Prime Minister Papandreou has apparently shocked some European leaders by announcing that he and his cabinet have decided to submit the latest bail-out and austerity package to a democratic referendum. In the crucible of democracy this seems wholly appropriate since the Greek people are being asked to shoulder a huge burden for years to come. I think it speaks well of Mr. Papandreou’s democratic credentials that he is willing to do this. Some critics argue that that it is a bargaining ploy on his part to put pressure on the foreign lenders and politicians to come up with an improvement of the package and lessening of the austerity which accompanies it. That may be so.

After all, if the European Central Bank had behaved differently much earlier much of what has happened might not have. The total outstanding Greek debt owed to foreigners is of the order of 190 billion euros. M2 according to the European central bank is of the order of 8,605 billion euros. If the ECB had simply bought temporarily half of the 190 million euro foreign debt  in the form of Greek government bonds the crisis would have been reduced considerably. It could have done so with near zero risk of inflation because of such an action. Of course, the problem of Greece also involves a large quantity of credit default swap bonds that have been bought and sold on Greek debt in a highly speculative fashion by banks throughout Europe.(See the very revealing article in Forbes,Why Europe is really freaked out over a Greek Default by Adrian Ash, July 15, 2011 on this)  Deficit hysteria has also played a major role, of course , in grotesquely exaggerating the risks associated with sovereign debt and supporting a failed policy of excessive austerity.) These practices need to be much more tightly regulated and the speculative aspects of the derivative drastically curbed.

If Mr.Papandreou wins his confidence motion in Parliament and his government lives on to fight and win the referendum my earlier optimism about resolving the crisis may well turn out to be justified.

If not, perhaps the package can be improved upon or the increasingly popular alternative of leaving the Euro and returning to the drachma will over time solve the problem. After all paying off the debts in drachmas will shave more than likely 50 % off the debt load forcing the bondholders to take the haircut they are currently being offered in any case, substantially increase the attraction of Greek exports and locally provided services, lessen austerity thereby permitting economic growth and allow Greece over time to reform its tax practices and social welfare state.

But as I wrote at the outset much of this could and can still be avoided if the ECB steps up to the plate and becomes a true central bank.