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[Senate Hearing 114-110]
[From the U.S. Government Publishing Office]

                                                        S. Hrg. 114-110

 
         ECONOMIC CRISIS: THE GLOBAL IMPACT OF A GREEK DEFAULT

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
         NATIONAL SECURITY AND INTERNATIONAL TRADE AND FINANCE

                                 of the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                    ONE HUNDRED FOURTEENTH CONGRESS

                             FIRST SESSION

                                   ON

   EXAMINING THE SYSTEMIC RISKS GREECE COULD POSE TO THE REST OF THE 
             EUROZONE AND THE BROADER INTERNATIONAL ECONOMY

                               __________

                             JUNE 25, 2015

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban Affairs
  
  
  
  
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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  RICHARD C. SHELBY, Alabama, Chairman

MICHAEL CRAPO, Idaho                 SHERROD BROWN, Ohio
BOB CORKER, Tennessee                JACK REED, Rhode Island
DAVID VITTER, Louisiana              CHARLES E. SCHUMER, New York
PATRICK J. TOOMEY, Pennsylvania      ROBERT MENENDEZ, New Jersey
MARK KIRK, Illinois                  JON TESTER, Montana
DEAN HELLER, Nevada                  MARK R. WARNER, Virginia
TIM SCOTT, South Carolina            JEFF MERKLEY, Oregon
BEN SASSE, Nebraska                  ELIZABETH WARREN, Massachusetts
TOM COTTON, Arkansas                 HEIDI HEITKAMP, North Dakota
MIKE ROUNDS, South Dakota            JOE DONNELLY, Indiana
JERRY MORAN, Kansas

           William D. Duhnke III, Staff Director and Counsel

                 Mark Powden, Democratic Staff Director

                       Dawn Ratliff, Chief Clerk

                      Troy Cornell, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

 Subcommittee on National Security and International Trade and Finance

                     MARK KIRK, Illinois, Chairman

        HEIDI HEITKAMP, North Dakota, Ranking Democratic Member

TOM COTTON, Arizona                  MARK R. WARNER, Virginia
BEN SASSE, Nebraska

   Bryan Blom, Senior Policy Advisor and Subcommittee Staff Director

      Jillian Fitzpatrick, Democratic Subcommittee Staff Director
      

                                  (ii)
                                  
                                  

                            C O N T E N T S

                              ----------                              

                        THURSDAY, JUNE 25, 2015

                                                                   Page

Opening statement of Chairman Kirk...............................     2

Opening statements, comments, or prepared statements of:
    Senator Heitkamp.............................................     1

                               WITNESSES

Desmond Lachman, Resident Fellow, American Enterprise Institute 
  for Public Policy Research.....................................     3
    Prepared statement...........................................    17
    Responses to written questions of:
        Senator Sasse............................................    40
Matthew J. Slaughter, Incoming Paul Danos Dean, Tuck School of 
  Business, Dartmouth College....................................     4
    Prepared statement...........................................    25
Carmen M. Reinhart, Minos A. Zombanakis Professor of the 
  International Finance System, John F. Kennedy School of 
  Government, Harvard
  University.....................................................     6
    Prepared statement...........................................    30
Jacob Funk Kirkegaard, Senior Fellow, Peterson Institute for 
  International Economics........................................     8
    Prepared statement...........................................    32

              Additional Material Supplied for the Record

Wall Street Journal chart of Greek debt due 2015-2055............    45
CRS/NATIXIS chart of total Greek debt owed.......................    46

                                 (iii)

         ECONOMIC CRISIS: THE GLOBAL IMPACT OF A GREEK DEFAULT

                              ----------                              

                        THURSDAY, JUNE 25, 2015

U.S. Senate, Subcommittee on National Security and 
                   International Trade and Finance,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee convened at 1:36 p.m., in room 538, 
Dirksen Senate Office Building, Hon. Mark Kirk, Chairman of the 
Subcommittee, presiding.
    Chairman Kirk. We will begin. I will recognize my Ranking 
Member, Ms. Heitkamp, for an opening statement.

              STATEMENT OF SENATOR HEIDI HEITKAMP

    Senator Heitkamp. Thank you. I want to thank you, Chairman, 
for arranging this hearing on Greece's financial situation, and 
thank you to all of our witnesses for offering your expertise 
in this area. Your perspectives and opinions are incredibly 
important as Congress monitors the global financial system and 
I look forward to hearing those opinions. Barring consideration 
of reauthorization of the Export-Import Bank, which both me and 
the Chairman are leading on, I cannot think of a more timely 
topic.
    The United States and Greece are a tale of two economies. 
In 2007, our country experienced a housing crisis driven by low 
interest rates, poor underwriting, and outright fraud, and then 
a financial crisis driven by lax oversight and regulation and a 
complex financial system we did not understand. The Nation's 
real GDP fell by 2.6 percent in 2009, the largest decline in 
six decades. Our unemployment rate rose to 10 percent in 
October of 2009. And, fortunately, we have a mature economic 
recovery, in part because of Federal efforts to buoy the 
economy and actions taken by the Federal Reserve.
    Five years after the onset of the global financial crisis, 
however, Greece's economy remains in turmoil. The country has 
experienced what is essentially a second depression. Since 
2007, the Greek economy has contracted by nearly 25 percent. 
Unemployment has tripled, to nearly 25 percent. Youth 
unemployment is over 50 percent. And public debt has risen to 
173 percent of GDP.
    The causes of Greece's precarious situation are multiple 
and complex and I look forward to our witnesses shedding some 
light on how we got here and where we go from here.
    Much has changed since Greece negotiated its second 
financial assistance package. Ireland and Portugal, countries 
who also turn to the Eurozone and the IMF for financial 
assistance, successfully concluded their programs and have 
returned to capital markets and are in the process of repaying 
the IMF early. The economies of the Eurozone, barring Greece, 
have strengthened, and importantly for the United States, 
private financial institutions have substantially reduced their 
exposure to Greece and policy measures adopted over the last 
several years have lessened the chance that a Greek default or 
an exit from the Eurozone results in another global financial 
crisis.
    As Greece and its creditors negotiate a third and, 
hopefully, final financial assistance package, several points 
appear clear to me. First, we must balance fiscal 
responsibility with economic development. The Greek people have 
suffered an unimaginable hardship. The economy will remain in 
shambles for years, and unfortunately, likely decades to come, 
because of poor decisions and potentially because of severe 
austerity policies.
    Second, we must continue to develop and implement a sound 
regulatory framework for viable global financial systems 
through international cooperation. I am hopeful that Greece and 
its creditors will reach a pragmatic compromise to prevent more 
hardship for the Greek people and calm the situation in Europe.
    Thank you, Mr. Chairman, for bringing this hearing together 
on this very important topic and I look forward to hearing from 
our witnesses.

            OPENING STATEMENT OF CHAIRMAN MARK KIRK

    Chairman Kirk. I will recognize myself for a quick opening 
statement before introducing the witnesses.
    I will say that I have been wanting to call this hearing 
since I became the Chairman of the Subcommittee. The Greek 
situation serves as a warning for local and State governments 
around America that are now running out of money.
    Many of us can recall the names of these Governments that 
are struggling with some of these issues. The American 
governments that we are worried about in the credit situation 
include Detroit, Michigan, and Stockton, California, 
Harrisburg, Pennsylvania, plus my own home State of Illinois, 
including our Chicago Public School System.
    As policymakers, Senators must make sure that these credit 
crises are reduced. I will note that issues arising from German 
reparations after World War I did play a role in sparking the 
Great Depression and ensuing Second World War. Luckily, the 
greatest generation did found a financial firefighting team 
that included the IMF and World Bank and other Bretton Woods 
institutions.
    This hearing is intended to calm fears by outlining what 
implications there are for America's economy in the face of the 
Greek credit crisis. I look forward to hearing from our 
distinguished witnesses, all doctors, I would note, to tell us 
what the effect could be on the U.S. economy.
    Let me start with some introductions. I would like to 
introduce some of our witnesses. We are very happy to have Dr. 
Desmond Lachman, the Senior Resident Fellow for the American 
Enterprise Institute for Public Policy.
    Dr. Carmen Reinhart is the coauthor of this best selling 
New York Times book, ``This Time Is Different''. Carmen is also 
the Minos A. Zombanakis Professor of International Financial 
Systems at the John F. Kennedy School of Government at Harvard 
University.
    We also have with us Dr. Matthew Slaughter, the incoming 
Dean of the Dartmouth Business School, otherwise known as the 
Tuck School of Business at Dartmouth College.
    And, we also have Dr. Jacob Kirkegaard, a Senior Fellow at 
the Peterson Institute for International Economics.
    Let us start with Desmond. Why do you not deliver your 
testimony.

    STATEMENT OF DESMOND LACHMAN, RESIDENT FELLOW, AMERICAN 
        ENTERPRISE INSTITUTE FOR PUBLIC POLICY RESEARCH

    Mr. Lachman. Thank you very much, Senator Kirk and Ranking 
Member Senator Heitkamp, for giving me the honor to testify 
before you this afternoon.
    I would like to make five basic points. First, Greece is 
very likely to exit and default within the next 12 months. Now, 
while an agreement between Greece and its official creditors 
still appears possible that could release the funds that Greece 
needs to avoid defaulting to the IMF next week, it is highly 
questionable how long such an agreement will last.
    An essential component of such an agreement would likely 
appear to be yet more of the same failed policies that Greece 
has pursued under IMF tutelage of the past 5 years. Namely, it 
would involve substantial fiscal policy tightening within a 
Euro straightjacket that relies almost exclusively on tax 
increases to achieve its budget objectives. Judging by the 
dismal results of the past, one would think that such an amount 
of budget tightening in a Euro straightjacket that does not 
allow currency depreciation is almost certain to deepen 
Greece's economic depression. That, in turn, risks spreading 
the Syriza party and throwing the country into a new period of 
political turmoil that will, in the end, force Greece to exit 
the Euro.
    The second point I would make is that today, fortunately, 
Europe is in a very much better position to deal with the 
immediate fallout from a Greek event than it was in 2012. 
Europe now has in place a European stability mechanism with 500 
billion Euros that can provide adequate financing to any 
Eurozone member that might come under market pressure. More 
important yet, the European Central Bank now has in place an 
outright monetary transaction facility that should allow it to 
do whatever it takes to maintain market stability in the event 
of a Greek exit. This should prove sufficient to reinvent 
Greece in the very short run.
    The third point I would make is that while European 
policymakers appear in a good position to deal with the 
immediate fallout from a Greek event, they do not appear to be 
in a good position to deal with the longer-run damage that a 
Greek exit might cause to the Euro project. A Greek exit would 
signal very clearly to markets that Euro membership was no 
longer irrevocable. In addition, it would become apparent to 
bank depositors and the rest of the European economic periphery 
that the ECB was not always there to backstop the safety of 
their deposits.
    Heightening the longer-run risk of a Greek exit on the rest 
of the European periphery is the fact that countries like 
Italy, Portugal, and Spain are all now characterized by 
significantly high public debt levels than they were in 2012. 
They also have very low economic growth and are experiencing 
strong politically based austerity backlashes. This will make 
these countries especially vulnerable to speculative attack 
when global liquidity conditions are not as ample as they are 
today.
    The fourth point relates to the impact of a Greek exit on 
the United States economy. And here, I would say that there are 
three basic channels where the United States could suffer 
considerable economic and geopolitical costs.
    The first is that in the immediate aftermath of a Greek 
exit, one must expect a significant further depreciation of the 
Euro as the ECB took more forceful measures to deal with the 
Greek crisis and as investors fled to the safety of the U.S. 
dollar. The resulting dollar appreciation could continue--
constitute a significant headwind to the U.S. economic 
recovery, particularly considering that we have already had a 
15 percent effective appreciation of the dollar over the past 
year.
    Second, over the longer term, any eventual spread of the 
Eurozone debt crisis to other countries in the European 
periphery could roil global financial markets. This would be 
bound to impact the U.S. economic recovery, considering how 
integrated is the United States in the global financial system, 
and how important Europe is to the United States as a trade 
partner.
    The third way that a Greek exit could impact the United 
States is of a geopolitical nature. If a Greek exit leads to a 
souring of European and Greek relations and to the further 
erosion of Greek political stability, one could see a failed 
Greek State increasingly coming into the Russian orbit. This 
would give Russia a firmer and unwelcome foothold in the 
Balkans.
    The last point that I would like to make is in relation to 
the IMF, and I would say that a Greek exit would have 
considerable implications for the IMF's credibility. It would 
inevitably raise questions as to the design of the IMF's Greek 
lending programs and as to the IMF's wisdom in loaning 
unprecedented amounts of money to Greece to keep it in the Euro 
at all costs, thereby putting the global taxpayer at risk.
    It will also be asked why the IMF did not foresee the depth 
of the Greek economic collapse as well as to what end was 
Greece put through years of austerity within a Euro 
straightjacket at the cost of sending its economy into the 
deepest of depressions when in the end it was forced to exit 
the Euro.
    Thank you, Mr. Chairman.
    Chairman Kirk. Professor Slaughter.

