendums in order to take important national

decisions is important as it is more democratic and it can lead to social stability and less public reactions.

And finally, capital controls may be necessary at the start of the introduction of a new Drachma to avoid

capital flight.

3.7 Meta-summary of historical parallels

In order to sum-up, the following meta-study table contains some important indicators of the historical

parallels that were examined.

Table 3. Meta-data summary table

Country

Devaluation

Change in

Unemployment

Rate after two

years after the

breakup

Inflation Rate

after two years

after the breakup

Quick recovery

after the breakup

Austria - - 134% (peak) No

Hungary - - 98% (peak) No

Czech - -0.3% 7.86% Yes

Slovakia 10% 0.9% 7.21% Yes

U.S.A. 59.06% -4% 2.2% Yes

Russia - 2.9% 840% No

29

Estonia - 5.1% 89.8% Yes

Argentina 72.2% -2.2% 13.4% Yes

Iceland 50% -0.6% 4% Yes

As we can see most of the cases suffered from high inflation rates after the breakups and great devaluations;

the latter though was part of the economic policies of the countries. Most countries managed to quickly

recover after the breakup and decrease their unemployment rate. We cannot say the same for Russia and

Estonia though, as the Soviet Union had a unique and different political regime.

30

CHAPTER 4 The Hellenic Crisis and the Troika The next section will contain a brief overview of the Greek sovereign debt crisis and a comparison of the

expectations of the Troika for Hellas and the actual data after the implementation of the measures. More

specifically, the data are taken from the five reviews of the EC for Greece (1st economic adjustment program

for Greece) and the two reviews for the 2nd adjustment program for Greece.

4.1 The Hellenic Crisis

The Greek economy was an indebted economy, in terms of public debt, most of the years after the

establishment of the sovereign Greek state in 1830. However, the levels of government debt were always

sustainable, at least until the 1980s. The situation deteriorated when Andreas Papandreou of the socialist

party PASOK (PanHellenic Socialistic Movement), was elected Prime Minister in 1981. Andreas

Papandreou ushered a new era of fiscal policy, by targeting the increase in the income of the average

household and creating new jobs in public organizations; he managed to do this by extensive borrowing

from the markets and by increasing public debt. The new fiscal policy which aimed at raising the living

standards of Greek people in conjunction with agricultural and infrastructure subsidies coming from the

EU which were aimed to the convergence of European countries led to an excessive increase in public debt.

The situation got even worse after Greece was accepted as a member of the Eurozone, as this stabilized, at

least temporarily its economy, and made creditors more optimistic. Greece could borrow money at pretty

low rates, its 10-year bond spreads fell by 18% in the period 1993-1999. The misperception of convergence

of the European economies was strengthened through agreements such as the Stability and Growth Pact.

The agreement was imposing to the Eurozone members limits on their public debt levels (60% of GDP)

and on their public deficits (3% of GDP); members that would not comply with these requirements would

face sanctions i.e. fines of up to 0.5% of GDP. Nevertheless, because of the difficulty of most countries to

comply with those requirements, no country was ever sanctioned. Greek governments continued borrowing

from the markets benefiting from the low interest rates due to investor’s confidence; however money was

intended to finance current consumption and not productive investments that would create revenues to repay

the debt. Conclusively, the great debt accumulation was partly a result of politicians planning only in the

short run and not in the long run and partly because of corruption, as Greek politicians were being bribed

by German corporations in order to buy their equipment and tax evasion. Currently, politicians like A.

Tsochantzopoulos are being prosecuted by the Greek courts.

The credit crisis in 2008-2009 and the collapse of Lehman Brothers triggered a series of events and

difficulties for several European economies. The situation for Greece was worsened when the new Prime

Minister George Papandreou publicly announced that the budget deficit was underreported by the previous

government. The underreporting started by Prime Minister C. Simitis who bribed Goldman Sachs in order

to change the numbers so that Greece would be able to enter the Euro-zone and continued by the next

31

government of C. Karamanlis who underreported the Olympic Games of 2004 budget. This immediate

increase in reported deficit from 6.7% to 12.7% led to the downgrade of the credit rating of Greece by Fitch.

Due to fears of a Greek default, G. Papandreou introduced a series of budget cuts. After what happened,

market lost its confidence to Greece, something that increased the Greek yield spreads and made future

borrowing really costly. On April 2010, George Papandreou without even informing Greek people sought

help from his EU partners, the ECB and the IMF. Fearing a possible disorderly Greek default, as it could

be contagious and dangerous even for the whole union, the Eurozone decided to help Greece in May 2010.

A three-year bailout package of €110 billion was agreed for Greece; the Eurozone countries contributed the

€80 billion while the IMF contributed the rest. It is noteworthy, that the treaty of Lisbon includes a so called

no-bail out clause; it is article 125. More specifically, this article states: “The Union shall not be liable for

or assume the commitments of central governments, regional, local or other public authorities, other bodies

governed by public law, or public undertakings of any Member State, without prejudice to mutual financial

guarantees for the joint execution of a specific project. A Member State shall not be liable for or assume

the commitments of central governments, regional, local or other public authorities, other bodies governed

by public law, or public undertakings of another Member State, without prejudice to mutual financial

guarantees for the joint execution of a specific project.”. The same clause is part of the Maastricht treaty

as well, in its article 104b, which states “The Community shall not be liable for or assume the commitments

of central governments, regional, local or other public authorities, other bodies governed by public law, or

public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint

execution of a specific project. A Member State shall not be liable for or assume the commitments of central

governments, regional, local or other public authorities, other bodies governed by public law or public

undertakings of another Member State, without prejudice to mutual financial guarantees for the joint

execution of a specific project. ”; meaning that it is illegal for a country to assume the debts of another.

Arnold and Lemmen (2001) state that if EU and ECB try to rescue an indebted government, its idiosyncratic

default risk will change in a combination of systematic and inflation risk. At the same time, a new European

mechanism, called European Financial Stability Facility (EFSF) was created in order to provide funding to

countries which were facing problems. Greece had to introduce a series of austerity measures and budget

cuts in order to accept the bailout package. The aim of these measures were to decrease Greece’s deficit by

11% by 2013. More specifically, the measures aimed at reducing government expenditures, fight tax

evasion and increase competitiveness of the Greek economy through large wage cuts. Furthermore, they

tried to increase government revenues by raising taxes such as income taxes, average value-added tax, and

implementation of excise taxes on tobacco, fuel and alcohol; another great objective was of course to fight

tax evasion. In addition, the program included privatization of Greek public sector companies in an attempt

to raise €50 billion. The ECB tried to make matters easier for Greece by announcing the purchase of

European countries’ (mostly Greek) bonds in the secondary market and by providing liquidity to the Greek

commercial banks by repurchase agreements. It has to be noted that three years after the measures, the IMF

32

announced on the first week of June 2013 that its policy with the first bailout package was all wrong;

according to the publication in the Financial Times, the IMF published a scathing report saying that its

growth assumptions for Greece were too optimistic and that the debt restructuring should have occured

earlier. As C. Lagarde put it, 2011 was a “lost year”. The Troika admitted that using only austerity

measures and not trying to completely reform the Greek economy was wrong; and the only thing they

managed to do was to earn some time for Greece and turn the unsustainable debt into sustainable.

After the first package, things did not go as planned and the Greek economy was declining even more. The

troika officials decided that in conjunction with the severe austerity measures a PSI (Private Sector

Involvement) agreement was necessary. More specifically, for each privately held bond, 53.5% of its face

value was forgiven, 15% was exchanged for short-dated EFSF securities and the rest was exchanged for 20

new bonds with maturities of 11-30 years with an amortization of 5% per year. The new bonds are governed

under English law and have a coupon of 3.65%; however the coupon will be increased 2% for 2012-2015,

3% for 2015-2020 and 4.3% for 2020-2042; some kind of GDP indexed bonds. These are bonds that will

pay a higher coupon when GDP growth is higher, and a lower coupon when GDP growth is lower. It also

has to be mentioned that other securities that have to do with future GDP growth will be offered and they

will pay 1% if growth exceeds the anticipated levels. One of the biggest losers of the PSI were the Greek

pension funds, since they have lost, because of the haircut, €11.92 billion; however the loss is even larger

if we take into account the loss of value of the new Greek government bonds. Greek private banks were

also members of the top bondholders group, as it can be seen in figure 6, however the recapitalizations

covered most of their losses. Therefore, on October 2011 along with a second bailout package of €130

billion and more austerity measures, the haircut of 53.5% was officially agreed on the Greek government

bonds. This strategy aimed at decreasing the Greek debt by €110 billion. The situation was so bad,

especially taking into account that during the campaign period, George Papandreou told people that money

existed while it did not, that people started protesting across the country as the austerity measures resulted

in numerous job losses and tax increases. Unemployment rate increased during the period 2010-2011 from

12% to 17.3%. On November 2011, Prime Minister George Papandreou resigned after announcing a

referendum, in order for Greek people to decide about the second bailout package he was under international

pressure in fears of a Grexit. The transitional coalition government was formed with Loukas Papadimos as

the new Prime Minister. At the same time Greece was downgraded to junk level by Fitch. This second

bailout package along with the PSI became active in March 2012, and it aimed to cover Greece’s needs

until 2015, when Greece should be ready, if things were to go according to the plan, to attract funds from

the markets. Meantime, elections in Greece did not have a clear result, and on the second round of elections

in June 2012 a coalition government had to be formed; the new government was consisted of the political

parties N.D. (New Democracy), PASOK (PanHellenic Socialistic Movement) and DIM.AR (Democratic

Left) with Antonis Samaras as Prime Minister. Greece faced another recession in 2012 and it failed to

implement the planned scheme, and as a result the Troika decided to delay the next disbursement of €31.5

33

billion. Greece went back on schedule after negotiations with the Troika and it received the next

disbursements.

Today, more austerity measures have been implemented to Greece and they are progressively worsening

the situation as more firms are going bankrupt every year and more people are laid off. It has to be noted

that Greeks are so frustrated with the whole situation and there even have been talks about democratic

deficit especially after the recent closure of the ERT (Hellenic Broadcasting Corporation). The Fund’s

austerity measures had not only economic impact in Greece but a serious social impact as well. People go

into public protests and strikes and desperate people, unable to repay their debt or taxes even commit

suicide; there has been a rise in suicide rate of 26% in 2013. Finally, another impact was the rise of right-

wing neo-Nazi parties that even managed to enter the Greek parliament with a percentage of votes of 6.97%.

And finally, another great issue is the brain drain; as young people and scientists who are unable to find a

job inside Greece because of the youth unemployment of 60%, are forced to leave the country.

Figure 6; Source: Barclay’s Capital, Bank of Greece, EU, IMF, Company reports, Media reports; In Others are mostly included private investors and financial institutions with a percentage of bonds of 1 or lower.