 STATEMENT OF MATTHEW J. SLAUGHTER, INCOMING PAUL DANOS DEAN, 
           TUCK SCHOOL OF BUSINESS, DARTMOUTH COLLEGE

    Mr. Slaughter. Chairman Kirk, Ranking Member Heitkamp, and 
fellow Members, thank you very much for inviting me to testify 
on these important and timely issues. My testimony will make 
three main points about Greece, one focused on the short-term, 
one focused on the medium term, and one on the long term.
    In the short term, a Greek default would surely inflict 
additional pain on the Greek economy and on the broader world. 
One force driving the downturn would likely be the turmoil of 
reintroducing the Greek Drachma when there are no treaties, 
laws, or precedents for how to do this. The Greek contraction 
would dampen economic activity in Europe and, to a lesser 
extent, the rest of the world, as well.
    Through the usual linkages of international trade, however, 
this scale of dampening would be slight. The basic reason for 
this is that the Greek economy is quite small. Last year, Gross 
Domestic Product in Greece was about 240 billion dollars. This 
was only about one-third of 1 percent of worldwide GDP. In 
economic terms, Greece is only about the size of Louisiana or 
Connecticut, fine though those two States are.
    The one possible economic impact of a Greek default that 
might be quite important is the chance that default triggers 
another world financial crisis. There are sound reasons not to 
expect such a crisis. For example, today, the majority of Greek 
sovereign debt is owned not by banks, but rather by public 
entities. But, no one really knows what will happen in global 
capital markets if Greece defaults and/or exits the Eurozone. 
There is simply no historical precedent as a guide.
    Before Lehman Brothers died in 2008, wise voices intoned 
that a medium-size U.S. bank could do little damage. Those wise 
expectations were proven very wrong. No one can completely rule 
out such destabilization in the wake of a Greek default.
    In the medium term, a Greek default accompanied by an exit 
from the Eurozone would set a precedent that had been intended 
to be an impossibility, of a Eurozone member reverting to its 
own sovereign currency. The main advantage of currency unions 
like the Eurozone is, or so it is hoped by their creators, 
eliminating the possibility of the speculative attacks that 
have so often bedeviled fixed exchange rate regimes, like in 
the early 1990s turmoil in Europe's exchange rate mechanism, 
which was a major impetus for creating the Euro in the first 
place. A ``Grexit'' would shatter the intended permanence of 
the Euro and would revive the possibility that Eurozone 
countries can print their own currencies.
    The pressures for additional exits would arise from two 
forces, potentially interrelated. One is investors demanding 
higher interest rates from countries they perceive to be 
possible exitors. The other is fringe political parties, 
already surging in countries such as Spain's Podemos, that 
might follow poor policies. The combination of higher interest 
rates and all the related uncertainty could tend to depress 
economic growth in certain countries and thereby could trigger 
a dynamic not unlike that of Greece in recent years.
    And any future exits from the Euro would surely bring 
greater chances of triggering the financial crises described 
above because of how much larger and interconnected other 
countries are compared to Greece. Yes, a Grexit might not spark 
a crisis today, but what about an exit by larger Spain tomorrow 
or by an even larger Italy?
    In the long term, a Greek default is largely irrelevant to 
the fundamental challenge still facing Greece and every other 
advanced country, how to foster growth of output, jobs, and 
incomes in societies with aging populations and looming 
entitlement pressures. In this sense, the default question is 
not the most important question facing Greece today. Rather, 
that honor goes to a different question: Who will be able to 
foster growth in Greece?
    For any country, long-run economic growth requires an 
ability to accumulate some combination of labor, of capital, 
and of productivity. What will ultimately create sustainable 
recovery and hope in Greece is growth in some combination of 
these factors. For example, Greece's total population fell by 
about 200,000 over the past decade. Greece today is also 
saddled with very low levels of innovation and very low levels 
of research and development spending. Greece's growth problems 
are a potent reminder to many other countries that poor 
policies today have consequences that can accumulate far into 
tomorrow, and those consequences are intensified when talent, 
capital, and ideas can easily move around the world to where 
they are welcomed and rewarded.
    Lest we all wag our fingers at Greece as uniquely 
profligate, keep in mind that the dynamic of slowing growth, 
aging populations, and looming entitlement pressures face many 
countries, including the United States, where productivity 
growth has slumped in recent years to many decade lows. In this 
sense of needing progrowth policies, we in America and in many 
other countries are not unlike Greece.
    In conclusion, wise leaders will reflect on Greece not as a 
unique outlier, but rather as a sobering leading indicator for 
the challenges that are approaching many advanced countries 
around the world, including the United States.
    Thank you again for your time and interest in my testimony 
and I look forward to answering any questions that you may 
have.
    Chairman Kirk. Dr. Reinhart.

STATEMENT OF CARMEN M. REINHART, MINOS A. ZOMBANAKIS PROFESSOR 
OF THE INTERNATIONAL FINANCE SYSTEM, JOHN F. KENNEDY SCHOOL OF 
                 GOVERNMENT, HARVARD UNIVERSITY

    Ms. Reinhart. Thank you, Chairman Kirk and Ranking Member 
Heitkamp, for the opportunity to comment on the crisis in 
Greece and its global ramifications.
    I will organize my remarks around three topics: 
Developments in Greece, the impacts of a Greek exit on the 
European economies, and the repercussions on the United States 
and global currency markets. My focus is on the near term.
    Greece--even if the Greek Government meets its obligations 
next week, the probability of a default over the summer looms 
large. I will focus on two reasons why default appears 
probable.
    First, there is a widespread loss of confidence in the 
sustainability of the status quo that has led to a sharp 
escalation in internal arrears. The private sector, concerned 
about the likelihood of an exit from the Euro, has increasingly 
defaulted on its existing debts. If credit cards are included, 
three-quarters of the loans in the banking sector are 
nonperforming. Tax payments are being postponed. Citizens are 
hoarding Euros. Bank deposits have fallen around 45 percent 
since 2009. Banking sector is near a bank holiday. The 
Government is financing itself by not paying its bills, similar 
to what transpired ahead of the Russian default of 1998 or 
Argentina 2001. Government deposits in banks are off around 40 
percent.
    Second, the 1.6 billion payment due to the IMF next week is 
only a fraction of the amounts that are coming due in the next 
3 months, 20 billion Euro, approximately, some of that to the 
private sector, largely to the official sector. These payments 
are a multiple of the cash balances of the central Government 
and even a multiple of the cash balances of general Government.
    Implications for Europe. In my work on contagion, I found 
that fast and furious financial contagion is more likely when 
the triggering crisis takes investors and Governments by 
surprise. There is no surprise here. The Greek drama has been 
unfolding over years and private sector exposure to Greece, as 
has already been mentioned, has declined sharply. Prior to the 
crisis, most Greek debt was held by private external creditors. 
Such financial links significantly increase the odds of 
spillovers. Since then, however, official creditors have 
absorbed the Greek debts.
    Real-side exposure to Greece via trade, which is another 
channel of transmission, as noted, is not a new factor. Greek 
GDP has already contracted by about 25 percent, and imports, 
Greek imports, have fallen by even more.
    Now, whether investors become indiscriminate and pull out 
altogether of other European periphery countries remains a 
risk. However, I would argue that this risk is mitigated by the 
fact that also a significant share of sovereign periphery debt 
is in official hands, especially for Portugal and Ireland, and 
also in the event of such a shock to periphery Europe, I think 
the official community would support them.
    The U.S. The effects of a Grexit on the United States are, 
in my view, likely to be limited. Financial exposure, which was 
marginal in the first place, is not a source of concern for 
financial institutions. Nor is the Greek market a major 
destination for U.S. exports.
    Now, predicting currency fluctuations is an elusive goal 
for economists, so take my observations with a dose of 
skepticism. If a Greek default triggers turmoil in Europe, we 
would expect to see a flight to safety into U.S. dollar assets, 
notably Treasuries. This has been the response in past waves of 
global volatility. Further appreciation in the dollar vis-a-vis 
the Euro and most other currencies would follow. The potential 
adverse effects of an appreciating dollar would be felt by U.S. 
manufacturing, not unlike the impact seen already this year.
    An appreciating dollar may also act as a headwind in the 
Fed's efforts to withdraw monetary stimulus and normalize 
monetary policy. Emerging markets, which we have not mentioned, 
with dollar denominated debt, would be increasingly vulnerable 
to further dollar appreciation, as well.
    Greece is close right now to financial autarky. The gap 
between what is a de jure default and a de facto one has 
narrowed. The next stage in this crisis may have limited 
immediate consequences for the global economy.
    Thank you.
    Chairman Kirk. Thank you.
    Dr. Kirkegaard.