4.2 Data and Methodology

What I will do now is a series of regression analyses in order to find out the relationship between first, the

Greek and the German 10 year bond yields, second, the relationship between the Greek yield spreads and

the Greek debt; third, the relationship between the Greek CDS spreads and the debt to GDP ratio, the

German CDS spreads and also the Open Market Operations of the ECB. Moreover, I will try to find out if

0

5

10

15

20

25

30

35

40

Top bondholders of Greek government bonds (percentage of bonds)

34

Okun’s law is applicable to Greece. Finally, I will try to find the relationship between the credit rating of

Greece, by the three rating agencies (Moody’s, S&P, Fitch), and the Greek over the German 10 year bond

yield spread. The same regression analysis will be also run to examine the relationship between the Greek

CDS spreads and the credit rating of Greece by the three credit rating agencies. All the data are gathered

from Bloomberg and the ECB database and the computer software which is used for all the regressions is

the Stata12 SE.

On the first analysis I will compare the yield to maturity of the 10 year Hellenic bonds to the yield to

maturity of the 10 year German bonds. The examination will start on January 2010, before the first bailout

package and will end with the yields of the end of 2012, so nine months after the Greek haircut. The

dependent variable is the 10 year Greek bond yields to maturity and the independent variable is the yield

to maturity of the 10 year German bonds. What I expect to find is a negative relationship between the two

yields as when countries like the PIIGS face problems most risk averse investors try to limit their risk by

investing in German bonds. The regression equation that will be run is the following:

𝐺𝑟𝑏 = 𝑎 + 𝑏 ∗ 𝐺𝑒𝑟𝑏 + 𝑒 (1)

Where: Grb= 10yr Greek bond yield to maturity

Gerb= 10yr German bond yield to maturity

The next analysis aims at finding out the relationship between the Greek over the German yield spreads

and the Greek debt. The spreads constitute the difference of the Greek 10 year bond yields from the

German 10 year bond yields. As far as the debt is concerned, the debt to GDP ratio data will be used. A

six-year period will be examined from 2008 to 2013. The regression equation that will be examined is the

following:

𝑆 = 𝑎 + 𝑏 ∗ 𝑑𝑒𝑏𝑡 + 𝑐 ∗ 𝑑𝑒𝑏𝑡2 + 𝑒 (2)

Where: S=Greek over German yield spread

debt=Debt to GDP ratio

debtsqrd=(Debt to GDP)^2

The debt squared term is inserted in order to capture the non-linear effect of the debt to the spreads. More

specifically, the term is used to measure the credit rationing effect. The expected relationship between the

Greek spreads and the Greek debt is positive. As the more debt is accumulated by Greece the more difficult

35

and costly becomes for Greece to borrow more money. However the same result is not expected for the

relationship between the Greek yield spreads and the debt squared. As the more the Greek debt increases,

the more reluctant the lenders become to lend money as they already maximize their profits; and a market

imperfection is created.

The third regression that will be run will aim at finding out how the Greek debt along with the German

CDS spreads relate to the Greek CDS spreads. But most importantly the regression will be run in order to

find out how helpful was for the Greek economy the increase of liquidity by the ECB. The data that will be

used are from the period of 2008 to 2011. The regression equation that will be examined is the following:

𝐶𝐷𝑆 = 𝑎 + 𝑏 ∗ 𝑂𝑀𝑂 + 𝑐 ∗ 𝑔𝑒𝑟𝐶𝐷𝑆 + 𝑑 ∗ 𝐷𝑒𝑏𝑡 + 𝑒 (3)

Where: CDS=Greek CDS spreads

OMO=Open Market Operations

gerCDS=German CDS spreads

Debt=Greek Debt to GDP ratio

CDS spreads are a good measure of risk, so finding their relationship with the liquidity of the market is a

good way to find out how the ECB monetary policy affects this risk. The relationship we expect to find

between the Greek CDS spreads and the Open Market Operations is negative while the relationship of the

Greek CDS spreads to the German CDS spreads and the Greek debt is expected to be positive.

The final analysis constitutes an attempt to find out if the Okun’s law is applicable to Greece’s economics.

The data that will be used are taken from the period 2005-2013. More specifically, the 3-month change in

unemployment rate along with the 3-month GDP change rate are used. The regression equation is the

following:

edybadu * (4)

Where: du=3-month change in unemployment rate

dy=3-month percentage change in GDP

36

Okun’s law is the observed relationship between unemployment and losses in a country’s production. What

I expect to find is a negative relationship between the two variables. The higher the coefficient (b) of dy

the stronger the relationship.

On the following regression analyses, I will try to find the relationship between the credit rating of Greece,

by the three rating agencies (Moody’s, S&P, Fitch), and the Greek over the German 10 year bond yield

spread. The data that will be examined are from the period of 2004-2013. The regression equations are the

following:

111 _* eratMbaS (5)

222 _* eratSPbaS (6)

333 _* eratFbaS (7)

Where: S=Greek over German bond yield spread

M_rat=credit rating of Moody’s rating agency

SP_rat=credit rating of Standard and Poor’s rating agency

F_rat=credit rating of Fitch rating agency

In order to convert the credit rating into a quantitative variable, I gave a number from 1 to 23 at each rating

level of the three different credit rating scales; starting from Aaa/AAA=1, Aa1/AA+=2 etc.. The three scales

along with the numbering of each rating level can be found on table 28 at the Appendix C of the thesis.

Among the expected results is a positive relationship between the credit rating of Greece and the Greek

over the German bond yield spread.

The same regression analysis will be also run to examine the relationship between the Greek CDS spreads

and the credit rating of Greece by the three credit rating agencies. Once again the data that will be used are

for the period 2004-2011. The three regression equations are the following:

111 _* eratMbaCDS (8)

222 _* eratSPbaCDS (9)

37

333 _* eratFbaCDS (10)

Where: CDS=Greek CDS spread

M_rat=credit rating of Moody’s rating agency

SP_rat=credit rating of Standard and Poor’s rating agency

F_rat=credit rating of Fitch rating agency

Once again as CDS spreads are a measure of risk, we expect a positive relationship between the change in

the credit ratings and the change in the CDS spreads. The same numbering is used here too, in order to

convert credit ratings into quantitative variables.

4.3 Results

The following table show the main results of the first regression.

Table 4. Regression analysis of Greek and German 10yr bonds yields to maturity

eGerbbaGrb *

Coefficient Standard

Errors

t-stat p-

value

Min Max Mean Standard

deviation

Greek Bond

YtM (Grb)

- - - - 5.52 37.1 17.29 8.41

b -8.48 0.33 -25.76 0.00 1.16 3.49 2.34 0.67

a 37.11 0.80 46.35 0.00 - - - -

2R 0.46

As we can conclude from table 4, both coefficients are statistically significant. When the German bond

yield to maturity increases by 1% the Greek bond yield to maturity decreases by 8.47%. We can also

conclude that there is a negative correlation between the two yields to maturity. This negative correlation

is conspicuous at the scatterplot that follows (figure 7) which clearly suggests the negative relationship

between the two variables. We could state from the negative trend of the plots that the relationship between

the variables is strong. The great difference though between the two yields can be seen by looking at the

minimum and maximum values of the observations. The exceptionally high yields to maturity of the Greek

38

bonds is a result of turbulent situation in Hellas. After running a skewness/kurtosis test (the results can be

seen on table 17 of the Appendix) for normality instead of a typical Jarque Bera test because this specific

dataset is of medium size, we can conclude that our residuals are non-normally distributed. If we take a

look of the data we will find out that the Greek bond yield to maturity continued its increasing course until

February of 2012, exactly one month before the Greek PSI and the exchange of the bonds (figure 8). From

the summary table we can derive that the Hellenic bonds’ yields to maturity have a much greater standard

deviation because of their large fluctuations. So we can conclude from the data that there is an important

relationship between the economic situation in Greece and what happens in Germany. It could be the case

that when the situation in Greece becomes worse and the Greek bond yields increase, in conjunction with

the bad economic situation in the other indebted economies (PIIGS), the German bonds are seen as “safe

haven”. More specifically, a 1% lower German government bond yield due to safe haven effects will result

in 8.5% higher Greek government bond yield. This as Jens Boysen-Hogrefe (2013) mentions, leads many

investors who prefer to invest in government debt to turn to the German bonds and causing their yields to

fall to unusually low levels. He also states in his article that these low yields have saved the German

government over €80 billion. Of course the bond yields are affected by the ECB’s interest policies and the

low business cycles dynamics but on the same article Jens Boysen-Hogrefe supports that the German yields

would not be so low if the other European economies had not faced any economic problems. Therefore, it

is true that economies like Germany and France made money because of the crisis and the bad economic

situation of the other European countries. This money could have been spent to support those indebted

economies but of course it was not. Therefore, would it be an exaggeration to say that the northern

economies like Germany take advantage of the crisis in economies like Greece?

39

Figure 7; Regression analysis scatterplot.

Figure 8; Source: Bloomberg.

010

20

30

40

grb

1 1.5 2 2.5 3 3.5gerb

0

5

10

15

20

25

30

35

40

10yr Greek and German bond YtM

GrB GerB

40

The results of the second regression are the following:

Table 5. Regression analysis of Greek yield spreads to Greek debt

edebtcdebtbaS 2**

Coefficients Standard

Errors

t-Stat p-

value

Min Max Mea

n

St.

Deviat

ion

Greek over German

bond yield Spread (S)

- - - - 0.03 0.35 0.94 0.90

b 1.56 0.12 13.3

5

0.00 1.12 1.79 1.48 0.23

c -0.45 0.40 -

11.28

0.00 1.26 3.22 2.24 0.66

a -1.20 0.08 -

14.4

0

0.00 - - - -

2R 0.43

The estimation of the equation 2 was done by using non-linear ordinary least squares (OLS). Table 8 shows

the estimated coefficients, their standard errors and the associated R². All the coefficients are statistically

significant. The coefficients imply that when debt to GDP ratio increases by 1% the Greek spreads also

increase by 156 basis points; a relationship that was expected. The same is not true for the debt to GDP

squared term for which the estimated coefficient is equal to -0.45. This negative relationship captures the

debt rationing effect. Although, Greek debt may increasing along with the Greek yield spreads, investors

show a reluctance in lending more money despite the high yields. Table shows a summary of the statistics

of the variables. What is noteworthy here is the difference between the minimum and maximum values

(range) of the spreads; something that can be seen in figure 9. The correlation of the two variables, as it

was expected is high. A Jarque Bera test was run to see if the data match the normal distribution. The

summary of the residuals can be seen in table 20 of the Appendix. By checking the data and the histogram

of the residuals, we conclude that the data show signs of right skewness and kurtosis. The Jarque Bera test

gives us a value of 463; so that we can reject the hypothesis that the residuals are normally distributed.

41

Figure 9, Source: Data taken from Bloomberg

The results of the third regression follow:

Table 6. Regression analysis of Greek CDS spreads to OMO, Greek Debt and German CDS spreads

eDebtdgerCDScOMObaCDS ***

Coefficie

nts

Standard

Errors

t-Stat p-

value

Min Max Mean St. Dev.