  STATEMENT OF JACOB FUNK KIRKEGAARD, SENIOR FELLOW, PETERSON 
             INSTITUTE FOR INTERNATIONAL ECONOMICS

    Mr. Kirkegaard. Chairman Kirk, Ranking Member Heitkamp, it 
is a pleasure for me to appear before you to testify on the 
global impact of what I will say is still a hypothetical Greek 
default.
    In my oral testimony, I will focus on three issues: The 
near-term situation in Greece; the political nature of the 
Greek debt structure; as well as the implications of a default 
on Euro membership and the rest of the global economy.
    The current situation in Greece remains in limbo. 
Negotiations between Greece and the Troika are ongoing and will 
continue into the weekend. There is, as a result, some risk 
that Greece will go into arrears against the IMF as early as 
next week.
    However, it remains, in my opinion, a near certainty that 
an agreement between the Greek Government and the Troika will 
eventually be found in the coming weeks. The principal question 
is really whether reaching an agreement will require a brief 
period of restrictions on deposits in the Greek banking sector 
or not. Consequently, as things stand now, in the unlikely 
event that there is no agreement by Sunday evening, we should 
not, in my opinion, expect Greek banks to open normally on 
Monday.
    The political effects of deposit access control on the 
Greek economy and financial system would likely be dramatic, 
and in all probability, in a matter of a few days, lead to 
significant or sufficient domestic political pressure on the 
Government to reach an agreement with the Troika.
    Given that the Euro area has sufficient retained profits 
from the security markets program available for potential 
immediate release, that means without the need to consult 
national parliament in the Euro area, to the Greek Government 
in the event an agreement is being reached, any arrears run-up 
against the IMF would be quickly settled. In my opinion, 
therefore, any actual default by the Greek Government in the 
coming days would be of very short duration, measured in only a 
few days.
    Substantial amounts of political brinkmanship are currently 
being utilized to achieve a negotiated outcome consisting of a 
quid pro quo agreement between Greece and the Troika of 
reforms, fiscal consolidation, in return for ongoing financial 
support. This ultimate ability to find a political agreement 
with the Greek Government is of the utmost importance, as it 
suggests that the Greek Government debt levels are today and 
will most likely in the future remain sustainable, despite the 
country's extremely high gross Government debt levels and 
uncertain future growth prospects.
    This conclusion follows from the particular current 
structure of Greek Government debt, which is overwhelmingly 
owned by the other Euro area Governments and the IMF, while 
remaining privately held debt is structured at very long 
maturities with low nominal interest rates. Consequently, the 
cost of servicing and, therefore, the financial sustainability 
of Greek Government debt is largely unrelated to the size of 
the gross debt or, indeed, financial market fluctuations. 
Greece already has a substantially longer debt maturity profile 
and substantially lower implied rates of interest on its debt 
than, for instance, does the United States Federal Government.
    Rather, Greek debt sustainability and ability to avoid a 
future default is dependent on principally two things: The 
Greek Government's ability to restore economic growth in the 
country, or, in other words, the continuation of growth-
friendly structural economic reforms; and the country's ability 
to reach an ongoing political agreement with its official 
sector creditors in the Euro area and the IMF.
    Unlike the rules-bound IMF, the Euro area, which has 
already been done in June 2011, March 2012, and November 2012, 
has the political freedom to ex post restructure its holdings 
of Greek Government debt in a manner sufficient to maintain 
debt sustainability for the country and closely calibrated to 
the preceding degree of Greek Government delivery of agreed 
structural reforms and fiscal targets. In short, Greece is and 
will remain solvent if its own Government and the Euro area 
wants it to be.
    Now, in the event that a Greek Government nonetheless does 
default, it will quickly prove an economic disaster for the 
country, as it loses not only ECB banking sector liquidity 
support, ongoing financial support from the Troika, but also 
net ongoing budgetary transfers from the EU budget consisting 
to roughly about 3 percent of GDP on an annual basis.
    At the same time, it is important to recognize that any 
default by Greece will not likely lead to an exit from the Euro 
area as there, first of all, is no public support for such a 
momentous decision in Greece, and under any scenario it likely 
will prove impossible for the Greek Government to successfully 
reintroduce a new national currency side-by-side with the Euro. 
Rather, in my opinion, the country risks ending up a little bit 
like the country of Montenegro, which unilaterally Euro-ized 
its economy in 2002 in a manner similar to, for instance, how 
Ecuador and El Salvador have fully adopted the United States 
dollar. Attempts at implementing a Grexit, therefore, will de 
facto mean that Greece will only leave the institutions of the 
Euro area and the EU, not the currency itself.
    Finally, let me quickly note that Greece is a small country 
consisting of only 1.8 percent of Euro area GDP, and, 
therefore, as a result of also improving Euro area economic 
performance, a more resilient institutional structure in the 
Euro area, and not least, additional likely ECB monetary 
stimulus in the event of a default by Greece, any cross-border 
contagion spillover is likely to be contained. As a result, 
therefore, a hypothetical Greek default does not pose systemic 
risks to either the Euro area or the global area at large.
    Thank you very much.
    Chairman Kirk. Let me ask the first question to the panel. 
I wanted to ask you what we would call in the John McLaughlin 
days the mega-question. How likely is the Greek crisis to 
actually hurt the U.S. economy, in your view?
    Mr. Kirkegaard. Well, following from my testimony, I 
believe that probability is very, very low, because I do not 
believe, as I said, that there will be a default by Greece, but 
rather that----
    Chairman Kirk. Let me follow up on that. Understand this 
crisis right now is a crisis of Greece being unable to repay 
the IMF 1.7 billion dollars that they owe on the latest 25 
billion dollar loan that the IMF extended to Greece, and that 
payment is due on June 30. To fuzz over the differences, I 
think IMF will declare that Greece is in arrears. They will not 
use the ``d'' word, which might be too alarming. Is that what 
we are facing?
    Mr. Kirkegaard. In my opinion, that is correct, yes, and I 
think running into arrears against the IMF does not, in my 
opinion, have any implications, really, for the short-term 
operation of the IMF. You know, we are basically--and this is 
in my written testimony--it will merely--merely, I say--double 
the current outstanding arrears that the IMF memberships to the 
institution so that we go back to levels of actual arrears by 
the membership at the IMF that we saw last in the early 1990s. 
So, it would not be an unprecedented situation, by any means.
    Chairman Kirk. If we look at the forward commitment 
authority for the IMF to be able to take on further and make 
other loans, my understanding, they have about 421 billion 
dollars left in their forward commitment authority. Is there 
any chance that a European crash that could wipe out IMF's 
forward commitment authority, basically making them unable to 
respond in a major way to a big crisis?
    The thing that I worry about is--you guys are far more 
expert on this. I remember in the Mexico crisis when the 
Mexican collapse was so big that it exceeded the abilities of 
the international financial institutions to help out. And, you 
can correct me if I am wrong. I remember it was the U.S. Fed 
that had to step in directly. Is that wrong?
    Mr. Kirkegaard. [Off microphone.]
    Chairman Kirk. Yeah. At that point, we would think that in 
the case of contagion or collapse, then the U.S. exposure is 
high.
    Ms. Reinhart. I do not really see the U.S. exposure in the 
current context as being high on the financial side or on the 
real side. I think the greatest risk are those that some of us 
have already alluded to, which is another round of dollar 
appreciation in the context of a flight to U.S. assets.
    Chairman Kirk. Just let me point out that I mentioned the 
case of official debtors like Stockton, California, and 
Detroit, Michigan, and the State of Illinois, and the Chicago 
Public School System. How much does this Euro problem interfere 
with municipal and State debt overhanging the bond market in 
the United States?
    Ms. Reinhart. I am not an expert on the municipal market or 
the subsovereign debt, but the parallel--there are important 
parallels and differences. The biggest difference is, of 
course, no State in the United States is facing the bank runs 
prospects that Greece currently has. The biggest parallel is 
the need to avoid the hidden debts or the arrears which are a 
major issue internally in Greece now. So, technically, one 
could say, Greece has domestic default already.
    Chairman Kirk. Desmond, I would note that under U.S. 
bankruptcy law, a United States State cannot declare 
bankruptcy. There is no provision in our code.
    Mr. Lachman. Yes. Let me just say that I do not share the 
sanguine view being expressed that this does not have the 
potential to cause real problems for the United States, not 
immediately, but down the road. We are talking about something 
hugely significant, is that one member of the Euro could be 
leaving the Euro as a currency. That shows that the Euro does 
not last forever, and that can throw focus in times of 
different liquidity conditions on a country like Italy that has 
2.5 trillion dollars of debt. It is the third-largest debtor, 
and by any means, Italy's debt is not sustainable. This is a 
country that has not grown for 15 years. It has got a debt-to-
GDP level of 135 percent.
    In regard to your question on the municipal market, what 
has to be of concern is that these Greek events are playing out 
at the same as events are playing out in Puerto Rico. Puerto 
Rico has 73 billion dollars of debt. It is going to have 
payments due in July to its electric company. It has got other 
payments to the National Bank in September. Markets are 
thinking that the chances of Puerto Rico making these payments 
are very slim. So, what you could get is you could get two big 
bankruptcies playing simultaneously, and I do not think any of 
us knows how that might affect the municipal market, but it is 
an event that I do not think we can just gloss over.
    Mr. Slaughter. Senator----
    Chairman Kirk. When you mentioned Puerto Rico, you are now 
kind of scaring me a bit. I was just watching the European 
situation. If we look at the market and how it would see a 
Puerto Rican default around the same time of a Greek default, 
do you have potential contagion there?
    Mr. Lachman. Yes, that markets--you know, that you think 
that there is going to be a repricing in the markets. You know, 
that is just looking at the electric company in Puerto Rico, 
that has alone got nine billion dollars of debt. That is a 
bigger default--would be a bigger default than was for Detroit. 
You know, you have got another 73 billion dollars there. So, 
markets--this is widely held, and it looks like that is another 
intractable situation.
    Mr. Slaughter. Senator, if I could add to that, the one 
thing that is not known well is when you start to think about 
these capital market price changes, who owns what assets and 
whether it is a pension fund or a hedge fund or a particular 
bank, how leveraged they might be. I think a common theme here 
is through the usual flows of international trade in goods and 
services, there is not that large of a risk to the U.S. 
economy. The small probability of a potentially very large risk 
comes through these capital market linkages.
    Chairman Kirk. Anybody else? Desmond Lachman.
    Mr. Lachman. I think I would add that I very much agree 
with Carmen that the usual channels of contagion might not be 
in play immediately in the case of Greece, but you do have 
problems with bank deposits that could be moving on a big 
scale. You know, if one sees that the Greek bank depositors 
lose their money, that the European Central Bank was not there 
to backstop them, you would expect that deposits will start 
leaving the other countries in the periphery, namely Italy and 
Spain, and that could cause a huge problem. So, contagion can 
take place in different ways in this crisis.
    I am not expecting this to occur immediately, but just 
looking at Europe with all of its political problems, with a 
series of elections the next 6 months, I do not think that one 
can dismiss the chances that something could go very wrong.
    Chairman Kirk. Ms. Heitkamp.
    Senator Heitkamp. Thank you, Mr. Chairman.
    You know, there is an old expression, do not go looking for 
trouble. Trouble will find you. And, I think, in part, we are 
in that spot where what we look at when we look at numbers is 
that this is the chance of catastrophic contagion in the near 
term. Certainly by the majority of testimony here, it does not 
exist.
    I am intrigued by the dollar value, which has obviously a 
very dramatic impact on any State that produces commodities and 
relies on exports. We are already challenged in the export area 
because of a high dollar value. I am intrigued by that.
    I have been thinking all along about this hearing and about 
the significance of trying to track the impact on the American 
economy, and it seems to me that of all the things that I have 
heard today, that is probably the thing that raises the--again, 
another rush to a safer currency, a safer economy, which is 
right now the American economy.
    But, Dr. Kirkegaard, if I can ask you to kind of respond to 
some of what you have heard here as it relates to the immediate 
impact. I know you have already testified, but if you were 
going to look more than the near term, which is a lot of what 
the discussion that we have had, and look down the road a 
couple years into the future, what needs to change to stabilize 
the overall Eurozone, but particularly those economies like 
Greece that are challenged at this point with low growth rates? 
What do we need to do?
    Mr. Kirkegaard. Well, I think, first of all, what Greece 
needs to do is to avoid defaulting, because if it defaults, it 
will lose access to the European Central Bank very quickly, as 
I said. If there is no agreement over the weekend, I will 
predict you will have deposit controlled in the country, which 
sets in motion another very, very dramatic economic decline.
    Senator Heitkamp. And as we have heard earlier from earlier 
testimony on this panel, we are already seeing some of that 
flow. We are already seeing some of that withdrawal from 
regular banking institutions, correct?
    Mr. Kirkegaard. Yes. But, I will stress, though, that in 
some ways, in my opinion, what is actually remarkable is that 
there is still by the latest data approximately 120 billion 
Euros left in the Greek banking system and it has not--we have 
not seen deposit withdrawals in any of the other Euro area 
countries.
    And, I must say that I am personally quite skeptical that 
we will see this, even in the event that there is a Greece 
default, because I think as we look forward, we have to 
recognize that this will be a very dramatic and traumatic 
experience for the Greek economy and the Greek population, 
despite that they have already, of course, suffered 
tremendously. If they default, things will get a lot worse.
    But, if you are looking at Greece in other countries, and I 
mean Podemos and other political movements in Spain and 
elsewhere were mentioned, we have to ask ourselves, what is the 
lesson that you then draw from events in Greece? Is it that you 
should follow the policies of the current Government and take 
your country into such a catastrophic path? I would argue that 
it is not, that, in fact, if Greece is going to default, which, 
as I said, is not what I think will happen, but were to happen, 
I think other populations in Europe will look at that and they 
will draw the conclusion that this is not the right way to go. 
So, I think we should be very careful in over-dramatizing the 
political contagion from current events in Greece.
    And, I would also say that the sometime expressed notion 
that if Greece were to leave the Euro area, it would 
automatically turn the Euro into a so-called fixed exchange 
rate regime, which is, of course, a much brittler or less solid 
entity I also believe to be conceptually flawed, because what 
we are looking at here is actually not the collapse, inevitable 
collapse of the Euro area following one country's exit, but it 
is actually rather the difficulties, as I alluded to in my 
initial testimony, of Greece actually succeeding in introducing 
a new currency, because the Euro will still be there and you 
are trying to institute a new currency, the new Drachma or 
whatever we call it, side by side with the Euro.
    And, I do not think the current Greek Government is going 
to be able to institute anything, any new currency, that 
actually retains the function as a store of value in that 
currency----
    Senator Heitkamp. Right.
    Mr. Kirkegaard. ----which means that we are not looking, 
therefore, from experiences from previously collapsing currency 
unions, you know, the Soviet Union or Yugoslavia or things like 
that, but, rather, we are looking at something which has not 
happened before in history. As far as I know, there is no 
example of a country that have fully dollarized, for instance, 
and actually reversed that decision.
    Senator Heitkamp. OK. I think those are all important 
parts.
    And, if I can just make another point from the original 
panel's testimony. Dr. Slaughter, I think you mentioned the 
lack of innovation, the lack of investment in, you know, aging 
populations, the lack of investment in research and 
development, and part of that is driven by this immediate move 
toward austerity. And, so, when we look at the austerity 
measures, it is kind of, like, where is the appropriate 
balance? Obviously, we all know that in a spending crisis, in a 
fiscal crisis, you need to make those adjustments. But, one of 
the things that you said that concerns me is the amount of GDP 
that is spent in investment and the things that we normally say 
will be leading indicators for growth in the future.
    Looking at this, what is happening in Greece and looking 
across kind of all the economies, how do you measure that 
balance between austerity and fiscal responsibility?
    Mr. Slaughter. Great question, Senator. I think a couple 
things come to mind. One is, and it connects with your earlier 
question about what happens in the next year or two, in some 
basic sense, I think, part of the challenge for Greece is of 
its elected and appointed Government officials, all of their 
time and energy and then some is spent kind of day to day with 
the crisis issues that we have been speaking to here. And I 
think the policy issues that speak to more sustainable economic 
growth--no fault, but an observation--simply are not being 
talked about there.
    So, what ideally would happen in the near term of the next 
couple years is some regulatory form would be put into place by 
the Greek parliament to introduce private capital, in 
particular, to help stimulate some of the research and 
development and economic activity that we are talking about.
    To their credit, Greece has made some substantial progress 
on this in the past couple years despite the crisis. So, the 
World Bank has--it is doing business rankings that it 
assembles. Greece's position in the World Bank's doing business 
rankings has risen from 109 in 2011 to 61 today, one of the 
largest increases of any country on the planet. So, they have 
made some progress, and many countries in Europe and elsewhere 
think of the Irish experience over the past 30, 40 years. A lot 
of the growth in jobs and opportunity come from international 
investors coming in to build new businesses, to make those 
investments in jobs.
    So, you have got agriculture, you have got tourism, you 
have got some industries in Greece that have more potential, 
and hopefully, that is something that will flourish more in the 
years ahead.
    Senator Heitkamp. Well, and that is the challenge, not 
destabilizing the economy to the point that you cannot 
attract----
    Mr. Slaughter. Exactly.
    Senator Heitkamp. ----international investment----
    Mr. Slaughter. Exactly.
    Senator Heitkamp. ----and there we are.
    Mr. Slaughter. Yes.
    Senator Heitkamp. And, I only say this, not that it is our 
job here in the U.S. Congress to try and help Greece achieve 
the appropriate balance, but I think in a much smaller scale, 
we are in that same discussion here with the American economy, 
which is how do we--with sequestration, which is a form of 
austerity----
    Mr. Slaughter. Right.
    Senator Heitkamp. ----how do we make those appropriate 
balances. And, so, it is informative and I really appreciate 
your testimony. I thought it was very timely and topical and 
important to hear.
    Chairman Kirk. Thank you.
    Senator Heitkamp. I think Dr. Lachman----
    Chairman Kirk. Let me ask Desmond, who was about to jump in 
here----
    Senator Heitkamp. Yes.
    Chairman Kirk. If you look at this chart, you will see the 
debt list through 2055. Do we look at a grim long-term future 
of almost no economic growth in this market overhung by debt?
    Mr. Lachman. Yes. Greece's debt, you know, the level that 
it has reached, now it is 175 percent of GDP. By any measure, 
the country is insolvent. It really needs debt relief of one 
sort or another. You need not write down the face value. You 
could extend the maturities 100 years and give them interest 
rates of zero, you would get the same kind of effect.
    But, the point I just wanted to make on fiscal austerity, 
which I think is really crucial and it is the lesson of Greece, 
is that it is very difficult to balance one's budget to bring 
down big deficits when you are in a fixed exchange rate system 
and you do not have monetary policy that is an offset to the 
fiscal tightening. So, what has occurred in Greece is that they 
have tried to tighten the budget, but they cannot devalue the 
currency to boost exports or to pump money into the system to 
offset the effect of the belt tightening, and that has proved 
to be counterproductive.
    And, my fear is that the kind of policies that they are 
discussing with Greece right now are very much more of the 
same. They are looking for as much as 2 percentage points of 
GDP or fiscal adjustment over the next 12 months and another 4 
percent of GDP over the medium term and they are going to be 
again doing it in a European Euro straightjacket that does not 
allow it to--an offset, and that is, I think, a very big 
difference than our situation in the United States. I am not 
saying that getting the budget into balance is an easy thing in 
the United States, but it is a lot easier if you have got a 
Federal Reserve that is pumping money into the system, 
cheapening the dollar, making this thing possible.
    Senator Heitkamp. So, it is a lot easier when you control 
both the fiscal policy and the monetary policy.
    Mr. Lachman. Absolutely, that if you are trying to do 
this--if you are just putting your foot on the brake and the 
car already is slowing down at a rapid rate, and, you know, you 
talk about a country that has had GDP declining by 25 percent 
and they have not brought down their debt, it has been 
counterproductive, what they have been doing.
    Senator Heitkamp. I think, Dr. Reinhart, you had a comment 
you wanted to make. I could see you kind of leaning in there.
    Ms. Reinhart. One piece of information that I think is 
relevant to this discussion is we are treating the Government 
in Greece as if what the Government will do. We really have 
little idea what the Government may be. Argentina had five 
different Governments within a year-and-a-half during its major 
crisis. So, that is another source of uncertainty. And, so, I 
think that the larger issue of restoring growth is also very, 
very deeply rooted to all the levels of uncertainty that we are 
dealing with, not just economic, but political, as well.
    Chairman Kirk. Dr. Reinhart, let me follow up by talking 
about the foreign policy implications here. When we look at 
Russia and her position as a creditor, does she have a 
significant ability to come in as a white knight asking for 
ridiculous things, like Greece's departure from NATO or 
something like that? Do they have that flexibility?
    Ms. Reinhart. Russia has its own significant--significant, 
let me reiterate--economic problems. They have lost a massive 
amount of reserves. They still have quite a reserve stockpile, 
but they are in deep recession. The ruble depreciation has not 
really helped them, given sanctions, given oil prices. And, I 
would say that if we were to look back to what position Russia 
was in 3 years ago, that might have been the case. But, I 
think, in the current context, I do not see them giving away 
their precious reserves, or what remains of them, to assist the 
Greek Government.
    Chairman Kirk. Dr. Lachman.
    Mr. Lachman. I am not sure that the Greek Prime Minister 
shares that view, because otherwise, I am not sure what he is 
doing so frequently in Moscow, talking about building of a 
pipeline that is going to go through Greece to take the gas, 
talking about possible loans from Russia. Russia has got a lot 
in this game, is that Greece is a member of Europe and in order 
for Europe to maintain sanctions on Greece--on Russia, they 
need Greece's consent. So, there is a trade in the making and 
the Russians will play a long game.
    Russia right now is hurting because the price of oil is 
where it is, but one does not know whether the price of oil is 
going to stay here for a long time and Russia will play a long 
game with the Greeks. I am not sure that we should just 
disregard what can occur in so strategic a part of the world as 
the Balkans.
    Senator Heitkamp. Dr. Kirkegaard.
    Mr. Kirkegaard. I think I would just strongly support what 
Carmen said, which is that Russia does not have the financial 
capacity, in my opinion, to really provide the kind of 
financial assistance that Greece would need if it were to 
default against its current Troika members, because it will 
lose literally hundreds of billions of Euros in liquidity 
support from the European Central Bank, and that kind of money, 
Vladimir Putin does not have.
    And, I would also say that with respect to the sort of 
ongoing diplomacy that we see, I regard it as politically not 
very wise of the Greek Prime Minister to fly to Moscow that 
often. But, if we look back at previous instances of this kind 
of flirtation between European countries and the Russian 
Government, we say it in Cyprus in 2013, where the then-Cypriot 
president tried to fly to Moscow and ask for--and this was when 
Vladimir Putin was in a much better financial position to 
provide that support--and ask for Russian money rather than 
take a Troika bailout and he got nothing. So, I would very 
strongly caution that actually Vladimir Putin is going to put 
any money into this. I do not think he is going to do that 
under the current circumstances.
    And, therefore, this geopolitical threat that Russia poses 
in Greece, I think it should also be kept in mind that the EU 
sanctions were, in fact, extended by 6 months just a few 
years--a few days ago during a process in which the Greek 
Government did not pose any problems of any kind actually at 
the negotiating table. And, so, I think this is a little bit 
getting ahead of ourselves if we think there is a real risk 
here.
    Chairman Kirk. Well, I would like to thank all of our 
witnesses very much for everybody coming. I thank my Ranking 
Member for participating in what has been a very good hearing 
to make sure the markets are not surprised and we can limit 
contagion in this problem.
    With that, I would like to adjourn here.
    [Whereupon, at 2:30 p.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
                 PREPARED STATEMENT OF DESMOND LACHMAN
   Resident Fellow, American Enterprise Institute for Public Policy 
                                Research
                             June 25, 2015
    Thank you Chairman Kirk, Ranking Member Heitkamp, and Members of 
the Subcommittee for affording me the great honor of testifying before 
you today. My name is Desmond Lachman and I am a Resident Fellow at the 
American Enterprise Institute. I am here in my personal capacity and I 
am not here to represent the AEI's view.
Introduction
    Recent economic and political developments in Greece suggest that 
it is only matter of time before that country both defaults on its 
large public debt and imposes capital controls. Those developments 
could very well pave the way for Greece's exit from the Euro within the 
next 12 months. Were that to occur, one must expect that Greece's 
economic and political crisis will deepen, which could lead to that 
country becoming a failed State.
    Europe is in a very much better position today than it was in 2012 
to handle the immediate fallout from a Greek exit. However, a number of 
countries in the European economic periphery continue to experience 
weak economic growth at a time that they still have very high public 
and private sector debt levels. This makes them especially vulnerable 
to swings in investor sentiment once global liquidity conditions are 
normalized and once the perception becomes widespread that Euro 
membership is no longer irrevocable.
    The implications of a Greek default for the United States are not 
to be underestimated. Immediate action by the European Central Bank 
(ECB) to limit contagion to the rest of the European periphery must be 
expected to further significantly weaken the Euro against the dollar 
that could have a material impact on the U.S. trade balance. From a 
longer term perspective, should market financing for a country as 
highly indebted as Italy dry-up in the wake of a Greek exit, one should 
expect renewed tensions in global financial markets that could 
constitute a significant headwind to the U.S. economic recovery. In 
addition, were Greece to become a failed State, a geopolitical price 
might be paid in the sense that Russia would have an opportunity to 
gain a firmer foothold in the Balkans.
    A deepening of Greece's economic and political crisis would further 
dent the credibility of the IMF, which has provided major financial 
support to Greece over the past 5 years and which has consistently 
underestimated the depth of the Greek economic depression. It could 
also result in Greece's defaulting on the US$24 billion it owes to the 
IMF, which could have implications for the U.S. taxpayer.

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Greek Economic and Political Backdrop
    Over the past 6 years, Greece has experienced an economic 
depression on the scale of that experienced by the United States in the 
1930s. Its economy has contracted by around 25 percent, its 
unemployment rate has exceeded 25 percent, and its youth unemployment 
has risen to over 50 percent. At the same time, despite 5 years of 
budget austerity and a major write-down of its privately owned 
sovereign debt, Greece's public debt to GDP ratio has risen to 180 
percent.

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    At the heart of Greece's economic collapse has been the application 
of draconian budget austerity within a Euro straitjacket. That 
straitjacket has precluded exchange rate depreciation or the use of an 
independent monetary policy as a policy offset to the adverse impact of 
budget belt-tightening on aggregate demand. To its credit, the IMF has 
conceded that in designing its economic program for Greece it had 
grossly underestimated the size of the Greek fiscal multipliers.
    The deterioration in Greece's economy has given rise to the 
fragmentation of its politics and to a major anti-austerity backlash. 
This has been underlined by the decline in support for, Greece's two 
establishment political parties, New Democracy and PASOK from 70 
percent in 2010 to around 25 percent at present. It has also been 
underlined by the rise of extreme political parties on both the right 
and the left side of the political spectrum as well as by the coming 
into office of the far-left Syriza Government in January 2015. That 
Government came into office on a platform of reversing the policies of 
budget austerity and structural economic reform that have been imposed 
on Greece by the IMF and Greece's European partners.
Negotiations With Its Creditors
    Over the past 5 months, the Syriza Government has been engaged in 
difficult negotiations with the IMF and EU on the release of much 
needed funds from its borrowing arrangement with those institutions. 
Until very recently, those negotiations have been characterized by 
large differences in positions over additional budget austerity and 
over pension and labor market reform that Greece's creditors are 
demanding of Greece in return for the release of those funds.
    Since end-2014, in an atmosphere of heightened political 
uncertainty, Greece's economy has taken a renewed downturn while its 
public finances have moved from a small primary budget surplus to a 
primary budget deficit. At the same time, the Greek banking system has 
experienced a slow run on its bank deposits. These deposits have now 
fallen by around 20 percent since the start of the year and have 
required substantial European Central Bank support to keep the Greek 
banking system afloat.

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    This week the outlines of an agreement between Greece and its 
official creditors finally appears to be emerging that could release 
the funds so desperately needed to avoid a Greek default on the IMF and 
the ECB. However, it is highly questionable how long such an agreement 
will last. An essential component of that agreement appears to be yet 
another 2 percentage points of GDP in fiscal tightening over the next 
year and as much as 4\1/2\ percentage points of GDP in tightening over 
the medium term. A further weakness of that agreement is that it relies 
almost exclusively on tax increases to achieve its budget objectives 
and that it sorely lacks either pension or labor market reform that are 
much needed to promote economic growth.
    If past is prologue to the future, such an amount of budget 
tightening in a Euro straitjacket and such a high reliance on tax 
increases is almost certain to deepen Greece's economic depression. 
That in turn again risks putting the country's budget objectives out of 
reach. It also risks splitting the Syriza Party, which is already 
divided on the question of persisting with budget austerity and 
structural economic reform.
Containing Contagion
    Europe is in a very much better position today than it was in 2012 
to handle either a Greek default or a Greek exit from the Euro. It now 
has in place a EUR 500 billion European Stability Mechanism that can 
provide adequate financing to any Eurozone member that might come under 
market pressure. More important yet, the ECB now has in place an 
Outright Monetary Transaction facility that should allow it to do 
``whatever it takes'' to maintain market stability in the event of a 
Greek exit. This should enable European policymakers to ring-fence the 
initial fallout from any eventual Greek exit, albeit at the probable 
cost of having to resort to the ECB's printing press.
    While European policymakers now appear to be well-equipped to 
handle the immediate fallout from a Greek exit, they do not appear to 
be so well positioned to deal with the longer run damage that a Greek 
exit might cause to the Euro project. A Greek exit would signal very 
clearly to markets that Euro membership was no longer irrevocable. In 
addition, in the wake of large losses by Greek bank depositors, it 
would become apparent to bank depositors in the rest of the European 
economic periphery that the ECB was not always there to backstop the 
safety of such deposits.
    Heightening the longer-run risks of a Greek exit on the rest of the 
European periphery, is the fact that the periphery is now characterized 
by significantly higher levels of public debt to GDP ratios than in 
2012. It is also of concern that these countries remain characterized 
by very low growth rates and by price deflation, which makes it very 
difficult for these countries to grow their way out from under their 
debt mountains. In that respect, it does not help that countries in the 
economic periphery are all experiencing political backlashes against 
further budget austerity and structural economic reform.

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    Italy's present position is particularly disturbing considering 
that the country has more than US$2\1/2\ trillion in public debt, 
making Italy the world's third largest sovereign debt market. Whereas 
at the start of the debt crisis in 2010, Italy's public debt to GDP 
ratio was 115 percent, today that ratio is around 135 percent. 
Meanwhile, since 1999 the Italian economy has shown no growth. It 
should perhaps come as no surprise that all of Italy's major political 
parties, other than the governing Democratic Party are now opposed to 
Euro membership. This is bound at some stage to turn the market's focus 
on Italy's shaky public debt dynamics.

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Implications for the United States
    Over time, a Greek exit could impose considerable economic and 
geopolitical costs on the United States. This could occur through the 
following three channels:

  a.  In the immediate aftermath of a Greek exit, one must expect a 
        significant further depreciation of the Euro as the ECB took 
        more forceful measure to prop up the European periphery and as 
        investors fled to the safety of the dollar. This would have the 
        effect of causing a further effective appreciation of the 
        dollar that would come on top of a 15 percent such appreciation 
        over the past year. As the Federal Reserve has noted, a strong 
        dollar appreciation could constitute a significant headwind to 
        the U.S. economic recovery and could exert significant downward 
        pressure on U.S. headline inflation.
        
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  b.  Any eventual spread of the Eurozone debt crisis to other 
        countries in the European periphery, like Italy, Portugal, and 
        Spain, could roil global financial markets and dent European 
        household and investor confidence. This would be bound to 
        impact the U.S. economic recovery considering how integrated is 
        the global financial system and how important the European 
        economy is to U.S. trade.

  c.  Should a Greek exit lead both to a souring of European-Greek 
        relations and to the further erosion of Greek political 
        stability, one could see a failed Greek State increasingly 
        coming into the Russian orbit. Already the Syriza Government is 
        actively engaged with Moscow about the construction of a 
        Russian gas-pipeline through Greece despite the U.S. 
        Administration's objections. A deepening of the Greek economic 
        crisis is all too likely to bring Athens and Moscow closer 
        together.
Consequences for the IMF
    A Greek exit would have considerable implications for the IMF's 
credibility. It would inevitably raise questions as to the design of 
the IMF's Greek lending programs and as to the IMF's wisdom in loaning 
unprecedented amounts of money to Greece to keep it in the Euro at all 
costs. It will also be asked why the IMF did not foresee the depth of 
the Greek economic collapse as well as to what end was Greece put 
through years of austerity within a Euro straitjacket at the cost of 
sending its economy into a deep depression, when in the end it was 
forced to exit the Euro.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    A Greek exit is also likely to involve Greece defaulting on the 
US$24 billion that the IMF has loaned to it. This would be of 
considerable concern considering that Greece together with Portugal and 
Ukraine account for around two-thirds of the total IMF loans presently 
outstanding. This will make it difficult for the IMF to make the case 
to Congress that U.S. taxpayer money was not put at considerable risk 
by the IMF's lending practices.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

    It will also make it difficult for the IMF to defend its 
``exceptional access'' lending policy that in effect removes limits on 
how much money the IMF can loan to an individual country. This will be 
particularly the case considering that over the past few years, very 
large scale IMF lending to Greece forestalled much needed debt 
restructuring in that country. In the process, it facilitated the exit 
of private sector creditors from that country by placing the global 
taxpayer very much on the hook in the event of a Greek default.
                                 ______
                                 