Greek CDS

spreads (CDS)

- - - - 0.22 34.02 4.65 4.68

b -5.27e-06 4.80e-07 -10.99 0.00 180433 910450 592723 145993

c 14.23 0.51 28.12 0.00 1.12 1.70 1.36 0.20

d 3.05 0.37 8.24 0.00 0.062 0.99 0.59 0.33

a -13.90 0.41 -33.36 0.00 - - - -

2R 0.82

0

5

10

15

20

25

30

35

40

2008

2009

2010

2011

2012

2013

2013

Greek over German yield spreads

42

The estimation of regression equation (3) was done by using linear OLS. The estimated coefficients, their

standard errors and their R² are displayed in table 6. From their p-values we can conclude that all the

coefficients are statistically significant. Furthermore, when the German CDS spreads increase by 1% the

Greek CDS spreads also increase by 3%. Moreover, there is also a strong positive relationship of the Greek

CDS spreads with the Greek debt as it was expected. Finally the relationship of the Greek CDS spreads to

the open market operations of the ECB is negative as it was expected; however the relationship is not as

strong as it was expected to be. Meaning that the ECB’s monetary policies did not strongly affect the risk

of the Greek debt. A Jarque Bera test was run in order to test the normality of the residuals, and gave a

value of 153.4; a relatively high Jarque Bera value which implies that the residuals are non-normally

distributed. However if we take a look of the histogram of the residuals, we may conclude that they are

normally distributed with a few only outliers. Removing the outliers was not considered as an option as

they contain valuable information.

The results of the fourth regression analysis are the following:

Table 7. Regression analysis of % change of Unemployment rate to % change of GDP

edybadu *

Coeffic

ients

Standard

Errors

t-stat p-

value

Min Max Mean St.

Dev.

% Change in

unemployment rate (du)

- - - 0.025 -1.13 2.53 0.51 0.93

b -0.13 0.55 -2.35 0.001 -7.09 8.07 0.14 2.74

a 0.53 0.15 3.55 - - -

2R 0.14

As it can be concluded from table 7, there is a negative relationship between unemployment and GDP

decrease in Greece. The Okun’s estimator takes a value of -0.13 and it is statistically significant. The

unemployment level is by 14% explained by the existing changes in Greek product. After running the

regression, the Breusch-Pagan test was run and it proved that the residuals show signs of heteroscedasticity.

Moreover, after running the skewness-kurtosis test the null hypothesis of normality was not rejected. The

Darbin-Watson test also proved that there are no signs of autocorrelation in the model.

43

On tables 8, 9 and 10, the results of the regression analyses of the credit rating and the Greek over the

German 10 year bond yield spread are shown:

Table 8. Regression analysis of Greek bond yield spreads to Moody’s credit ratings

111 _* eratMbaS

Coefficients Standard

Errors

t-stat p-

value

Min Max Mean St. Dev.

Greek over German

10yr bond yield spread

(S)

- 0.08 35.3 0.06 8.2

1b 1.07 0.01 83.2 0.00 5 21 9.49 6.56

1 -4.47 0.15 -30.2 0.00 - - - -

2R 0.73

Table 9. Regression analysis of Greek bond yield spreads to S&P’s credit ratings

222 _* eratSPbaCDS

Coeffic

ients

Standard

Errors

t-stat p-

value

Min Max Mea

n

St.

Dev.

Greek over German bond yield

spread (S)

- - - - 0.08 35.3 5.65 8.2

2b 1.42 0.01 110.29 0.00 5 23 9.68 5.26

2 -8.05 0.14 -56.98 0.00 - - -

2R 0.83

44

Table 10. Regression analysis of Greek bond yield spreads to Fitch’s credit rating

333 _* eratFbaS

Coefficie

nts

Standard

Errors

t-stat p-

value

Min Max Mean St.

Dev.

Greek over German bond

yield spread (S)

- - - - 0.081 35.3 5.65 8.2

3b 1.49 0.01 95.68 0.00 5 22 9.25 4.87

3 -8.12 0.16 -49.95 0.00 - - - -

2R 0.78

Table 8 shows the results of the regression of the Greek over the German bond yield spreads to the Moody’s

credit rating for Greece. The estimation was done by using OLS. As we can conclude from their p-values,

all the coefficients are statistically significant. A high R² indicates that the bond spreads are by 75%

explained by the credit rating. After conducting a Jarque Bera test, I conclude that the residuals are not

normally distributed. There are also signs of heteroscedasticity and autocorrelation after checking for both

with a Breusch Pagan and a Durbin Watson test respectively. Table 9 shows the results of the regression of

the Greek over the German bond yield spreads to the S&P’s credit rating for Greece. The estimation again

was done by using OLS, all the coefficients are statistically significant and the R² is even higher. The credit

rating coefficient ( 2b ) is 1.49 and proves a positive relationship between S and SP_rat. The Durbin Watson

and the Breusch Pagan tests showed signs of autocorrelation and heteroscedasticity respectively. The Jarque

Bera test, show signs of non-normality of the residuals. Finally, table 10 shows the results of the regression

of the Greek bond yield spread to the Fitch credit rating. The regression was done by OLS and the main

results are the same: positive relationship between the two variables, high R², signs of heterscedasticity,

autocorrelation and non-normality of the residuals.

Finally, the results of the regression analyses of the Greek CDS spreads and the credit rating of the three

agencies can be seen on tables 11, 12 and 13:

45

Table 11. Regression analysis of Greek CDS spreads to Moody’s credit rating

111 _* eratMbaCDS

Coefficients Standard

Errors

t-stat p-

value

Min Max Mean St. Dev.

Greek CDS

spread

(CDS)

- - - 10.62 4617.41 241.24 398.92

1b 115.91 0.90 128.9 0.00 5 20 6.44 3.26

1 -505.80 6.5 -77.88 0.00 - - - -

2R 0.90

Table 12. Regression analysis of Greek CDS spreads to S&P’s credit rating

222 _* eratSPbaCDS

Coeffici

ents

Standard

Errors

t-stat p-

value

Min Max Mean St. Dev.

Greek CDS spread (CDS) - - - - 10.62 4617.41 241.24 398.92

2b 127.54 0.92 138.58 0.00 5 20 7.45 2.98

2 -708.35 7.38 -95.96 0.00 - - - -

2R 0.91

46

Table 13. Regression analysis of Greek CDS spreads to Fitch’s credit rating

333 _* eratFbaCDS

Coefficie

nts

Standard

Errors

t-stat p-

value

Min Max Mean St. Dev.

Greek CDS spread (CDS) - - - - 10.62 4617.41 241.25 398.92

3b 152.38 1.18 129.15 0.00 5 18 7.07 2.48

3 -835.53 8.83 -94.56 0.00 - - - -

2R 0.90

Table 11, 12 and 13 show the results of the regression of Greek CDS spreads to Moody’s, S&P’s and Fitch’s

credit ratings respectively. The OLS method was used for the estimations. It clear from the three tables that

there is a strong positive relation between the credit ratings and the Greek CDS spreads. In all three

regressions R² is pretty high (0.90), meaning that the model explains most of the variability of the response

data around its mean. After testing for heteroscedasticity and autocorrelation, with the Breusch Pagan and

Durbin Watson tests respectively, signs of both were found. Moreover, there are signs of non-linearity of

the residuals after using the Jarque Bera test. The last three regressions show even more, how great is the

impact of a bad credit rating to the borrowing costs of Greece and also the risk of investing in the Greek

debt titles. More or less, being a member of the Eurozone, does not help Greece get a higher rating, or

decrease the costs of a lower rating.

47

4.4 Basic Indicators of the Greek Economy

Here are some important indicators of the Greek economy for the period 2007-2012:

25.00%

30.00%

35.00%

40.00%

45.00%

50.00%

55.00%

2007 2008 2009 2010 2011 2012 2013 2014

General Government Revenue and Expenditure as % of GDP

General Government Revenue (% of GDP)

General government total expenditure (% ofGDP)

Figure 10; Source: IMF; the red colored parts indicate IMF staff estimates

-20.00%

-15.00%

-10.00%

-5.00%

0.00%

2007 2008 2009 2010 2011 2012

Greek Government Budget Deficit (% of GDP)

current account balance

Figure 11; Source: Eurostat

-8.00%

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

2009 2010 2011 2012 2013

% change in Unit Labor Costs

Unit Labor Costs (% change)

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

120.00%

140.00%

2008 2009 2010 2011 2012

Net external debt in % GDP-quarterly data

1st quarter

2nd quarter

3rd quarter

4th quarter

Figure 13; Source: Eurostat Figure 12; Source: IMF

48

Figure 14; World Bank Data.

By taking a quick look at some basic indicators of the Greek economy, it can be concluded that although

the Greek economy faced a huge downturn in 2009, it surely started recovering after the implementation of

the austerity measures and the two rescue packages, however not in a way that can completely save the

Greek economy. More specifically, if we examine Greece’s government revenues and expenditure, we will

find out that although situation improved after 2009 the projections of the IMF for 2013 and 2014 are not

as optimistic as they were. It is obvious that the Troika were not anticipating things to be so difficult after

Greece got into the program; although the Greek deficit showed a downward trend from 2009 to 2011, it

increased again in 2012. One of the indisputable attainments of the Troika however, was the decrease of

the unit labor costs. However, the increased productivity did not, as it will be shown on the following

section, increased Greek competitiveness. Figure 14 is a combination of the points of the annual Greek CPI

rate and the annual Greek unemployment rate from 1988 to 2013, what is known as a Phillips Curve. It is

clear that for the last 25 years the Greek Phillips Curve has its typical form, as the negative relationship

between the inflation rate and the unemployment rate is apparent. Furthermore, it is noteworthy that the

difficulties that Greece faces and the severe situation in which it came after 2009 is mostly an impact of its

Phillips Curve of the Greek Economy

49

external borrowing. So the huge government debt would not be such an important issue if the debt was

domestic; a good example is Japan. It is clear that after 2009 external borrowing for Greece greatly

increased due to the two rescue packages.

Moreover, another important indicator of the Greek economy is the Government debt. As we can clearly

conclude from the above figure, a great increase of the Greek government debt took place in the period

1993-1996; and it was a result of the fiscal policy followed by Constantinos Mitsotakis who was Prime

Minister for the period 1990-1993, and was the politician who started external borrowing for Greece and

Andreas Papandreou who was his successor and started borrowing excessive amounts of money from the

markets to increase Greek consumption in order to win voters. The second great increase in Greek

government debt as can be perceived from the figure was in 2009 after the outbreak of the crisis. After

2009, we can see several increases in the Greek government debt, results of the two rescue packages, and

the shrinkage of the Greek economy. Some important remarks here are that firstly the PSI agreement was

not as successful as the Troika expected; in addition, the privatization could not so far collect the planned

revenues. On the other hand we should admit that after the announcements of the ECB and the optimistic

stance of the Troika for Greece, 10-year Greek government bond spreads have greatly decreased. As we

can see on figure 9, Greek spreads started increasing at the start of 2010 when Greek politicians of the

0.00%

20.00%

40.00%

60.00%

80.00%

100.00%

120.00%

140.00%

160.00%

180.00%

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

General Government Gross Debt to GDP ratio

General Government Gross Debt (as % of GDP)

Figure 15; Source: IMF

50

government started the careless announcements and G. Papandreou revealed the higher deficit; and of

course after the agreement for the first bailout package. The great increase in the Greek spreads came at the

end of 2011 with the announcement of the second bailout package for Greece. The most turbulent period

was that of 2012 when Greece was also downgraded by Fitch even deeper than before into junk. Finally,

the spreads have greatly decreased at the start of 2013 when Greece showed its solemnity, adherence and

discipline to the austerity measures and when it was upgraded again to BBB at the credit rating scale.