               PREPARED STATEMENT OF MATTHEW J. SLAUGHTER
  Incoming Paul Danos Dean, Tuck School of Business, Dartmouth College
                             June 25, 2015
Introduction
    Subcommittee Chairman Kirk, Ranking Member Heitkamp, Committee 
Chairman Shelby, Ranking Member Brown, and fellow Members, thank you 
very much for inviting me to testify on these important and timely 
issues of how a default by Greece on its sovereign debt would impact 
the United States and overall global economy.
    My name is Matt Slaughter, and at the Tuck School of Business at 
Dartmouth I am the incoming Paul Danos Dean, the Earl C. Daum 1924 
Professor of International Business, and the founding Faculty Director 
of the Center for Global Business and Government. From 2005 to 2007 I 
also served as a Senate-confirmed Member on the President's Council of 
Economic Advisers, where my international portfolio spanned topics such 
as currencies, international trade and investment, and the 
competitiveness of the U.S. economy. \1\ More recently I was a founding 
member of the Squam Lake Group, a nonpartisan group of 15 academics who 
came together to offer guidance on reform of financial regulation 
amidst the World Financial Crisis. \2\
---------------------------------------------------------------------------
     \1\ In the past 2 years, I have not received any Federal research 
grants. In addition to the above Tuck positions, currently I am also a 
Research Associate at the National Bureau of Economic Research; an 
adjunct Senior Fellow at the Council on Foreign Relations; a member of 
the advisory committee of the Export-Import Bank of the United States, 
a member of the academic advisory board of the International Tax Policy 
Forum; and an academic advisor to the McKinsey Global Institute. For 
many years I have consulted both to individual firms and also to 
industry organizations that support dialogue on issues of international 
trade, investment, and taxation. For a listing of such activities, 
please consult my curriculum vitae posted on my Web page maintained by 
the Tuck School.
     \2\ The book our Group coauthored that discusses the challenges in 
understanding and aiming to prevent financial crises is The Squam Lake 
Report: Fixing the Financial System, with Kenneth R. French, Martin N. 
Baily, John Y. Campbell, John H. Cochrane, Douglas W. Diamond, Darrell 
Duffie, Anil K. Kashyap, Frederic S. Mishkin, Raghuram G. Rajan, David 
S. Scharfstein, Robert J. Shiller, Hyun Song Shin, Matthew J. 
Slaughter, Jeremy C. Stein, and Rene M. Stulz; Princeton University 
Press, June 2010.
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    At the time of writing this testimony, the outcome of the latest 
chapter of the Greek-debt saga is still being written. Prime Minister 
Alexis Tsipras has just flown to Brussels to meet with fellow 
Government leaders, at least some of whom have objected to his latest 
compromise offer. There are many fluid and undefined issues about the 
immediate situation, none of which this testimony will address. Rather, 
I will make three main points about the consequences of a Greek 
default: one focused on the short term, one focused on the medium term, 
and one on the long term.

  1.  In the short term, a Greek default would surely trigger 
        additional short-term pain on the Greek economy. Through 
        various channels, it would very likely dampen overall economic 
        activity in the Eurozone--and thus, albeit to a lesser extent, 
        the rest of the world. And, there is some small but nonzero 
        chance that it would trigger another world financial crisis of 
        the magnitude of the World Financial Crisis of 2008-2009 
        triggered by the default of the U.S. investment bank, Lehman 
        Brothers.

  2.  In the medium term, a Greek default would raise the risks of 
        additional highly indebted and struggling countries exiting the 
        Eurozone. This elevated risk would tend to dampen economic 
        activity within Europe and beyond, through channels similar to 
        those cited above. And, arguably even more than Greece--because 
        of how small it is--these future exits would bring greater 
        chances of triggering financial crises.

  3.  In the long term, a Greek default is largely irrelevant to the 
        fundamental challenge still facing Greece and every other 
        advanced country: how to foster growth of jobs, incomes, and 
        output in societies with aging populations and looming 
        entitlement pressures. The current Greek crisis, however it is 
        resolved, does nothing to address this fundamental long-term 
        problem facing much of the global economy. Indeed, by crowding 
        out the attention of policy and business leaders, the current 
        crisis aggravates this looming long-term problem.
The Short-Term Default Consequences: Definite Economic Downturn, 
        Possible Crisis
    In the short term, a Greek default would surely trigger additional 
short-term pain on the Greek economy. In the past 5 years Greece has 
sustained a Great Depression-scale contraction. Gross Domestic Product 
has fallen by nearly 30 percent. Unemployment spiked to about 26 
percent, with unemployment of those aged 25 and younger peaking at a 
staggering 50 percent. Nearly all wages have fallen by double-digit 
percentages. That said, in the past year many economic indicators have 
stabilized and some have turned positive. For example, GDP has expanded 
slightly.
    In whatever form it might take, a default would contract the Greek 
economy further. A main contractionary mechanism would likely be a wave 
of bank runs and thus bank closures, with knock-on bankruptcies beyond 
the financial sector, amidst the turmoil of reintroducing the Greek 
Drachma when no treaties, laws, or precedents for how to reconvert all 
payment flows, assets, and liabilities out of Euro denomination. This 
turmoil would sharply curtail consumption and investment demand in 
Greece, which in turn would drive down short-term output and 
employment. The scale of this contraction is difficult to predict, but 
double-digit declines are conceivable. Over time, recovery in Greece 
would be facilitated by a sharp devaluation of the drachma relative to 
the Euro and to other global currencies--and thus a boost in export 
demand as Greek goods and services (such as tourism) become less 
expensive to foreign customers. This export fillip would almost surely 
be swamped in the short term, however, by contractions in consumption 
and investment demand.
    This Greek economic contraction would very likely dampen overall 
economic activity in Europe--and thus, albeit to a lesser extent, the 
rest of the world. Through the usual linkages of international trade 
and investment, however, the scale of this worldwide dampening would be 
slight. The basic reason for this is that the Greek economy is quite 
small. 2014 GDP in Greece was about $244 billion (down from a precrisis 
peak of about $342 billion). This was about one third of 1 percent of 
worldwide GDP in 2014 ($77.3 trillion, according to the International 
Monetary Fund). Greece is about the size of the economy of Louisiana or 
Connecticut. As such, however large a default-induced contraction in 
Greece might be, it simply would not be very large relative to the 
overall world economy. A further 10 percent contraction of the Greek 
economy would be about \1/30\th of 1 percent of the total world 
economy.
    The knock-on effects of reduced European or U.S. exports to 
Greece--and thus reduced capital investment in these countries--would 
be similarly quite small. In 2014 the United States exported $205.9 
billion in goods to the Eurozone. This amount was about 12.8 percent of 
total U.S. goods exports--which, in turn, were about 9.3 percent of 
total U.S. 2014 GDP of $17.4 trillion. Imagine that a default shrinks 
by 10 percent all spending by Greek households and businesses--and 
that, implausibly, all that spending reduction came in the form of 
fewer purchases from U.S. exporters. This drop in U.S. exports of about 
$20 billion would constitute only about \1/10\th of 1 percent of U.S. 
GDP. Yes, that would be a lot of money to the American businesses hit 
with canceled orders. But for the economy overall, this drop in exports 
would fall within the usual measurement error in the GDP measures 
produced by the U.S. Bureau of Economic Analysis.
    The one possible economic impact of a Greek default that 
paradoxically might be most important yet is most difficult to quantify 
is there is the small but nonzero chance that default triggers another 
financial crisis of the magnitude of the World Financial Crisis of 
2008-2009 triggered by the default of the U.S. investment bank, Lehman 
Brothers.
    There are sound reasons not to expect such a crisis. Today the 
majority of Greek sovereign debt is owned not by banks and other 
private investors but rather by public entities: other sovereign 
Governments, the IMF, and the ECB. Eurozone banks today have stronger 
balance sheets than in years, thanks to changes including capital 
accumulation as part of regulatory stress tests. And, the ECB is 
currently implementing its own ``quantitative easing'' program of 
buying substantial amounts of member-country sovereign debt, one impact 
of which is to support confidence in financial markets and in the 
broader economy. All of this means that the losses of default would be 
borne by other Governments (and, implicitly, their taxpayers) rather 
than by banks--and, to the extent that banks would incur some losses, 
they are better positioned today to absorb those losses without 
destabilizing runs and/or sharp credit contractions.
    All this said, no one really knows what will happen in global 
capital markets if Greece defaults and/or exits the Eurozone. All the 
world's ex ante analysis, meticulous and thoughtful though it may be, 
simply has no historical precedent as a guide. Before Lehman died, as 
its stock price slid and as creditors and other counterparties jogged, 
wise voices intoned that a medium-sized U.S. investment bank could do 
only so much damage. Those wise expectations were proven very wrong as 
traders and counterparties reacted in diverse and unexpected ways, 
which in turn triggered asset-price movements and comovements that even 
today we do not fully understand. No one can plausibly rule out such 
destabilization in the wake of a Greek default. Imagine a massive post-
default panic to sell the debt of Spain, Portugal, and Italy--and to 
then buy U.S. Treasurys--that leaves illiquid one of the world's 
largest and most-heavily leveraged hedge funds. As all its 
counterparties lose confidence in it and in each other, a post-Lehman 
lending freeze could again materialize around the world in another 
financial crisis.
The Medium-Term Default Consequences: Greater Risks of Further Euro 
        Exits
    In the medium term, a Greek default would raise the risks of 
additional highly indebted and struggling countries exiting the 
Eurozone. A Greek default accompanied by an exit from the Eurozone 
would set a precedent that had been intended to be an impossibility: of 
a Eurozone member reverting to its own sovereign currency.
    Currency unions such as the Eurozone function much like regimes in 
which member countries fix their currency values yet maintain separate 
currencies. For example, in either regime each member country cannot 
freely increase or decrease its money supply based on conditions in its 
own country alone. The main advantage of currency unions is--or so it 
is often hoped by their creators--irrevocability that eliminates the 
possibility of the speculative attacks that so often have bedeviled 
fixed exchange-rate regimes. Indeed, a major impetus for creating the 
Euro in the late 1990s was the early-1990s turmoil of waves of 
speculative attacks against the Exchange Rate Mechanism (in which many 
member countries effectively chose to fix the value of their currencies 
to the German Deutschmark). The British Pound, for example, was ejected 
from the ERM and floated in September of 1992 when speculators such as 
George Soros forced the Bank of England to relent its fix after 
sustaining losses of tens of billions of Pounds.
    A ``Grexit'' would shatter the intended permanence of the Euro and 
would revive the idea that Eurozone countries can create and print 
their own currencies. Quite simply, afterward no Government official 
could credibly claim that the Grexit was a one-off event never to be 
repeated. Investors and politicians alike would focus more on the 
actions of the Grexit, not on any words thereafter.
    How likely is it that in the years ahead another Eurozone country 
would exit the Eurozone? That is impossible to predict, but surely 
post-Grexit this likelihood would be higher than before. And, the 
pressures for additional exits would arise from two forces--potentially 
interrelated. One is investors demanding higher interest rates from 
countries they perceive to be possible exitors. The other is fringe 
parties--already surging in countries such as Spain, with radical party 
Podemos--that might speak favorably about, and follow the polices of, 
Syriza in Greece.
    One important indicator will be whether or not Eurozone countries 
manage to spur faster economic growth, as is discussed below. Countries 
lacking such policies--perhaps partly because of fringe parties coming 
to power--will be countries where interest rates rise, as they did in 
many weak Eurozone countries in 2010 and 2011. The combination of 
higher interest rates and all the related uncertainty would tend to 
depress hiring and economic growth, and thereby would trigger a dynamic 
not unlike that of Greece in recent years. The broader global economy 
would suffer from slowdowns (or outright recessions) in these 
countries, through the trade and investment linkages outlined above.
    And any future exits from the Euro would surely bring greater 
chances of triggering the financial crises described above, because of 
how much larger and interconnected other countries are compared to 
Greece. Yes, a Grexit might not spark crisis. But what about an exit by 
Spain or by Italy?
The Long-Term Default Consequences: From Where Will Growth Come?\3\
    In the long term, a Greek default is largely irrelevant to the 
fundamental challenge still facing Greece and every other advanced 
country: how to foster growth of jobs, incomes, and output in societies 
with aging populations and looming entitlement pressures. In this 
sense, the default question is not the most important question facing 
Greece today. Rather, that honor goes to a different question: Will the 
Syriza Government--or any Government after it--be able to foster growth 
in Greece's labor force, capital investment, and productivity?
---------------------------------------------------------------------------
     \3\ Much of this sub-section is excerpted from ``The Most 
Important Question Facing Greece'', The Slaughter & Rees Report, 
February 2, 2015, available at http://cgbg.tuck.dartmouth.edu/news-
events/blog/slaughter-rees-report-the-most-important-question-facing-
greece.
---------------------------------------------------------------------------
    For any country on the planet, long-run economic growth requires an 
ability to accumulate some combination of labor, capital, and 
productivity. Yes, policy to support aggregate demand through efforts 
like ECB quantitative easing is important to employ currently idle 
people and capital. And, yes, the outcome of this week's debt-
renegotiation game of chicken will influence companies' investments and 
innovativeness in Greece. But what will ultimately create sustainable 
economic recovery and hope in Greece is growth in its economic 
potential thanks to growth in some combination of these three factors. 
Without policies to spur their growth, no amount of debt renegotiation 
or forgiveness will matter.
    It is useful to remember precisely how and why the Greek economy 
plummeted. There were years and years of economic mismanagement, which 
was never reflected in the country's official statistics (statistics 
that were later revealed to be highly compromised). A handmaiden of the 
mismanagement was widespread corruption and highly restrictive 
regulation that protected well-connected groups and stifled 
entrepreneurship. Here is one example among many: in 2013, the 
Government acknowledged 343 professions had been effectively closed to 
outsiders.
    Syriza tapped into a wellspring of resentment over the country's 
economic woes; Prime Minister Alexis Tsipras has pledged to ``bring an 
end to the vicious circle of austerity.'' But the reforms announced 
thus far since his recent election are not obviously policies aimed at 
long-run growth: raising the minimum wage by 10 percent, reversing 
public-sector layoffs, and halting privatization. There has been 
discussion of raising taxes on hotels--one of the few sectors that 
remains healthy--and even restricting their ability to offer all-
inclusive packages.
    Regardless of how Greece and its creditors resolve their 
differences, the country will still face long-term growth challenges 
that must somehow be addressed. For example, its total population fell 
by about 200,000 people between 2001 and 2012 (and has surely declined 
even more since then)--a function of low birthrates, low immigration, 
and high out-migration. The median age is also projected to be 43.5 
this year (an increase of 10 years since 1970), which is one of highest 
in the world. Demographically, Greece has quickly become like already-
shrinking Japan. And who is fleeing Greece are almost surely the more-
talented, more-dynamic of its workers.
    Greece is also saddled with low levels of innovation and very low 
spending on research and development. Increasing that spending--e.g., 
by continued deregulation of the economy to incentivize private R&D 
spending and investment--could deliver a number of benefits: spurring 
domestic innovation, keeping Greek companies in Greece, attracting 
immigrants and foreign direct investment, and perhaps even persuade 
some of the millions of Greeks living abroad to return to their 
ancestral home.
    Greece has made some growth progress; for example, it has improved 
its position in the World Bank's Doing Business rankings from 109 in 
2011 to 61 today. No other country has come close to achieving this 
improvement over the past 4 years. One encouraging sign: Uber, which is 
in the crosshairs of regulators throughout the world, has been 
operating freely in the country thus far in 2015.
    But so much work remains if Greece is to raise its potential for 
long-term growth in output, jobs, and incomes. One place to start would 
be working through the 555 regulatory restrictions that the OECD, 
working in partnership with Greek authorities, identified as 
undermining competition and handicapping the Greek economy.
    Greece's experience over the past few years is a potent reminder to 
countless other countries that anti-growth public policies today have 
consequences that can accumulate far into tomorrow. And those 
consequences are intensified when capital and labor can move around the 
world to where it is welcomed and rewarded. Lest we all wag our fingers 
at Greece as uniquely profligate, keep in mind that the dynamic of 
aging populations and looming entitlement pressures--all approaching 
when in recent years public debt has already spiked and economic growth 
has already slowed--faces many advanced countries today.
    According to the IMF, gross public debt as a share of GDP has 
surged pretty much everywhere in the wake of the World Financial 
Crisis. From 2007 to 2014 it increased in the United States from to 
67.2 percent to 104.8 percent, in the Eurozone from 66.4 percent to 
94.0 percent (e.g., in Italy from 103.1 percent to 132.1 percent), and 
in Japan from 183.0 percent to a staggering 246.4 percent.
    What is Europe, for example, to do? Even ECB President Mario Draghi 
knows that ballooning the ECB balance sheet would accomplish only so 
much. Economic sluggishness across the continent reaches back decades. 
Consider this stunning statistic: total factor productivity (TFP)--
which reflects the efficiency of capital and labor used together, and 
growth of which is central to long-run growth in output, jobs, and 
wages--is lower today in France, Italy, Spain, and Germany than it was 
in 1980. The U.S. TFP increase during this period has been about 35 
percent.
    Boosting TFP tends to require long-term, wise investments in areas 
including education, skilled immigration, and competition--both 
domestic and international--in product markets, labor markets, and 
capital markets. In a recent interview Mr. Draghi acknowledged that 
``progress on the important structural reforms--more flexible labor 
markets, less bureaucracy, lower taxes--is clearly too slow.'' Asked to 
specify which Eurozone countries need to prioritize these reforms, he 
didn't mince words. ``All of them.''
    And what is the United States to do? U.S. productivity growth has 
slumped in recent years to many-decade lows. Output per worker hour in 
the U.S. non-farm business sector grew in the 4 years of 2011-2014 by 
just 0.2 percent, 1.0 percent, 0.9 percent, and 0.7 percent, 
respectively. Contrast this with the late 1990s and early 2000s: in the 
decade of 1995-2005, productivity growth averaged 3.0 percent per year. 
This surge was widely visible in accelerated growth in U.S. GDP, jobs, 
and worker earnings. At one point in 2000, U.S. unemployment dipped to 
just 3.9 percent and for several years during this period earnings rose 
briskly for all U.S. workers--even less-skilled workers including high-
school dropouts. These large economic gains spread even to the U.S. 
Government, for which unexpected surges in tax receipts led to Federal-
budget surpluses from 1998 through 2001, the first in generations.
    America today continues to confront a competitiveness challenge of 
too little economic growth, of too few good jobs, and of real earnings 
for most of those working not rising. The good news is there is a 
future in which America can create millions of good jobs connected to 
the world via international trade and investment. Doing so will require 
bold and thoughtful U.S. policies, however, that extend beyond fiscal 
and monetary stimulus whose viability and impact are questionable. 
Productivity growth to spur growth in output, jobs, and incomes for 
American workers is within reach--but only if America finds a way to 
pursue wise policies such as business-tax reform that reduces rates and 
complexity, high-skilled immigration expansion, trade and investment 
liberalization, and sound investments in public infrastructure.
Conclusion
    Greece has a glorious past. If it can use the ongoing crisis as an 
opportunity to transform its economy, and unlock economic opportunity, 
it could have a glorious future as well. Debt discussions of today must 
not obscure the deeper reforms that are needed for attaining that 
future. The current Greek crisis, however it is resolved, does nothing 
to address the fundamental long-term problem of how to accelerate 
economic growth. Indeed, by crowding out the attention of policy and 
business leaders, the current crisis aggravates this looming long-term 
problem.
    The same is true for so many other advanced countries in the world, 
including the United States. Wise leaders will reflect on Greece, not 
as a unique outlier but rather as a sobering leading indicator for the 
challenges that are approaching.
    Thank you again for your time and interest in my testimony. I look 
forward to answering any questions you may have.
                                 ______
                                 
                PREPARED STATEMENT OF CARMEN M. REINHART
Minos A. Zombanakis Professor of the International Finance System, John 
          F. Kennedy School of Government, Harvard University
                             June 25, 2015
    Thank you, Chairman Kirk and Ranking Member Heitkamp, along with 
the other Members of the Subcommittee, for the opportunity to comment 
on the unfolding crisis in Greece and its global ramifications. I am 
currently a professor at Harvard Kennedy School. I suspect that I was 
invited today because, for more than a decade, my research has focused 
on various types of financial crises and their economic consequences, 
including international contagion. One of the main lessons emerging 
from this work is that, across countries and over time, severe crises 
follow a similar pattern.
    I will organize my remarks around three connected topics: (i) 
developments in Greece, as these relate to the Greek Government's 
potential default later this month or sometime this summer and the 
country's likely exit from the Eurozone in that event; (ii) the 
repercussions of such an exit on European economies, particularly 
periphery countries (Ireland, Italy, Portugal, and Spain); (iii) the 
possible broader repercussions of the crisis on the United States, 
global currency markets, and emerging market economies.
The Situation in Greece
    I will focus on the multiple possibilities of default. Even if 
events are arranged so that the Greek Government meets its obligations 
to the International Monetary Fund at the end of this month, the 
probability of a default over the course of the summer looms large. 
There are many reasons why default appears probable. Consider the top 
two.
    First, the widespread loss of confidence in the sustainability of 
the status quo has led to a sharp escalation in internal arrears 
(public and private). The private sector, concerned about the 
likelihood of an exit from the euro and a renewed contraction in 
economic activity, has increasingly defaulted on existing debts; about 
half of the bank loans are nonperforming and the share rises to more 
than \3/4\ if credit card debt is included. Tax payments are postponed 
or avoided, aggravating an already precarious fiscal position. The 
attempt to hoard euros by the citizenry is also manifest in the sharp 
escalation of deposit withdrawals. A very conservative estimate would 
indicate that deposits have fallen by around 45 percent since their 
peak in 2009. The combination of a rapidly shrinking deposit base and a 
staggering share of nonperforming loans imply that the banking sector 
is near a bank holiday. The Government is financing itself by not 
paying its bills, similar, for instance, to what transpired ahead of 
the Russian default of August 1998 or Argentina at the end of 2001. 
Also, general Government deposits in the banking sector were off more 
than 40 percent at the end of April.
    Second, the approximate 1.6 billion euro payment due to the IMF at 
the end of this month is only a fraction of the amounts coming due in 
July, August, and September, which total about 7, 5.6, and 6 billion 
euro, respectively. These payments are a multiple of current Government 
cash balances. At present, Greece is allocating less than 2 percent of 
GDP to interest payments, so even another round of compromise from 
official creditors that would delay such payments would not free up 
significant resources, so at to deal with domestic arrears and external 
payments on maturing debts.
European Contagion
    A point of departure in assessing the current scope for contagion 
from a Greek default is the absence of the ``surprise'' element. \1\ In 
my work on contagion, I have found that ``fast and furious'' financial 
contagion is far more likely when the triggering crisis takes investors 
and Governments by surprise.
---------------------------------------------------------------------------
     \1\ See Kaminsky, Graciela L., Carmen M. Reinhart, and Carlos A. 
Vegh, ``The Unholy Trinity of Financial Contagion'', Journal of 
Economic Perspectives, Vol. 17(4), Fall 2003, 51-74.
---------------------------------------------------------------------------
    There is no surprise here. Because the Greek drama has been 
unfolding over several years, private sector exposure to Greece (that 
is to say, outside of Greece) has declined sharply since the spring of 
2010. Prior to the financial crisis, most Greek debt was in the hands 
of private external creditors (banks and nonbanks, as shown in Figure 
1). Such financial links increased the odds of significant spillovers. 
During the past 5 years, official creditors (including the IMF and the 
European Central Bank) have absorbed Greek sovereign debts. Thus, at 
this time the scope for contagion via financial channels is limited. 
Real-side exposure to Greece via trade is not a new factor to consider, 
as Greek GDP has approximately contracted by 25 percent since the 
outset of the crisis, which an even bigger contraction in imports from 
the rest of Europe. Whether investors become indiscriminate and pull 
out of other European periphery countries in the event of a Greek 
default still remains a risk. The likelihood of such a scenario, 
however, is mitigated by the fact that a significant share of sovereign 
periphery debt (particularly Portugal and Ireland) is also in official 
hands, that these countries have been recovering much more rapidly than 
Greece, and that in such an event periphery Europe would receive 
support from the center and from the IMF.
Implications for the United States, Global Currency Markets, and 
        Emerging Market Economies
    The effects of a Greek default, probably in the context on an exit 
from the eurozone, on the United States are likely to be very limited 
in scope. Financial exposure, which was comparatively marginal in the 
first place, is not a prevalent source of concern for U.S. financial 
institutions. Nor is the Greek market a major destination for U.S. 
exports. Predicting currency fluctuations is an elusive goal for 
economists, so take my observations with a healthy dose of skepticism. 
If a Greek default triggers substantial turmoil in Europe, we would see 
a flight to safety into U.S. dollar assets, notably Treasuries. This 
has been the ``standard'' pattern of response in past waves of global 
volatility. If so, further appreciation in the U.S. dollar vis-a-vis 
the euro and most other currencies follows. In this setting, the 
potential adverse effects of an appreciating dollar would be largely 
felt by U.S. manufacturing, not unlike the impacts already seen earlier 
this year.
    In terms of broader consequences, an appreciating dollar may act as 
a headwind in the Federal Reserve's efforts to begin the process of 
pulling its policy interest rate off the zero lower bound. Also, many 
emerging markets with dollar-denominated external debt (whether these 
are public or private) would be other things equal, we worse off with 
further dollar appreciation.
    Greece is already close to financial autarky. It relies almost 
entirely on support provided by the ECB and other official lenders. The 
gap between a de jure default and a de facto one has narrowed 
significantly. As a result, the next stage in this crisis may have 
limited consequences for the global economy.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