4.5 Will the Troika succeed?

The next diagrams show a comparison of the Troika’s expectation about Greece and what really happened.

The data are taken from the five reports on the 1st adjustment program for Greece by the EC.

-8.00%

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

2011 2012 2013 2014

Real GDP growth

1st review 3rd review 4th review 5th review realization

Figure 16; Source: 1st adjustment program for Greece, European Commission reviews 1-5; and IMF

51

It is clear from a first look of figures 16 and 17 that the Troika’s expectations on the first adjustment program

for Greece do not reflect not even close the reality. However, we have to take into account that all the

reviews have been conducted before the haircut of the Greek government bonds. It is notable that most

recent reviews reflect better the trend of the real data, but there are huge deviations, both for the growth

rate and the unemployment. By taking a closer look of the data, it is understood that when the Troika was

implementing the austerity measures was not aware of the actual intensity of the consequences of its

policies. As the report was conducted before the second rescue package and the PSI agreement, it is only

fair to examine only the data for 2011. The first review of the EC, was predicting in its macroeconomic

scenario a GDP shrinking rate of only 3% while at the same year Greece faced a shrinkage of 7.11%. The

fifth review is the one that is closest to reality as it was conducted in October of 2011; at the same time

when the haircut of the Greek bonds had been decided. The deviations are even larger for the Greek

unemployment rate, as not even the fifth review could predict an unemployment rate of 17.47% in 2011.

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

2011 2012 2013 2014

Unemployment rate

1st review 3rd review 4th review 5th review realization

Figure 17; Source: 1st adjustment program for Greece, European Commission reviews 1-5; and IMF

52

-8.00%

-6.00%

-4.00%

-2.00%

0.00%

2.00%

2011 2012 2013 2014

Real GDP growth rate

1st review 2nd review realizations

Figure 19; Source: 2nd adjustment program for Greece, European Commission reviews 1-2; IMF

Figure 18; Source: 2nd adjustment program for Greece, European Commission reviews 1-2; IMF

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

2011 2012 2013 2014

Unemployment rate

1st review 2nd review realizations

53

It is obvious by taking a look at the figures of the second adjustment program for Greece that the

expectations of the macroeconomic scenarios are much closer to reality; especially the expectations of the

second review. Of course we should not underestimate the fact that those two reviews were conducted on

the end of 2012 and on the first quarter of 2013. The EC had the time, the data and all the information it

needed to assess the situation better and to achieve better estimations. The two reviews incorporated the

impacts of the new austerity measures, the second rescue package and of course the haircut. Nevertheless,

once again we can recognize deviations from reality; especially in the case of the unemployment rate, the

EC underestimated the negative impact of its program. Unemployment rate reached 24.24% in 2012 and

27.4% in 2013; these are unprecedented levels of unemployment for a European country. Moreover, if we

take into account the data published on June 2013 by the General Secretariat of Government Revenues, we

will find out that the Greek people and the Greek firms find it difficult to meet their tax liabilities; according

to the official data the outstanding debts to the state increased from €56,105,000,000 at the end of 2012 to

€59,774,229,887.97 on 2013. Two out of six millions of tax-payers owe taxes.

However, the true target of the Troika was from the beginning of the program the increase of

competitiveness of the Greek economy, in order to create a trade surplus by also decreasing imports.

The above figures present EC’s macroeconomic forecast for the annual percentage change in the value of

exports of goods and services of the Greek economy. It is quite obvious that the forecasts of the second

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

2011 2012 2013 2014

Annual % change of exports of goods and services

1st review 2nd review3rd review 4th review5th review

Figure 20; Source: 1st Economic Adjustment Program for Greece, European Commission reviews 1-5

0.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

2011 2012 2013 2014

Annual % change of exports of goods and services

1st review 2nd review

Figure 21; Source: 2nd Economic Adjustment Program for Greece, European Commission reviews 1-2

54

adjustment program for Greece are much more pessimistic. However, according to the formal data

presented by the IMF on its ex post evaluation of exceptional access under the 2010 Stand-By Arrangement

the estimated annual percentage change of exports of goods and services for Greece was 0.3% in 2011 and

-2.4% in 2012 and the projection for 2013 is an increase of 3%. Once again the EC underestimated the

negative impact of its policies and overestimated its probability of success. What we see in the Troika’s

reviews is a continuous shift of the Greek recovery at later dates. Heiner Flassbeck and Costas Lapavitsas

state in a paper for Rosa Luxemburg Foundation that the only way for the austerity policies of the Troika

to be successful is the creation of a trade deficit by Germany. It is impossible for the Greek economy to

recover by being thrifty when at the same time the exact same strategy is applied to Germany as well. So

the only way for the Greek economy to get back on track and be able to repay its debt by turning its current

account deficit into surplus is the adoption by Germany of the exact opposite policy. This problem was

thoroughly analyzed by Keynes (1929) and is known as the “transfer problem”

Conclusively, seeking help from an institution who does not have the appropriate experience in fighting

crises in a developed countries such as Greece and especially after three years of implemented measures

that did not have the expected success, maybe it is better for the Hellenic Republic to consider another way

in order to fight the crisis. It is clear now more than ever, that the policy implemented by the Troika did not

have the expected outcomes for the Greek economy, as not only Greece found it impossible to recover after

three years, but Greece is also worse off, as it faces no growth, larger unemployment and its government

debt increases with every new rescue package. The IMF supports that Greek debt will only be sustainable

if the Greek government manages to decrease it to 120% of GDP, something that looks unlikely with the

current data as Greece does not face the appropriate primary surplus. More specifically, Greece right now

may face a primary surplus, as the Greek government claims, but this is only large enough to cover part of

the interest; therefore until the primary surplus becomes large enough so that Greece can also cover part of

its amortization, the Greek debt will keep increasing every year. It is noteworthy that Greece’s interest

needs for 2013 are reaching €6.4 billion, while its primary surplus is only €2.55 billion; this means that

Greece will be able to repay only part of its interest. It is worth mentioning that the primary surplus of €2.55

billion that the Greek government claims it succeeded, is calculated without taking into account data such

as the profit refund of foreign central banks; calculating the surplus including this data, turns it into a

primary deficit of €3.25 billion. In addition, since the main problem for Greece is the structure of its debt,

which is mostly external, even if Greece had its own currency, a devaluation would only make the debt

more expensive. So Greece faces a situation in which, on the one hand by continuing on the path that the

Troika sets out and with the implementation of more austerity measures, things will get only more difficult

for its economy, and maybe after some years an exit from the Euro may seem the only solution, and on the

other hand, if Greece exits the Euro, introduce its own currency and proceed to devaluation will only make

matters worse. Therefore, it is pretty much straightforward that regardless of a Greek stay or exit, Greece

should restructure its debt, but this time, the restructuring of the debt has to be initiated by the borrower.

55

Furthermore, as the austerity measures are being implemented across the whole Europe, it will be

impossible for Greece to become competitive especially in relation to Germany. So the best solution as we

see it, is for Greece to proceed to an orderly default, an exit from the Eurozone and the introduction of a

new national currency.

It would not be an exaggeration to state that Greece’s entry in the Eurozone was a critical mistake from the

beginning. Of course becoming a member of the Eurozone helped Greece develop, but at what cost? It is

true that after Greece entered the Eurozone, it faced a growth rate of 4%, at the same time though, the

external borrowing increased by approximately 18%; so this development was a fictitious development. It

was a development, powered by loans, and targeted in the increase of consumption. The increase in the

borrowing was partly a result of the cheap funding, Greece could enjoy as a member of the Eurozone and

partly a result of the decrease of the monetary circulation that was imposed to Greece by the Eurozone,

while a same policy was not followed in the other member-countries. More specifically, the monetary

circulation faced a decrease in Greece from €7.7 billion in 2000 to €7.2 billion in 2001 (6.5% decrease);

while in 2002 the monetary circulation decreased in €5.4 billion (approximately 30% decrease from 2000).

It is noteworthy that the two devaluations of the Drachma before the entry made things even worse for the

Greek economy. Greece was after the entry a weak economy with a strong currency, a policy that improved

the exports of the strong economies like Germany but made things difficult for Greece. In 2000, the

Dollar/Drachma exchange rate was 365.40; the next year, when Greece introduced the Euro with an

exchange rate of 340.75 Drachmas per Euro, the Dollar/Euro exchange rate was 1.0493. Therefore, the

Dollar/Drachma exchange rate decreased to 357.54, which means an appreciation for the Greek currency.

It is important to mention that after the change of the currency with an exchange rate of 340.75 Drachmas

per Euro, the prices of products and services in Greece greatly increased as while economy had not become

any richer people were spending euro coins and banknotes without considering their much higher value. In

addition, upward rounding of prices was a common phenomenon as well. Moreover, signing the

Memorandum by the government of G. Papandreou was also the signing of concession of sovereignty of

Greece. Papandreou not only signed as collateral for the loans Greek public property but he did it under the

English law. To help the reader get a better picture of the situation after Greece entered the Eurozone, the

PPP conversion factor to market exchange ratio is shown on the next figure for the period 1998-2008.

56

Figure 22; Source: World Bank

Figure 22 depicts the situation in Greece after the introduction of the Euro. The PPP conversion factor to

market exchange ratio tells how many dollars are needed to buy one dollar’s worth of goods and services

in Greece; the upward trend is a result of the inflation created by the introduction of a strong currency in a

weak economy. It can be seen that the upward trend continued until 2008, and the outbreak of the financial

crisis. After 2008 the indicator decreased until it reached 0.93 in 2010, and it faced an increase again in

2011 when it reached 0.98.