                                 ______
                                 
              PREPARED STATEMENT OF JACOB FUNK KIRKEGAARD
     Senior Fellow, Peterson Institute for International Economics
                             June 25, 2015
    Subcommittee Chairman Kirk, Ranking Member Heitkamp, Members of the 
Subcommittee on National Security and International Trade and Finance, 
it is a pleasure to testify before you today on the global impact of 
a--hypothetical--Greek default. \1\ In my written testimony, I will 
address two issues; the probability of a Greek default and its 
implications on the eurozone and the global economy, and the exposure 
to the U.S. taxpayer from loans given to Greece by the IMF.
---------------------------------------------------------------------------
     \1\ I am grateful to my colleagues at the Peterson Institute for 
ongoing and highly rewarding discussions of this and related issues, in 
particular Edwin Truman, Avinash Persaud, Joe Gagnon, Douglas Rediker, 
Angel Ubide, William Cline, Nicolas Veron, and Adam Posen. Any 
remaining errors conveyed are solely mine.
---------------------------------------------------------------------------
The Probability and Implications of a Greek Government Default on 
        Greece, the Euro Area, and the Global Economy
    In light of ongoing negotiations in the euro area, it is at the 
time of writing an open question if the Greek Government can avoid a 
default against its official sector creditors, as well as whether the 
IMF gets paid on time on June 30th and arrears to the organization thus 
averted.
    Substantial amounts of political brinkmanship are being utilized to 
achieve a negotiated outcome, which aims to see a self-identified 
radical leftist anti-austerity Government agree to a reform package 
with the Troika in exchange for the continuation of financial support. 
\2\ Whatever today's negotiation situation is, it remains a near 
certainty that an agreement will eventually be found in the coming 
weeks. The principal question is whether an agreement will require a 
brief period of restrictions on the Greek banking sector to be sealed 
or not.
---------------------------------------------------------------------------
     \2\ Sometimes officially now referred to as the ``Brussels 
Institutions'', consisting of the IMF, the European Commission and the 
ECB, with the EuroGroup functioning as the European entity politically 
agreeing to the technical proposals of the Troika.
---------------------------------------------------------------------------
    This ultimate ability to find an agreement with the current or a 
new Greek Government is of the utmost importance, as it suggests that 
Greek Government debt is and will most likely in the future remain 
sustainable, despite the country's extremely high gross Government debt 
levels of 177 percent of GDP in 2014 \3\ and uncertain future growth 
prospects.
---------------------------------------------------------------------------
     \3\ Eurostat data at http://ec.europa.eu/eurostat/tgm/
table.do?tab=table&init
=1&language=en&pcode=teina225&plugin=1.
---------------------------------------------------------------------------
    This conclusion follows from the particular current structure of 
Greek Government debt, which is overwhelmingly held by the other euro 
area members, the IMF as a super-senior creditor, and with remaining 
privately held debt at very long maturities and low nominal interest 
rates (See Figures 1 and 2). Consequently, the cost of servicing and 
therefore the financial sustainability of Greek Government debt is 
largely unrelated to the size of gross debt or financial market 
fluctuations. The country currently faces very small debt payment 
obligations until at least 2023, and already has a substantially longer 
debt maturity profile and substantially lower implied rate of interest 
on its debt than for instance the United States Federal Government 
(Figure 3).
    Rather Greek debt sustainability and ability to avoid a future 
default is dependent on two things; the Greek Government's ability to 
restore economic growth in the country, or in other words the 
continuation of growth-friendly structural economic reforms, and the 
country's ability to reach an ongoing political agreement with its 
official sector creditors in the euro area and the IMF. Unlike the IMF, 
the euro area has--as has already been done in June 2011, March 2012 
and November 2012 \4\--the political freedom to restructure its Greek 
Government debt holdings in a manner closely calibrated to the 
preceding degree of Greek Government delivery of agreed structural 
reforms and fiscal targets. Provided the Greek Government in the future 
offers politically satisfactory implementation of an agreed program, 
the euro area will, in accordance with earlier promises to consider 
``further measures and assistance, including inter alia lower 
cofinancing in structural funds and/or further interest rate reduction 
of the Greek Loan Facility, if necessary, for achieving a further 
credible and sustainable reduction of Greek debt-to-GDP ratio'', \5\ 
offer the country further debt restructuring. Such additional 
restructuring of the euro area holdings of Greek Government debt will, 
however, only be contemplated once the Greek Government has proven its 
commitment to faithfully implementing a program agreed with the Troika. 
Ex ante debt relief to Greece will not be granted.
---------------------------------------------------------------------------
     \4\ See ESM (2015:29) for the details of these earlier 
restructurings of euro area holdings of Greek debt. Available at http:/
/www.esm.europa.eu/pdf/204204_ESM_RA_2014_web.pdf.
     \5\ Eurogroup Statement on Greece, November 27th 2012, available 
at http://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/
ecofin/133857.pdf.
---------------------------------------------------------------------------
    Recalling that Greece is a small country, accounting for only 1.8 
percent of total euro area GDP, and hence does not pose a material risk 
to overall euro area financial stability (see also Table 1), Athens' 
ability to avoid a future default is a question of the Government's 
domestic reform capability and internal euro area politics, not 
objective debt sustainability criteria or financial markets.
    In short, Greece is and will remain solvent if the euro area wants 
it to be.
    Discussions about the implications of a Greek Government default 
are per the above likely to remain hypothetical. If the Greek 
Government were nonetheless to default, the precise circumstances and 
against which creditors it did so would determine the consequences. 
Failure to for instance pay the IMF on time on June 30th, 2015, would 
not immediately and independently have any real consequences for 
Greece, as it per IMF (2012:21) would merely initially result in: 
``Staff sends a cable urging the member to make the payment promptly; 
this communication is followed up through the office of the concerned 
Executive Director. The member is not permitted any use of the Fund's 
resources nor is any request for the use of Fund resources placed 
before the Executive Board until the arrears are cleared.'' \6\
---------------------------------------------------------------------------
     \6\ Available at http://www.imf.org/external/np/pp/eng/2012/
082012.pdf.
---------------------------------------------------------------------------
    Only following a lengthy internal procedure lasting up to 24 months 
could Greece face expulsion from the IMF.
    However, were Greece to go into arrears against the IMF on June 
30th, 2015, as a result of a failure to reach an agreement with the 
Troika, the European Central Bank (ECB) would in all probability almost 
immediately stop, or at least substantially scale back the ongoing 
provision of emergency liquidity assistance (ELA) to the Greek banking 
system. \7\ This would make it impossible for the Greek banks to 
operate and necessitate the imposition of a bank holiday, or at least 
severe deposit access controls at the institution level, which again 
would throw the Greek economy into another dramatic economic decline.
---------------------------------------------------------------------------
     \7\ Latest available data for May 2015 indicates ELA had reached 
approximately $87bn (up 4bn from April). See http://www.reuters.com/
article/2015/06/24/eurozone-greece-ecb-idUSA8N0Z
300J20150624.
---------------------------------------------------------------------------
    The political effects of deposit access controls--which importantly 
under new Banking Union regulations could potentially be imposed by the 
central euro area banking supervisors at the ECB against the will of 
the Greek Government--on the Greek economy and financial system would 
likely be dramatic, and in all probability sooner or later lead to 
sufficient domestic political pressure for the Government to reach an 
agreement with the Troika. This would restore ECB support for the Greek 
banking system and broader Troika financial support. As such, any 
actual default by the Greek Government against any official sector 
creditor is likely to be of relatively short duration.
    Notions that it, given its current projected small primary fiscal 
surplus, would be in Greece's economic interest to declare a sudden 
unilateral and total default against its public and private creditors 
are based on a dangerously simplistic understanding of the close 
financial, political, economic and budgetary ties between Greece and 
especially its euro area and EU partners.
    Such a unilateral default against its creditors would for instance 
result in the immediate loss of ECB support for the banking system and 
thus cause the instant closure of Greek banks system and a highly 
probable loss of ongoing EU budget support of around 3 percent of GDP. 
\8\ Any current projected Government primary surpluses in Greece would 
quickly as a result of slumping growth, disappearing net budget 
transfers and declining Government revenues be converted into likely 
sizable Greek Government primary deficits. Any defaulting Greek 
Government would ultimately not be able to pay even the claims of its 
domestic Greek stakeholders, undermining its political support. 
Moreover, it should be emphasized that the lessons from economic 
history concerning the aftermath previous sovereign defaults are of 
relative limited predictive value for the likely effects in a country 
like Greece, which is a relatively closed economy with limited export 
potential, has a far older population, a much larger Government share 
of GDP than earlier recorded sovereign default cases.
---------------------------------------------------------------------------
     \8\ See European Commission data at http://ec.europa.eu/budget/
mycountry/EL/index
_en.cfm.
---------------------------------------------------------------------------
    A Greek sovereign default would have very, very severe domestic 
economic consequences for Greece, yet a Greek default does not imply an 
automatic, or even probable, departure of Greece from the euro area 
(the so-called Grexit). Default against some or all its official sector 
creditors could be implemented by any incumbent Greek Government simply 
by failing to pay its dues on time, in the same manner the current (and 
previous) Greek Government has gradually run into sizable arrears 
against many of its domestic Government suppliers. \9\ Leaving the 
euro, however, would represent a reversal of nearly 40 years of Greek 
economic and political participation in European integration. It would 
in all probability require an explicit public mandate to the Government 
to undertake such a momentous volte face. Given how a large majority of 
at least two-thirds of the Greek public and over 80 percent of Greek 
MPs (including both parties in the current governing coalition) has 
consistently supported staying in the euro, \10\ such a public mandate 
look politically impossible in Greece for the foreseeable future.
---------------------------------------------------------------------------
     \9\ See latest Greek Government budget implementation data at 
http://www.mnec.gr/?q=en/content/state-budget-execution-january-may-
2015.
     \10\ See discussion here http://blogs.piie.com/realtime/?p=4756.
---------------------------------------------------------------------------
    Occasionally researchers seek insights into what a Grexit might 
involve from previous recent dissolutions of currency unions in for 
instance the Soviet Union, Yugoslavia, or Czechoslovakia. Such 
historical comparative work though is of limited relevance, as Grexit 
would not involve the dissolution of the euro, but rather attempts by a 
Greek Government to (re)introduce its own national currency, while the 
euro would continue to function more or less as before.
    Concerns expressed by some that the departure of one member of the 
euro would invariably result in the collapse of the common currency are 
excessively alarmist for at least two reasons. First, it is highly 
unlikely that populations in other euro area members would attempt to 
emulate what would for certain be a highly disruptive and economically 
destructive Greek departure from the euro. And secondly, it does in 
light of the institutional deepening witnessed in the euro area since 
2010 seem probable--if politically very challenging--that the remaining 
euro area members would following a Grexit implement additional 
integrative measures among themselves, including additional political 
and fiscal integration, in order to counter renewed centrifugal 
political and economic forces inside the common currency area.
    The fact that any Greek Government would seek to (re)introduce its 
own currency, while the euro would still be in normal circulation has 
important implications for the likelihood of success of such a new 
currency. Recalling how a large majority of the Greek population wishes 
their country remains in the euro, and that any new Greek currency 
would be backed solely by the credibility of Greek governing 
institutions, it seems highly unlikely that a new Greek currency would 
be imbued with the key currency function as a ``store of value''. \11\ 
When presented with a choice between a new national currency and the 
still circulating euro, Greek residents are--when not potentially 
legally prevented from doing so \12\--overwhelmingly likely to demand 
euros. This suggests any new Greek currency will quickly decline in 
value relative to the euro and the country suffer a rapid nominal 
currency depreciation.
---------------------------------------------------------------------------
     \11\ The store of value function of a currency is one of three key 
attributes. The other two are the functions of medium of exchange and 
unit of account. To successfully function as a store of value, a 
currency has to be capable of being predictably saved, stored, and 
retrieved for (roughly) the same value. In other words, any currency 
inflation affecting it must be kept within a certain range.
     \12\ The Greek Government might for instance pay wages or accept 
payments from residents only in a new currency, or require that bank 
deposits covered by any deposit guarantee scheme in Greece be held in 
their new currency.
---------------------------------------------------------------------------
    Being a relatively small economy, which imports many essentials 
(energy, food, medicine, etc.) and exports only a relatively limited 
number of often volatile items (tourism and shipping services), Greece 
has a more limited scope for import substitution and dramatic changes 
in exports than larger and more diversified economies. The pass-through 
from a declining nominal exchange rate to domestic inflation in Greece 
following the introduction of a new currency is thus likely to be 
strong. This again means that achieving a lasting reduction in the 
Greek real exchange rate from introducing a new currency will be 
difficult and only potentially achievable in conjunction with a 
material--and highly regressive--increase in the domestic inflation 
level. All told, attempt by the Greek Government to implement Grexit by 
introducing a new currency is likely to fail to improve the economic 
outlook for the Greek population and fail to displace the euro as the 
dominant currency in circulation in the Greek economy.
    Consequently, the actual effect for a defaulting Greece of losing 
access to banking sector support from the ECB, financial aid from the 
Troika and budgetary transfers from the EU budget, is not a smooth 
transition to a new national currency. Rather, it is a disastrous high 
domestic inflation scenario. Unable to successfully switch to a new 
national currency, the country ends up a bit like Montenegro, which 
unilaterally euro-ized its economy in 2002. Attempts at Grexit will de 
facto mean that Greece has only left the institutions of the euro area/
EU, not the currency itself.
    Highlighting the dramatic difficulties of actually (re)introducing 
a national currency by a Government with low institutional credibility, 
when the previous anchor currency remains in circulation, is also 
witnessed in the ongoing usage of the U.S. dollar. No modern economy 
that has ever fully adopted the U.S. dollar (e.g., full currency 
substitution as for instance seen in Ecuador, Panama and El Salvador)--
has ever undone the decision and re-introduced their own national 
currency. There is little reason to believe that Greece now in the euro 
would manage to do so either.
    A Greek default would prove devastating to the Greek economy even 
without a Grexit, and the costs passed on to the euro area would be 
sizable, but not economically or financially catastrophic. Private 
sector exposures to Greece through trade (Figure 4) and the banking 
sector (Figure 5) are today limited and manageable. Public sector 
exposures in the euro area from financial assistance (excluding IMF 
loans) and liquidity assistance provided to Greece amount to about 3.3 
percent of euro area GDP, ranging from 1.4 percent in Ireland to 5 
percent in Malta (Table 1 provides total ``worst-case'' exposures 
assuming a recovery rate of zero). These exposures are large and would 
in already fiscally challenged countries, such as Italy, Portugal, or 
Spain, prove a material additional burden on Government finances. They 
will not, however, in all probability cause any other euro area 
sovereign to risk losing market access.
    The most pressing economic policy problem arising from a Greek 
default for the euro area would be for the ECB, as it would 
dramatically complicate plans ongoing asset purchases, currently 
scheduled to end in September 2016. It would first and foremost be up 
to the ECB to ensure that any potential financial market cross-border 
contagion effects--likely only at a magnitude far below what was seen 
in 2012 in the euro area--would not pose a threat to euro area growth. 
The ECB is likely if required to act decisively and be successful in 
this task.
    Most likely, the ECB would in a Greek default scenario feel 
compelled to expand current levels of asset purchases (=60bn/month), as 
well as potentially postpone any exit. Given the relatively limited 
level of financial asset purchased to date by the ECB in comparison 
with other major central banks like the Federal Reserve, such 
additional monetary stimulus would not pose any noteworthy financial 
risk or economic problems.
    Recalling the limited present day private sector exposures to 
Greece, direct risks to global growth beyond the euro area from a 
default are relatively limited and linked to threats to the euro area 
regional growth outlook. However, given likely ECB policy activism, the 
generally robust euro area economic performance to date (short-term Q2 
indicators point to around 1.6 percent growth annualized with June 
composite PMIs at 49-month high \13\), the lower levels of external and 
budget deficits now found in the euro area, and new euro area 
institutions put in place since 2010, the regional fallout from a Greek 
default is likely to be contained and not derail the current euro area 
cyclical recovery.
---------------------------------------------------------------------------
     \13\ http://www.markiteconomics.com/Survey/PressRelease.mvc/
986c020abdb0457
f9574c56ff8a80e79
---------------------------------------------------------------------------
    In sum, a default by the Greek Government will quickly prove an 
economic disaster for Greece, though for that reason domestic political 
pressures to seal a deal with the Troika will keep any failure to pay 
international creditors brief. Any default by Greece will not 
automatically lead to Grexit, and it will under any scenario likely 
prove impossible for a Greek Government to successfully reintroduce a 
national currency. Improving euro area economic performance, a more 
resilient--though still incomplete--institutional structure in the euro 
area, and not least additional ECB monetary stimulus is likely to 
contain any cross-border spillovers from a Greek default. As a result, 
a Greek default does not pose systemic risks to either the euro area or 
the global economy.
The Exposure of the U.S. Taxpayer to Loans Provided to Greece by the 
        IMF
    As noted in the previous section, any actual default by the Greek 
Government is likely to be relatively short-lived. The domestic 
economic implications would be very negative through the rapid 
introduction of a bank holiday/bank deposit controls, while the 
domestic political reactions hereto would in all probability produce 
the required domestic political pressure on the Greek Government to 
seal a deal with the Troika. As a result, any financial risks for the 
IMF appear quite limited, as Greece would eventually secure the 
required funding from the euro area or from own funds to repay the IMF.
    It appears a relatively high risk, but not the base case, that 
Greece may not pay the IMF the approximately $1.7bn due on June 30th, 
precipitating the serious domestic economic and political implications 
discussed above. However, from the perspective of the IMF, new Greek 
arrears of this magnitude would not pose any financially material risk 
and would only approximately double the IMF's current levels of arrears 
of $1.8bn. \14\ This would take total member State arrears to the IMF 
back to levels of the early 1990s, \15\ but not in any way affect the 
operations of the IMF or pose any threat to its shareholders, including 
the United States.
---------------------------------------------------------------------------
     \14\ Owed to the IMF by Somalia, Sudan, and Zimbabwe. Data from 
May 31st 2015 at https://www.imf.org/external/np/fin/tad/
extdbt2.aspx?valueDate=2015-05-31.
     \15\ Table 5 in IMF (2012) available at http://www.imf.org/
external/np/pp/eng/2012/082012.pdf.
---------------------------------------------------------------------------
    Total current IMF exposures to Greece from the 2010 Stand-By 
Arrangement and 2012 Extended Fund Facility amount to approximately 
$39bn, \16\ currently scheduled to be fully repaid only by 2026 (Figure 
2). The IMF is Greece's super-senior creditor, and any potential future 
euro area additional debt restructuring of its Greek debt holdings are 
likely to include a conversion of costlier IMF loans into longer 
maturity and cheaper ESM loans, implying that the IMF's exposure to 
Greece is likely to be eliminated before 2026. Both issues suggest that 
the actual financial risk to the IMF and its shareholders from lending 
to Greece is relatively limited, as the IMF will ultimately get fully 
paid back, even as euro area taxpayers will surely not in net-present-
value terms.
---------------------------------------------------------------------------
     \16\ See overview of Greece's financial position in the IMF at 
http://www.imf.org/external/np/fin/tad/
exfin2.aspx?memberKey1=360&date1key=2015-06-25.
---------------------------------------------------------------------------
    Consequently, estimates of potential liabilities to the U.S. 
taxpayer from IMF lending to Greece should be treated as a very low-
probability worst-case scenario.
    The United States' IMF quota stands at 16.74 percent, implying that 
the United States' share of total current Greek IMF exposure of about 
$39bn is approximately $6.5bn.
    In relation to the U.S. Government and economy, this is a very 
small number, amounting to 0.2 percent of 2014 Federal Government 
outlays and 0.04 percent of U.S. 2014 GDP.

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT

        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SASSE
                      FROM DESMOND LACHMAN

Q.1. I'd like to hear more about the policy choices Greece made 
that led to their debt crisis, prior to Greece's 2009 
announcement that it had been understating its deficits.
    My understanding is that Greece's public employment grew 
fivefold from 1970 through 2009, at a growth rate of 4 percent. 
Over the same time period, private sector employment increased 
by only 27 percent, at an annual growth rate of less than 1 
percent. How much did Greece's expanding public sector 
contribute to their debt crisis?

A.1. Greece's expanding public sector was one of the principal 
factors in Greece's public deficit ballooning between 2000 and 
2010. It has also been one of the major factors that has sapped 
vitality from the Greek economy. As such it has to be regarded 
as a primary contributor to the country's sovereign debt 
crisis.

Q.2. Beyond debt payments and public sector employment, are 
there other particular sectors--for example such as defense 
spending--during the lead up to their debt crisis where 
Greece's Government spending levels were imprudent?

A.2. Aside from public wages, the uncontrolled increase in 
pension payments has been a major factor in the deterioration 
of Greece's public finances. Currently pension payments in 
Greece account for over 17 percent of Greek GDP and they are 
very much more generous than in other European countries.

Q.3. What is Greece's labor participation rate, how does it 
compare to other Eurozone countries, and did it contribute to 
Greece's fiscal crisis? Are these statistics similar to those 
found in other Eurozone countries?

A.3. According to the World Bank, Greek labor participation is 
only 53 percent. While low, it might be noted that other 
European countries like Italy also have very low participation 
rates. Meanwhile the participation rate in Germany is only 60 
percent.

Q.4. Beyond a generally underperforming economy, what else 
explains Greece's low labor force participation rate? For 
example, does their welfare and entitlement system encourage 
such a low participation rate?

A.4. Besides generous welfare and entitlement programs, a major 
contributor to low participation is Greece's very rigid labor 
market and onerous labor market regulations which make it 
difficult to hire and fire workers. In that respect, Greece is 
not alone in Europe in needing major labor market reform.

Q.5. How much of the blame for Greece's debt crisis can be 
blamed on tax evasion?

A.5. Tax evasion in Greece is rampant and is certainly a 
contributory factor in the debt crisis. Asides from directly 
impacting the public finances, it means that tax rates are very 
high and onerous on that small part of the population that does 
pay taxes. This is hardly conducive to economic growth.

Q.6. How much of the blame for the crisis can be placed on 
Greece's membership in the Eurozone, either because of the 
constraints Eurozone membership places on Greece, or because of 
efforts Greece underwent to secure Eurozone membership?

A.6. Euro membership is at the core of the Greek crisis for 
many reasons. From the very outset, placing a highly sclerotic 
country like Greece in a currency arrangement with an economic 
powerhouse like Germany was to invite problems in the 
competitiveness field. In addition, Euro membership had the 
effect of lowering interest rates at which the Greek Government 
could borrow to German levels. Those low borrowing rates 
facilitated Greece's public sector going on a spending spree. 
When the music stopped, Greece found that attempting to redress 
domestic and external balances in a Euro straitjacket 
contributed importantly to sinking the economy into a 1930s 
style economic depression. That in turn contributed to Greece's 
rising public debt to GDP ratio.

Q.7. What other significant factors, demographic or otherwise, 
contributed to Greece's debt crisis?

A.7. Greece certainly engaged in reckless borrowing that got 
the country into its debt crisis. However, it is a truism that 
one cannot have reckless borrowing without there also being 
reckless lending. In the Greek case, Greece could never have 
got into its monumental debt problem to the degree that it did 
without the willing help of the German and French banks, which 
lent recklessly to the Greek Government.

Q.8. How far back in time would Greece have to go to prevent 
this debt crisis, and what policy changes would be necessary 
then to place Greece on a stable footing now?

A.8. It is difficult to overstate how many major policy changes 
would be required to put the Greek economy on a stable footing. 
The economy would need to be modernized through fundamental 
reform to the labor market, the pension system, to tax 
administration, and to the privatization of State assets. 
Greece would also need to be accorded major debt relief by its 
official creditors. The country would also need to engineer an 
orderly exit from the Euro that would provide the conditions 
for a recovery in the economy.

Q.9. This hearing touched on the impact of austerity on 
Greece's dire economic situation. For example, Mr. Lachman 
argued that ``at the heart of Greece's economic collapse has 
been the application of draconian budget austerity within a 
Euro straitjacket,'' which ``preclude exchange rate 
depreciation or the use of an independent monetary policy.'' 
While I understand this argument, Greece's irresponsible fiscal 
policy is what led to their debt crisis in the first place. It 
seems reasonable to expect Greece to make structural changes to 
their economy before they can receive help from other 
creditors.
    How significant of an economic drag has ``austerity'' been 
on Greece? Why?

A.9. While Greece might have lagged in the area of structural 
reform policy, the size of its fiscal adjustment over the past 
5 years has been enormous. Despite an economic depression, 
Greece has reduced its budget deficit from around 15 percent of 
GDP in 2010 to around 3 percent of GDP at present. There can be 
no doubt that this constituted an enormous amount of fiscal 
drag.

Q.10. Has austerity been particularly hard on Greece, as 
compared to other countries? Why?

A.10. Other European countries like Ireland, Portugal, and 
Spain did massive budget adjustment as well but not on the 
scale of that of Greece. In addition, an economy like that of 
Ireland displayed much greater labor market flexibility than 
did Greece and, having a large export sector, Ireland was able 
to offset at least in part some of the negative effect of 
budget tightening on aggregate demand.

Q.11. Couldn't you argue that some form of austerity was 
inevitable, because of the deep fiscal hole that Greece had dug 
itself in? Shouldn't any country with a structural fiscal 
deficit exceeding 18 percent of its GDP--as Greece had in 
2009--go through austerity measures?

A.11. There is no question that Greece needed major fiscal 
adjustment. However, it was unreasonable to expect that this 
degree of fiscal adjustment could be effected in a Euro 
straitjacket without sending the economy into the deepest of 
economic recessions. As the IMF itself now recognizes, Greece's 
situation would have been more manageable had the country 
restructured its privately owned sovereign debt very much 
earlier than it did. The country's situation would also have 
been made more manageable had it exited the Euro as soon as the 
very large size of its domestic and external imbalances became 
apparent.

Q.12. Will austerity lead to longer-term economic growth, even 
if it may be difficult in the immediate-term?

A.12. The latest round of austerity imposed on Greece by its 
European partners within a Euro straitjacket is misguided and 
is bound to end up in tears. It basically repeats the policy 
approach of the past that contributed to Greece's economic 
depression. There is no reason to think that such policies will 
work this time around.

Q.13. Are there other structural economic reforms in the public 
and private sector that Greece could enact alongside austerity, 
to create the best conditions for growth?

A.13. Greece has to modernize its economy if it is to have 
sustainable economic growth. In addition to basic reform of 
pensions, the labor market, and tax administration, Greece 
needs to move away from its patronage system and to improve its 
basic governance.

Q.14. This hearing contained a lot of discussion about the 
sustainability of Greece's debt levels. On the one hand, Greece 
has more than a 175 percent debt to GDP ratio and has a 
significant amount of debt due over the next 3 months. On the 
other hand, others argue that Greece has a relatively low 
interest rate burden, a favorable debt repayment timetable, and 
low borrowing rates from the bailout fund. Is Greece close to 
insolvency? Or is it only illiquid, but solvent?

A.14. A fundamental mistake made by the IMF at the start of the 
Greek sovereign debt crisis in 2010 was to treat Greece's 
problems as one of liquidity and not of solvency. Greece's 
situation is very much worse today than it was in 2010 and the 
country is patently not able to repay its debt. That is not to 
say that Greece necessarily needs to have its debt written down 
through reducing its face value. However, it is to say that 
Greece needs to have its debt maturities extended and its 
interest rates reduced in a major way.

Q.15. I'd like to focus on Russia's influence in this debt 
crisis. Russia has said that it is considering giving Greece a 
bailout. Russia has also announced that Greece has agreed to 
let the Russian State-owned energy giant, Gazprom, build the 
Turkish Stream natural gas pipeline in Greece.
    How significant of a possibility is it that Russia will 
step in at some point in the near future to resolve Greece's 
debt problems?

A.15. Russia should not be expected to step in and resolve 
Greece's debt problems. However, should the Greek crisis deepen 
and should anti-European sentiment in Greece grow, one must 
expect Russia to take advantage of the political opportunity of 
gaining a firm foothold in the country.

Q.16. What is Russia's strategic interest in developing 
stronger ties to Greece?

A.16. In 1947, the Truman doctrine recognized Greece's 
geopolitical importance as a gateway to the Middle East as well 
as to the Mediterranean. Today Greece retains that strategic 
importance. The warm welcome Vladimir Putin has accorded to 
Alexis Tsipras in Moscow should be a reminder that Russia has 
real interests in the Balkans.

Q.17. What would Greece have to give Russia in exchange for 
accepting Russia's support?

A.17. The immediate prize that Mr. Putin is seeking is to build 
a pipeline that would carry Russian gas to Europe through 
Greece and Turkey. One would also think that Russia would have 
an interest in Greece's ports.

Q.18. Could Russia afford to bail Greece out, economically?

A.18. Russia is known to play a long game. While low 
international oil prices are placing a strain on the Russian 
economy at present, this is not expected to last forever. In 
addition, the amounts of money that it would cost Russia to 
gain real influence in Greece are not inordinately large.

Q.19. Would Putin have to worry about internal political 
dynamics that could constrain him from bailing out Greece?

A.19. Judging from Mr. Putin's behavior in Ukraine, it would 
seem that Mr. Putin is very much in control of Russia's 
external policies.

Q.20. Would Russia's increased influence in Greece prove to be 
a destabilizing factor in the region or in the broader 
Eurozone?

A.20. At a time that Russia is proving itself to be a major 
menace in Ukraine, the last thing that Europe and the United 
States need is having Russia gain an opening in Greece.

Q.21. How significant of a hindrance has Eurozone membership 
been for Greece? Does this call into question the viability of 
the Eurozone model for smaller countries?

A.21. For reasons explained above, Eurozone membership has been 
a major mistake for Greece. There are many lessons for the 
other highly indebted European countries like Italy, Portugal, 
and Spain. Among the most important of these lessons is that 
those countries have to effect major structural reform and soon 
in order to get their economies moving if they are successfully 
to resolve their debt problems in a Euro straitjacket.
              Additional Material Supplied for the Record
              
         WALL STREET JOURNAL CHART OF GREEK DEBT DUE 2015-2055
         
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

               CRS/NATIXIS CHART OF TOTAL GREEK DEBT OWED
               
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
```