Although, a Grexit may lead to the desired results, it might be the case that also the exit from the EU would

be necessary for the Greek economy to recover. According to the Treaty of Lisbon this is possible; Article

50 mentions: "Any Member State may decide to withdraw from the Union in accordance with its own

constitutional requirements". If a member of the EU decides to leave it first should notify the European

Council; after that an exit agreement would be negotiated with the leaving member and the Union. The

whole procedure may last for two years. It is a fact that twenty years ago Greece had a developed

agricultural sector, which constituted about 20% of the country’s GDP; it was a sector that was creating

surpluses. Everything changed with the Europeanization of Greece. It is true that EU gave a lot of subsidies

to Greek farmers, but most of these subsides were spent on consumption as most farmers were moving to

the cities and looking for jobs, increasing unemployment. Of course, Common Agricultural Policy played

an important role to the diminishing of the Greek agricultural sector, along with the trading restrictions such

as quotas and importing and exporting duties. Twenty years ago most Greeks had not much faith in the EU,

but this stance changed with policies like Integrated Mediterranean Programs (MPC) and Community

0

0.2

0.4

0.6

0.8

1

1.2

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

PPP Conversion Factor (GDP) to Market Exchange Ratio in Greece

57

Support Framework (CSF) later. These were programs that targeted in developing Greece and achieving

convergence with Europe. The fact though behind these projects was that for any amount of money that

was given to Greece as funding, Greece had to spend much more money and increase its borrowing. Most

of the companies that undertook public works funded by European projects like these, were French or

German. Therefore, EU was spending money in Greece using MPC programs or even by bribing Greek

politicians in order to finance its own corporations. It is not a coincidence that the huge public work of the

Eleutherios Venizelos airport was undertaken by German companies and the Rio-Antirrio Bridge was

constructed by Vinci, a French company; we can also consider the case of Siemens or the malfunctioning

submarines, and the list is really big. Finally, it should not be ignored that after an exit from the Eurozone,

Greece may face some problems with its EU membership anyway. Other members may think of Greece as

a member that disregards its commitments as Barry Eichengreen (2007) states.

4.5.1 A mathematical scenario

It would be pretty illustrative to construct a possible scenario of the repayment of the Greek debt, using the

assumptions made by the EC on its reviews of the adjustment program for Greece. The mathematical model

that will be used is taken from an IMF paper by Julio Escolano (2010). J. Escolano uses the following

equation (equation 22) in order to compute the appropriate constant per year primary balance (p*) in order

to reach a target debt ratio (d*) in N periods.

𝑝∗ =𝜆

(1+𝜆)−𝛮−1((1 + 𝜆)−𝛮𝑑𝑁

∗ − 𝑑0) (11), 𝜆 =𝜄−𝛾

1+𝛾

Where: p*=primary balance

d*=target debt ratio

d=current debt ratio

γ=annual nominal GDP growth rate

i=annual nominal interest rate which the country pays for its outstanding debt of the previous

period.

The assumptions that will be used are the following: d*=1.2, d=1.8, γ=0.0415, i=0.0475 and N=10. The

target debt ratio of 120% is the target the IMF put for Greece. The annual nominal growth rate of 4.15% is

the average of the projected nominal growth rates for Greece from 2014 to 2020. The rather optimistic

nominal interest rate of 4.75% is the average interest rate that Greece pays after the Greek haircut for the

money it borrowed at a range of 30 years. It is important here to mention that the assumption of a 4.75%

nominal interest rate has as a prerequisite that Greece will be able to find credit for the next 10 years which

58

is the period I examine at this specific and rather low rate. Putting the above values on equation 11, will

give us a primary surplus of about 6.9%. Even if we extend the period from 10 to 25 years the necessary

yearly primary surplus reaches 3.27%. It is noteworthy that right now Greece faces a nominal GDP growth

rate of -7.1%. Furthermore, by taking into account the comparison of the other Troika’s expectations and

assumptions to the realizations we find out that achieving the debt level of 120%, at which the debt is

considered sustainable, seems impossible.

4.5.2 How probable is the exit?

Taking into account that the current Greek government is not considering leaving the Eurozone as an

option, it would be logical to think that the probability of Greece leaving the Euro would greatly increase

with a left party government. The following election poll was carried by the firm Palmos Analysis in a

sample of 1,009 voters across the country.

Figure 23; Source: tvxs.gr

At the above figure, it can be seen the percentage distribution of the Greek voters. It is clear that SY.RIZ.A.

which is the left party is 2.6 percentage points in front of N.D. which is the neoliberal right party. Given

the views of the two parties and also the treatment they enjoy in their relationships with the Troika and the

Eurozone we could figure out that an election of SY.RIZ.A. would mean possibly an exit from the

Eurozone.

0

5

10

15

20

25

Election Poll 2013

59

Another way to assess how probable a Grexit is, is the examination of the Greek import coverage. A general

rule of thumb is that foreign exchange reserves should be enough to cover three months’ worth of imports.

If they are not adequate to cover three months’ worth of imports, a confidence crisis can arise, that could

force Greece to exit the Eurozone.

Figure 24; Source: Bank of Greece

By taking a look at the official data of Greece, we will find out that in 2011 the yearly average of foreign

exchange reserves for Greece was €4853.9 million, in 2012 it was €5550.9 million and €5036.4 million for

2013. After the appropriate calculations it can be derived whether Greece’s import coverage is adequate

according to the three month rule of thumb and whether it is not. The results are showed on the next figure.

0

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2000

3000

4000

5000

6000

7000

Feb

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Imports vs Foreign Exchange Reserves

Imports ForEx reserves

60

Figure 25

As it can be concluded from the above diagram, Greece’s foreign exchange reserves for the period 2011-

2013 are enough to cover the value of imports of just one month, violating the international standard of

three months. It is obvious that the import coverage was lower in 2011 when Greece faced many economic

problems, it increased in 2012 and again decreased in 2013. The decrease in 2013 proves once again that

Troika’s policies did not have the expected results. It would also be helpful here to show the progress of

the consumers’ confidence over the years. It is clear from figure 25 how low the Greek consumers’

confidence from 2010 until now is. And what is important to underline here is that their confidence did not

improve during the three years that Greece follows the Troika’s policies. Famous financial sites like Capco

and Sentix give Greece the highest probabilities of Exit in the Eurozone.

Figure 26; Data from Eurostat. *-100 means complete lack of confidence, 0 neutrality and 100 extreme confidence.

0

0.4

0.8

1.2

1.6

Import Coverage for Greece

2011 2012 2013

-90

-80

-70

-60

-50

-40

-30

-20

-10

0

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Mar'10

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Consumer's Confidence for Greece

61

Chapter 5 Plan B The main objective of the thesis after taking into account the lessons we drew from the precedents was to

construct an exit plan for Hellas. Although making the decision to leave the Eurozone is a big step for

Greece, the most difficult part of an exit would be the planning and organizing of the appropriate measures

that have to be taken in order for the exit to be beneficial for the Greek economy and the Greek people;

what is called “the Plan B”. The exit plan is based on three basic pylons: suspension of payments-auditing

of debt and liabilities, introduction of new national currency-capital controls and organizing of the next

steps-development. The construction of the whole plan along with the assessment of the probable outcomes

must be completed in secrecy in order not to cause panic and capital flight.

Suspension of Payments is the pretty first step that the Greek government needs to take in the path of a

Grexit. It is clear that a suspension of payments initiated by the lender did not have the appropriate results,

so what has to be done is a suspension of payments initiated by Greece itself. A suspension of payments is

equivalent to an orderly default. Of course the default of a country is nothing like a bankruptcy of a firm.

When a firm goes bust, it stops existing and its creditors have legal rights to proceed to confiscation of its

property. On the other hand the same cannot happen with a country which after the default continues to

exist, as its people continue to live in it and its property continues to belong to its people. It has to be

emphasized that a temporary suspension of payments does not necessarily mean the permanent default on

all of Greece’s debts and liabilities. It also has to be noted that a suspension of payments is not illegal; the

United Nations’ International Covenant on Economic, Social and Cultural Rights (ICESCR) includes the

right to work, the right to just and favorable conditions of work, trade union rights, the right to social

security, rights related to the protection of the family, the right to an adequate standard of living, the right

to health, the right to education and rights related to culture and science; rights that have been clearly

violated with the implementation of the Troika’s austerity measures by the coalition government of Antonis

Samaras as unemployment reached unprecedented levels, people have to work more hours for lower wages,

workers are laid off without compensations, schools and hospitals were shut down, different municipalities

assimilated, public property was sold or privatized arbitrarily without taking into account its strategic nature

or its financial utility to the budget and also there have been incidents with the government prohibiting

strikes and public demonstrations. The latter in conjunction with the encroachment of the collective

agreements via the salary reductions in both public and private sector constitute a massive blow for the

labor rights. More specifically, Dr. G. Katrougalos (2013) states in his article that the austerity measures

violate several structural constitutional principles (such as the principles of equality of public burdens and

of a social state of law – article 4, paragraph 5 and article 25, paragraph 1 of the Greek Constitution) and

fundamental social rights (articles 21, 22 and 23 of the Constitution). Moreover, they constitute a violation

of collective autonomy, which is guaranteed by Article 22, paragraph 2 of the Greek Constitution and a

number of international treaties, for example Article 8 of International Labor Convention no 151 of 1978

and Article 6 of the European Social Charter. They also violate essential guarantees of the EU Charter of

62

Fundamental Rights and International Labor Law. Even the EC admitted in its first review of the second

adjustment program that important budgetary measures are likely to be challenged in courts, something that

could lead to the need to fill a fiscal gap emerging as a consequence. It is noteworthy that in similar

situations such as the precedent in Hungary in 1990, the existence of the Constitutional Court was

substantial as it could act in the interest of the Hungarian democracy by blocking IMF imposed cuts and

measures if it considered it necessary; the absence of a similar institution in Greece constitutes a basic lack

as no opposition MP seem to resist actively either. It is noteworthy here to mention the case of the Greek

loan to Germany during the German occupation of Greece. A loan that although has been recognized even

by Hitler, it has never been repaid by the Germans. Dr. Christoph Smink Gustavous (2013) believes that

Greece must demand the repayment of the loan who were signed by force on 14 March 1942 by the Greek

government.

Auditing of the debt and liabilities is the very next step after the suspension of payments. It is important

to commit auditing of the debt and liabilities in order to find out which part of the debt is odious and which

is not. The characterization of debt as odious was first used by the Russian jurisprudence expert and

professor of Russian law Alexander Nahum Sack in Paris on 1927. He defined as odious the debt which

was generated at the expense of the people, without them agreeing on that debt. There are several parts of

the Greek debt that could be characterized as odious. It is important to arrange an auditing of the debt so

that the Greek people will decide which part of their debt they accept and they are willing to pay. More

specifically, as odious debts could be characterized:

Debts that were created in the past and have been repaid before. It is noteworthy that Greece

defaulted four times in the past (1827, 1843, 1897,1932), but it continues to pay part of the

interests of those debts.

Debts that were created during the period of the dictatorship of the colonels and were quadrupled

between 1967 and 1974.

Debts that were created after the organization of the Olympic Games of 2004. The scandal was that

when the Greek government announced on 1997 that the Olympic Games would take place in

Greece, it also announced that the games would cost $1.7 billion while later the cost increased to

$5.3 billion. After the end of the Olympic Games the official cost amounted to $14.2 billion.

Debts due to signed contracts with Siemens, the multinational firm that was accused by both the

Greek and the German justice for bribing of Greek politicians, and martials for the sale of

equipment and other services such as Anti-missile Patriot Systems, digitization of

telecommunication centers of OTE, equipment for OSE, telecommunications system Hermès for

the Greek military, equipment for Greek hospitals and security system C4I.

Debts due to the German submarines scandal. The word is for the purchase of two German

submarines (for €5 billion) by the Greek government that were defective.

63

The debts due to the rescue packages from the Troika. The main reasons for characterizing these

debts as dubious are mainly the time of repayment, the very high and usurious interest rates and

the fact that the Greek people never agreed with the signing of those loans.

The €3 billion Goldman Sachs loan that was signed by then Prime Minister C. Simitis in order to

bribe Goldman Sachs to change the national economic data so that Greece could enter the European

Economic Union.

And these are just a few of the examples of parts of the Greek debt that could be characterized as odious.

It should be noted that the auditing of public debt and liabilities is not something new, as it was done

by Ecuador in 2007-2008, and their government managed to greatly diminish the government debt. If

we take a look of the Greek government budgets of the period 1984-2011 we would find out that Greece

spent in order to service its debts €785 billion, of which €209.5 billion were interest. It is noteworthy

to quote the official data from the Greek budget of 2013; in 2009 the debt servicing needs reached

€41.460 billion in interest and amortization plus €36.904 billion in repayments of short term securities,

in 2010 the debt servicing needs decreased to €32.772 while at the same time the repayments of short

term securities reached €22.601. The situation greatly changed during 2011 when the debt servicing

needs amounted to €45.195 billion plus €33.395 in repayments of short term securities, and in 2012

while the debt servicing needs decreased to €25.160 billion the repayment of short term securities

increased to €43.607 billion. It is clear after the calculation of the sums that Greece mainly borrows

money in order to repay previous loans.

Introduction of the new national currency: Proceeding to the two previous steps presupposes that

the Greek government will be eager and ready to leave the Eurozone. Stepping out of the Euro is not

an easy step and will be costly both in time and money. The introduction of the new currency needs

good planning, quick decisions and as much secrecy as possible at least at the beginning. Stepping out

from a monetary union is not something new, so the Greek government can easily follow the examples

of previous breakups in order to minimize the costs.

The Grexit should start with a bank holiday. It is better if this is planned to happen on a Greek national

holiday or else on a Friday, so that the government will have 3 to 4 days (including Monday) to plan

the next steps. In this bank holiday all transaction would be prevented; the same applies for electronic

transactions via e-banking and for transactions with ATMs. It is of grave importance along with the

temporary freezing of the deposits that the government will announce capital controls, as most people

will try to move their money abroad in order not to lose purchasing power. After the bank holiday and

the announcement of the introduction of the new currency, it is impossible to start immediately the

circulation of the new currency; the government may need 4-6 months in order to print and to introduce

the new currency in the economy. Although starting the printing of the new currency before even

64

announcing the Grexit may seem a good idea, it would be merely impossible to do this in complete

secrecy; there would be leaks that could ruin the whole plan. A good question is how the economy

would operate those 4-6 months without a currency. We saw that in previous exits from monetary

unions stamping of the old currency was used as a solution; this consisted a good solution for other

unions because the old currency would stop circulating after the introduction of the new. But in the

case in point, the Eurozone will continue to exist and other countries will continue to use the Euro after

the exit of Greece. There are two possible solutions:

One is to convert all prices into the new currency and let the economy to operate with plastic

money i.e. credit cards, debit cards, other bank cards etc. until the circulation of the new

currency. Of course using credit cards is easy for transactions of higher value but is more

difficult for everyday transactions. For transactions of low value people could work with credit.

The other is to continue using the Euro as a foreign currency. This dual currency system can be

used as it was used in most of the Soviet Union member countries after the collapse of the

union or as it is used in countries like Turkey where people in shops accept payment in Euros.

An important issue is the conversion exchange rate. Maybe the best solution would be the 1-1 conversion,

where €1 would be converted to 1 new Drachma. This was also suggested by Roger Bootle (July 2012) in

his practical guide. All deposits, prices, wages, pensions and loans will be converted from Euros to new

Drachmas, and all contracts in Euro will be redenominated in new Drachma. The 1-1 conversion is the best

solution in order to avoid inflation due to upward rounding of prices after the introduction of the new

Drachma. Of course this exchange rate would be valid only at the beginning and only inside Greece, as the

exchange rate with the Euro would later change and €1 would cost more than 1 new Drachmas.

Capital Controls: The next most important issue is the imposition of capital controls. As it was mentioned

before in this section, after the announcement of the Grexit most people and firms will try to move their

money abroad in order to benefit from the later devaluation. So it is a necessity that the government will

prohibit all money transfers, not only money transfers via banks and e-banking but also the physical money

transfers through the borders. This is not something new as capital controls were used in most of the cases

of union breakups we have examined. There are some concerns about the legality of the imposition of such

meters, as an EU member can impose capital controls according to a provision (Article 59) only for six

months and after the approval of the ECB and the Commission and the agreement of other members. This

is an issue that mainly concerned economists who believe that an exit should be temporary and who for no

reason consider an exit from the EU as well. However, in the case of Grexit, the legality of the capital

controls will be only a minor issue as there are so many other things that will be more important for the EU

and the other members. There is also the precedent of Iceland who used capital controls after the

recommendation of the IMF for far more than six months and is using them until today. Imposing capital

controls in order to prevent capital flight and sharp depreciation was a successful meter in the case of

65

Iceland, and it can surely be helpful in the case of Greece. As far as the Greek deposits in foreign banks are

concerned, government can impose higher taxes in order both for the country to benefit in the form of

government revenues and to discourage future capital flight.

After the new currency has been printed, banks will be able to exchange any amount of Euros for new

Drachmas at the initial conversion rate of 1-1. However most people will try to save Euros in their homes

in order to spend it abroad or exchange it after the devaluation of the new currency. A pre-emptive move

by the government and the banks would be to buy this money in a higher exchange rate, in order to take it

out of the economy and increase the country’s foreign exchange reserves.

It is important that the government will announce the nationalization of the Greek Central Bank and also

the nationalization of the largest private banks. Right now the Greek Central Bank is according to its article

8 of association a diversified private company, and while there is no limit to what extent it can be privately

owned there is a limit to the extent it can be publicly owned; this limit is 35%. It is unacceptable to leave

the conducting of monetary policy along with the ownership and management of the foreign exchange

reserves and the control of the private banks to a limited company. It is a fact that after the Greek exit, most

banks will face many difficulties and may even go bankrupt. In order to support the banks and avoid a

collapse of the whole Greek banking system the banks must be public. We should not overlook also the

fact that the Greek private banks were several times recapitalized by the government overloading the Greek

government budget; economist and researcher D. Kazakis supports that the cost of those recapitalizations

reaches €360 billion. It is a fact that most of the €50 billion that Greece borrowed from EFSF in order to

recapitalize the private banks did not go to the Greek market; the money was used by the banks in order to

increase their profitability by buying English and Luxembourg bonds. It should be noted that the annual

rate of change of the total funding of the domestic private sector was -4.1% on June 2013 from -3.7% on

May 2013. Moreover, the net flow of total credit to the domestic private sector was negative by €212

million, while on June 2012 it was positive at €852 million. After the nationalization of the banks, it is

important to stop any auctions of houses of people that could not repay their loans and also to delete the

debts of people and businesses that cannot repay them or repaid most of the loan so that the market will be

revivified.

Next Steps: After the implementation of the program it is necessary for the government to arrange the next

steps; and by next steps we mean, the devaluation of the currency, the export agreements, the planning of

protectionism of the internal market and the organizing of a development program for the future so that the

Greece will continue its good course.

One of the main reasons why being a member of the Eurozone made it difficult for the southern countries

to become competitive was the lack of the right to devalue their currency; however, after the Grexit, Greece

66

will be free to conduct its own monetary policy. A devaluation of the new Drachma will happen as soon as

the new currency is introduced. By taking into account precedents of exits from unions and devaluations

that happened there, such as the incident of Argentina, we can predict that the devaluation of the new

national currency could reach 40%-60%. This devaluation is substantial to happen in order for the Greek

economy to recover. This will happen by the immediate increase of the Greek exports as they will be

cheaper and at the same time the decrease of Greece’s imports as they will be more expensive. Although a

devaluation of the currency is necessary in order for the country to achieve the external devaluation it needs,

it is also substantial to avoid further depreciations of the currency that could only hurt the economy. This

can be done by using some kind of protectionist policy such as by being strict with its framework of fiscal

and its monetary policy and show its commitment to the framework. Using its foreign exchange reserves

to buy the national currency in the international market is another policy but of course this kind of policy

will be more difficult to use, as Greece’s foreign exchange reserves after the exit will not be enough. An

important issue here is also the return of the Greek gold reserves back to Greece. Greece owns 111.5 tons

of gold, and half of them are been kept in three different foreign banks; the UBS in Switzerland, the FED

and the Bank of England.

Another thing that the Greek government should take into account is the after the exit inflation. There are

precedents of hyperinflation on previous Union breakups so the government should take the appropriate

meters to avoid this from happening. This also can be done by being strict with its policies and remain

reliable to its commitments so that it will not change peoples’ and market’s expectations. The Greek

government should use an inflation targeted regime and again not use excessive fiscal policy. It can also

use index-linked bonds and disconnect the increase in wages from the inflation in order to strengthen the

anti-inflation expectations. Right now in Greece the automatic indexation for wages is used.

Among Greece’s next steps, the new export and import agreements are included. One of the main concerns

and fears of most Greek people is the ability of Greece to buy oil after the exit from the Eurozone. They

fear that for the first months at least Greece because of lack of money or because of ruined relationships

with other Eurozone members would find it difficult to ensure the necessary amounts of oil. A good solution

for these first months and while Greece is in the transitional stage, would be the government to start the

process of exit at the end of February; this would give it a seven month window until next winter –when

oil needs are increased due to heating needs- in order to sign new oil-import agreements. As far as

pharmaceuticals and food are concerned, until the time Greece develops the existing Greek industries and

sign new import agreements, the government could use administrative measures and priority coupons. After

these months Greece should be able to sign new agreements. However, Greece as a member of the EU is

obliged to adhere to specific import and export agreements, customs, duties and quotas and also specific

agricultural productions according to Common Agricultural Policy. If the EU will not cooperate and will

not agree to give Greece the freedom to act outside the legal framework at least until it recovers, it may be

67

necessary for Greece to consider the possibility of exiting the EU as well. Without any limitations Greece

can easily sign import agreements for oil and other products that will benefit it in terms of cost. The

agreements may also include some credit at least for the first years or payment in kind. The exchange of

products between countries is not something new, Greece did it in the past with Russia, by paying with

oranges for agricultural equipment; Honduras also buy oil from Venezuela with chickens and coffee. It is

noteworthy that the nationalization of ELPE (Hellenic Petroleum) which is the largest refining company in

Greece and one of the major groups in the energy sector in Southeast Europe could according to economist

and researcher D. Kazakis decrease the gasoline price by 2.5%.

It is a fact that after the Grexit, the introduction of the new national currency and its depreciation, Greek

exports will immediately increase. However, as both agricultural and industrial sectors of Greece are weak

right now, it is necessary that the Greek government will support those sectors by using protectionist policy.

The increase in the cost of imports will diminish them but it is also substantial to proceed to import

substitution with national products and use import duties in order to achieve the internal market recovery.

After some time Greek livestock and agricultural sectors can develop again and focus on the production of

quality goods and in products where they have a comparative advantage such as olive oil, tobacco, fruit and

vegetables, cotton, honey, wine, yoghurt, cheese. Greek industrial sector can also recover and become again

competitive; building a productive base for Greece is the number one priority along with the shrinkage and

improvement of services.

Finally, the government should proceed to the cancelation of every privatization and privatization

agreement of public property that is scheduled to happen or happened as part of the Troika’s plan for

Greece. In this list are included the privatization of OPAP which is being processed right now, the

privatization of water companies, the sale of the mine and forest in Halkidiki to the Canadian mining

company Eldorado and others. As we mentioned before privatizations cannot be the solution to the

problems of Greece. A public company can be organized and managed to work and supply the same quality

just like a private company. Furthermore it is one thing to privatize a public company without asking Greek

people and another to privatize free commodities such as water and forests. The sale of the forest of

Halkidiki which is the forest above the mine was done without taking into account the problems that its

destruction would cause to the people living there and to the environment; it was sold for the outrageous

price of €1. Moreover, if we take into account official data we will find out that the natural monopoly of

water gives the public companies of water the possibility to ensure large profits. In the period 2007-2011

the public water companies in Greece made a profit of €75.2 million and in 2012 a profit of €17.8 million;

it is noteworthy that the company has a reserve of €35 million. Therefore, the public water company is a

profitable company just like ERT (the Greek national radio-television company) that was shut down while

in 2012 face a surplus of €129 million. After all, why to sell public companies and benefit only once while

instead you can realize every year profits by owing them. But even if we examine examples of privatizations

68

of water in other countries we will find out that in most cases it created problems. The privatization of water

in Britain led to the increase of its price by 50%, to quality reduction, and to repeated violations of

environmental legislation. In Bolivia after the privatization, water tariffs increased by 200-300%. It is

obvious that by ceding the production and distribution of a public good to a private company that its main

objective is the maximization of its profits you are risking that the company will not act on the basis of the

social interest. It is no coincidence that the referendum for the privatization of water companies in Italy,

resulted in 95% of Italians voting against the privatization.

69

CHAPTER 6 Discussion and Conclusions The main purpose of this thesis, was to find out how possible a Hellexit is and construct an exit plan for

Greece. When the Hellenic Republic faced the dilemma in 2010 of staying in the Eurozone and trying to

fight the crisis with the help and suggestions of the Troika, or leaving the Euro, defaulting orderly and

introducing its own new national currency, the then prime minister G. Papandreou decided that accepting

help from the IMF and Europe and trying to fight the lack of competitiveness with internal devaluation was

the optimal solution. In this dissertation, I examined the possibility for Hellas to leave the Eurozone, default

on its debt and introduce its own new national currency. Although, it is not the first time that a country

leaves a monetary union, there is no precedent that constitutes a complete parallel of an exit from the Euro.

As the Eurozone is a 17 member monetary union with one common currency and a strong Central Bank

without any political union.

In the first section I examined several cases of union breakups that could become the examples of a Hellexit

and could be used to draw lessons for the exit plan. The case of the breakup of the Austro-Hungarian Empire

was not an optimistic one as both countries suffered from hyperinflation after the breakup and faced

problems with the stamping of the currency and capital flight. In the case of Czechoslovakia while it was a

two member union, the breakup was more optimistic as it was quick and successful. In addition, in the

incident of the breakup of the Soviet Union, the disintegration of the Union was more beneficial for the

stronger Baltic economies while more costly for the weaker ones. After these breakups I examined the case

of the United States during the Great Depression while F.D. Roosevelt proceeded to the suspension of the

gold standard and devaluation, a policy that turned out to be very helpful for the economy along with the

introduction of some Keynesian measures in order to limit the negative impacts of the crisis. Maybe the

incident that is the most close to a Hellenic exit was the case of Argentina in 1999. Although the two cases

share many things in common, we should keep in mind the differences in the economic environment back

then and now. Argentina dropped the peg with the dollar in an economic environment characterized by

prosperity and development, while this is not true for Hellas right now as most economies of the world are

facing economic difficulties. Last but not least I examined the case of the Icelandic crisis of 2008; a case

which also shares several things in common with the case of Greece. What we learned from the Icelandic

case was that leaving the banks to collapse is not always a bad thing, and that devaluations may help the

economy to recover.

On the next section I continued with empirical analysis by running several regression analyses. On the first

regression analysis I examined the relationship of the Greek to the German yields to maturity and I found

out, as it was expected, that there is a strong negative relationship, meaning that countries like Germany

made money because of the bad economic conditions in countries like Greece; money that was not used in

order to help the weaker economies. The second regression analysis examined the relationship between the

70

Greek yield spreads to the Greek debt. As it was expected there is a strong positive relationship between

the two variables. However, when I examined the relationship of the yield spreads to the debt squared, I

found out a negative relationship; a relationship which proves the credit rationing effect and captures the

debt market imperfections. The third regression examined the relationship of Greek CDS spreads to the

Greek debt, the German CDS spreads and the liquidity policies implied by the ECB. As expected the Greek

CDS spreads are positively affected by the German CDS spreads and the Greek debt and finally, negatively

by the open market operations of the ECB. This negative relationship may be explained by investors shifting

from investments in investment grade bonds to investments in sovereign bonds. Next, it was examined if

the Okun’s law is applicable in the Greek economy. The results showed that for the period 2005-2013, the

Okun’s law is conspicuous in the Greek economy with an Okun’s estimator of -0.13. This negative

relationship, means that when the Greek GDP decreases by 1% the unemployment rate increases by 0.13%.

The next step was to run regression analyses for examining the relationship of the Greek over the German

10 year bond yield spreads and the credit rating by the three credit rating agencies. As it was expected, a

positive relationship was conspicuous, meaning that the credit rating of the agencies affects the borrowing

costs of Greece. The same was results were found from the regression of the Greek CDS spreads to the

credit ratings of the three credit rating agencies. The positive relationship between the CDS spreads and the

credit ratings was even stronger meaning that credit rating by the agencies greatly affects the risk of

investing in Greek sovereign debt. After the econometrical analysis I examined the expectations of Troika

for Hellas and compared them to what really happened to the Hellenic economy. I examined several

indicators such as the real growth rate and the unemployment rate and in order to find out if the main goal

of the Troika which is the increase of competitiveness of Hellas was succeeded I examined the Greek

exports. In all of the cases, EC’s reports were always underestimating the negative impacts of the Troika’s

plan for Greece. Even by examining a mathematical scenario for the Greek debt repayment, the assumptions

in order Greece to decrease its debt to a sustainable level seem unrealistic with the current data. Finally, by

examining the election polls along with import coverage ratio for Greece, we concluded that after 2011

Greece faces an increased probability of exit. Not only internal devaluation did not have the expected results

but also worsened the situation for the country. So internal devaluation was not the optimal policy for Hellas

which did not manage to increase its competitiveness. Every new rescue package for Hellas greatly

increases its debt, which right now including the new package of 2012 and the installment of 2013 reaches

€378.8 billion or 194.81% of GDP. As this amount of debt is enormous and according to the IMF it will be

viable only if it reaches 120% of GDP, something that with the current data and with the lack of a primary

surplus is impossible, the only solution for Hellas is an orderly default and an exit from the Eurozone in

order to recover through external devaluation. In this way Hellas will manage to improve its terms of trade,

regain its internal market and create steadily an industrial base.

The final section of the thesis, constitutes the suggested exit plan for Hellas after taking into account the

famous precedents of monetary union breakups. The plan is divided in three main sections: suspension of

71

payments-auditing of the debt and liabilities, introduction of the new national currency-introduction of

capital controls and next steps-development. The suspension of payments should be initiated by the

borrower, in contrast with the PSI that already took place. At the same time the auditing of the liabilities is

important, in order to find out which part of the debt is dubious and which is not. The introduction of the

new currency should be done at a 1-1 exchange rate. The introduction of the capital controls is critical in

order to avoid capital outflows. Finally, the government should organize its next steps, in order for the

country to recover steadily.

Taking all the appropriate measures and following the path of a Hellexit will not be easy especially at the

beginning, but looking forward in the future and trying to build a stable, sovereign and strong economy

instead of looking how to avoid the temporary hardship of an exit must be the main objective of Hellenes

right now.

72

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APPENDIX A DEFINITIONS On the following section I will give some basic definitions, to make things more understandable to the

regular reader.

Monetary Union (Currency Union): When two or more groups (usually countries) share a common

currency or decide to peg their exchange rates in order to keep the value of their currency at a certain level.

One of the main goals of forming a currency union is to synchronize and manage each country's monetary

policy. More specifically there are three types of currency unions:

Informal - unilateral adoption of foreign currency

Formal – adoption of foreign currency by virtue of bilateral or multilateral agreement with the

issuing authority, sometimes supplemented by issue of local currency in currency peg regime.

Formal with common policy – establishment by multiple countries of common monetary policy

and issuing authority for their common currency.

Currency Peg: A country or government’s exchange rate policy of pegging the central bank’s rate of

exchange to another country’s currency. Currency has sometimes also been pegged to the price of gold.

Also known as a “fixed exchange rate” or “pegged exchange rate”.

Gold standard: A monetary system in which a country's government allows its currency unit to be freely

converted into fixed amounts of gold and vice versa. The exchange rate under the gold standard monetary

system is determined by the economic difference for an ounce of gold between two currencies. The gold

standard was mainly used from 1875 to 1914 and also during the interwar years.

Eurozone: The official name is Euro area. It is an economic and monetary union (EMU) of 17 European

Union (EU) member states that have adopted the euro (€) as their common currency and sole legal lender.

The countries that constitute Eurozone are Austria, Belgium, Cyprus, Estonia, Finland, France, Germany,

Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain. Any

other EU state is obliged to join once it meet the criteria to do so; UK and Denmark are excluded. There

are no provisions for a state to leave the union by itself or to be expelled.

International Monetary Fund (IMF): The international organization created for the purpose of:

Promoting global monetary and exchange stability.

Facilitating the expansion and balanced growth of international trade.

Assisting in the establishment of a multilateral system of payments for current transactions.

The fund surveys and monitors economic and financial developments, lends funds to countries with

balance-of-payment difficulties, and provides technical assistance and training for countries requesting it.

81

European Central Bank (ECB): The central bank responsible for the monetary system of the European

Union (EU) and the euro currency. The bank was formed in Germany in June 1998 and works with the

other national banks of each of the EU members to formulate monetary policy that helps maintain price

stability in the European Union. The European Central Bank has been responsible for the monetary policy

of the European Union since January 1, 1999, when the euro currency was adopted by the EU members.

The responsibilities of the ECB are to formulate monetary policy, conduct foreign exchange, hold

currency reserves and authorize the issuance of bank notes, among many other things.

Eurobond: It is defined as government bonds that would be the liability of the Eurozone in the aggregate.

Open Market Operations: The buying and selling of government securities in the open market in order

to expand or contract the amount of money in the banking system. Purchases inject money into the

banking system and stimulate growth while sales of securities do the opposite.

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APPENDIX B STATA RESULTS

1st Regression results

Table 14. Regression analysis of Greek and German 10yr bonds yields to maturity

Table 15. Summary of the Data

Table 16. Correlation Matrix

Table 17. Skewness/Kurtosis test

_cons 37.11046 .8006106 46.35 0.000 35.53884 38.68209

gerb -8.476647 .3290642 -25.76 0.000 -9.122611 -7.830683

grb Coef. Std. Err. t P>|t| [95% Conf. Interval]

Total 54936.282 775 70.8855251 Root MSE = 6.1818

Adj R-squared = 0.4609

Residual 29578.1549 774 38.2146704 R-squared = 0.4616

Model 25358.1271 1 25358.1271 Prob > F = 0.0000

F( 1, 774) = 663.57

Source SS df MS Number of obs = 776

.

gerb 776 2.337662 .6748133 1.167 3.491

grb 776 17.29493 8.419354 5.522 37.101

Variable Obs Mean Std. Dev. Min Max

gerb -0.6794 1.0000

grb 1.0000

grb gerb

.

myResiduals 776 0.0000 0.4852 40.24 0.0000

Variable Obs Pr(Skewness) Pr(Kurtosis) adj chi2(2) Prob>chi2

joint

Skewness/Kurtosis tests for Normality

83

2nd Regression results:

Table 18. Regression analysis of Greek yield spreads to Greek debt

Table 19. Summary of the statistics

Table 20. Summary of the Residuals for the Jarque Bera test

_cons -1.200041 .0833377 -14.40 0.000 -1.363514 -1.036569

debtsqrd -.4531265 .0401879 -11.28 0.000 -.5319577 -.3742954

debt 1.560669 .1169094 13.35 0.000 1.331344 1.789994

spread Coef. Std. Err. t P>|t| [95% Conf. Interval]

Total 11.9589794 1487 .008042353 Root MSE = .06739

Adj R-squared = 0.4353

Residual 6.74370162 1485 .004541213 R-squared = 0.4361

Model 5.21527782 2 2.60763891 Prob > F = 0.0000

F( 2, 1485) = 574.22

Source SS df MS Number of obs = 1488

debtsqrd 1488 2.248159 .6622092 1.265332 3.220984

debt 1488 1.482017 .2276363 1.12487 1.79471

spread 1488 .0941967 .0896792 .00304 .35301

Variable Obs Mean Std. Dev. Min Max

99% .1944198 .2176898 Kurtosis 4.077846

95% .1545934 .2124898 Skewness 1.256251

90% .1017034 .2123498 Variance .0045351

75% .0255086 .2122598

Largest Std. Dev. .0673432

50% -.028437 Mean 1.14e-10

25% -.0470794 -.094297 Sum of Wgt. 1488

10% -.0609936 -.094317 Obs 1488

5% -.074347 -.095027

1% -.088747 -.095277

Percentiles Smallest

Residuals

84

Table 21. Correlation Matrix

3rd Regression results:

Table 22. Regression analysis of Greek CDS spreads to OMO, Greek Debt and German CDS spreads

Table 23. Summary of the Statistics

debtsqrd 0.6070 0.9978 1.0000

debt 0.6228 1.0000

spread 1.0000

spread debt debtsqrd

_cons -13.90013 .41666 -33.36 0.000 -14.71782 -13.08245

Debt 14.23924 .5063752 28.12 0.000 13.24549 15.23298

OMO -5.27e-06 4.80e-07 -10.99 0.000 -6.22e-06 -4.33e-06

gerCDS 3.052076 .3702768 8.24 0.000 2.325417 3.778735

CDS Coef. Std. Err. t P>|t| [95% Conf. Interval]

Total 10376.5091 949 10.9341508 Root MSE = 1.3973

Adj R-squared = 0.8214

Residual 1846.90295 946 1.9523287 R-squared = 0.8220

Model 8529.60619 3 2843.20206 Prob > F = 0.0000

F( 3, 946) = 1456.31

Source SS df MS Number of obs = 950

Debt 950 1.369863 .2031695 1.12487 1.70617

OMO 950 651557.3 142321.3 396986 910450

gerCDS 951 .4017553 .2160321 .0626428 .9913332

CDS 951 3.426945 3.451009 .2228093 34.02913

Variable Obs Mean Std. Dev. Min Max

85

Table 24. Summary of the Residuals for the Jarque Bera test

Table 25. Correlation Matrix

Tables of fourth regression

Table 26. Regression analysis of changes in unemployment rate and changes in GDP

.

99% 4.402787 5.53477 Kurtosis 4.54057

95% 2.456737 5.505929 Skewness .6126806

90% 1.518952 5.324203 Variance 1.946157

75% .5831198 5.236639

Largest Std. Dev. 1.395047

50% .0752598 Mean -1.81e-09

25% -.9026355 -3.152142 Sum of Wgt. 950

10% -1.788751 -3.172124 Obs 950

5% -2.25315 -3.564428

1% -2.849439 -4.052996

Percentiles Smallest

Residuals

Debt 0.8746 0.7887 0.6940 1.0000

OMO 0.4553 0.3768 1.0000

gerCDS 0.8038 1.0000

CDS 1.0000

CDS gerCDS OMO Debt

_cons .531352 .1497031 3.55 0.001 .2264167 .8362872

dy -.1281691 .0545867 -2.35 0.025 -.2393586 -.0169796

du Coef. Std. Err. t P>|t| [95% Conf. Interval]

Total 28.5030614 33 .863729135 Root MSE = .87167

Adj R-squared = 0.1203

Residual 24.314142 32 .759816937 R-squared = 0.1470

Model 4.18891945 1 4.18891945 Prob > F = 0.0252

F( 1, 32) = 5.51

Source SS df MS Number of obs = 34

86

Table 27. Skewness/Kurtosis test

Regression analyses of the Ratings:

Table 28. The three agencies scales and the numbering of each level

Moody's S&P Fitch

Aaa 1 AAA 1 AAA 1

Aa1 2 AA+ 2 AA+ 2

Aa2 3 AA 3 AA 3

Aa3 4 AA- 4 AA- 4

A1 5 A+ 5 A+ 5

A2 6 A 6 A 6

A3 7 A- 7 A- 7

Baa1 8 BBB+ 8 BBB+ 8

Baa2 9 BBB 9 BBB 9

Baa3 10 BBB- 10 BBB- 10

Ba1 11 BB+ 11 BB+ 11

Ba2 12 BB 12 BB 12

Ba3 13 BB- 13 BB- 13

B1 14 B+ 14 B+ 14

B2 15 B 15 B 15

B3 16 B- 16 B- 16

Caa1 17 CCC+ 17 CCC+ 17

Caa2 18 CCC 18 CCC 18

Caa3 19 CCC- 19 CCC- 19

Ca 20 CC 20 CC 20

C 21 C 21 C 21

R 22 RD 22

SD 23 D 23

D 24

res 34 0.0749 0.6336 3.70 0.1574

Variable Obs Pr(Skewness) Pr(Kurtosis) adj chi2(2) Prob>chi2

joint

Skewness/Kurtosis tests for Normality

87

Table 29. Regression analysis of Greek bond spread to Moody’s credit rating

Table 30. Regression analysis of Greek bond spread to S&P’s credit rating

Table 31. Regression analysis of Greek bond spread to Fitch’s credit rating

_cons -.0670026 .1479056 -0.45 0.651 -.3570299 .2230247

M_rat .9361169 .0128218 73.01 0.000 .9109747 .9612591

S Coef. Std. Err. t P>|t| [95% Conf. Interval]

Total 142533.915 2552 55.8518475 Root MSE = 4.2526

Adj R-squared = 0.6762

Residual 46134.2555 2551 18.0847728 R-squared = 0.6763

Model 96399.6594 1 96399.6594 Prob > F = 0.0000

F( 1, 2551) = 5330.43

Source SS df MS Number of obs = 2553

_cons -3.348497 .1446685 -23.15 0.000 -3.632177 -3.064818

SP_rat 1.25653 .013134 95.67 0.000 1.230776 1.282284

S Coef. Std. Err. t P>|t| [95% Conf. Interval]

Total 142533.915 2552 55.8518475 Root MSE = 3.4898

Adj R-squared = 0.7819

Residual 31067.4694 2551 12.1785455 R-squared = 0.7820

Model 111466.445 1 111466.445 Prob > F = 0.0000

F( 1, 2551) = 9152.69

Source SS df MS Number of obs = 2553

.

_cons -3.318594 .1653387 -20.07 0.000 -3.642806 -2.994382

F_rat 1.311175 .0158157 82.90 0.000 1.280162 1.342188

S Coef. Std. Err. t P>|t| [95% Conf. Interval]

Total 142533.915 2552 55.8518475 Root MSE = 3.889

Adj R-squared = 0.7292

Residual 38582.8125 2551 15.1245835 R-squared = 0.7293

Model 103951.102 1 103951.102 Prob > F = 0.0000

F( 1, 2551) = 6872.99

Source SS df MS Number of obs = 2553

88

Table 32. Regression analysis of Greek CDS spread to Moody’s credit rating

Table 33. Regression analysis of Greek CDS spreads to S&P’s credit rating

_cons -505.7986 6.494425 -77.88 0.000 -518.5356 -493.0617

M_rat 115.9073 .8992148 128.90 0.000 114.1438 117.6709

CDS Coef. Std. Err. t P>|t| [95% Conf. Interval]

Total 303316337 1906 159137.637 Root MSE = 127.98

Adj R-squared = 0.8971

Residual 31200005.2 1905 16377.9555 R-squared = 0.8971

Model 272116332 1 272116332 Prob > F = 0.0000

F( 1, 1905) =16614.79

Source SS df MS Number of obs = 1907

_cons -708.3509 7.381468 -95.96 0.000 -722.8275 -693.8743

SP_rat 127.536 .9202776 138.58 0.000 125.7312 129.3409

CDS Coef. Std. Err. t P>|t| [95% Conf. Interval]

Total 303316337 1906 159137.637 Root MSE = 119.87

Adj R-squared = 0.9097

Residual 27370952 1905 14367.9538 R-squared = 0.9098

Model 275945385 1 275945385 Prob > F = 0.0000

F( 1, 1905) =19205.61

Source SS df MS Number of obs = 1907

89

Table 34. Regression analysis of Greek CDS spreads to Fitch’s credit rating

_cons -835.5324 8.835726 -94.56 0.000 -852.8611 -818.2037

F_rat 152.376 1.179829 129.15 0.000 150.0621 154.6899

CDS Coef. Std. Err. t P>|t| [95% Conf. Interval]

Total 303316337 1906 159137.637 Root MSE = 127.75

Adj R-squared = 0.8974

Residual 31090591.5 1905 16320.5205 R-squared = 0.8975

Model 272225745 1 272225745 Prob > F = 0.0000

F( 1, 1905) =16679.97

Source SS df MS Number of obs = 1907