IF WE WAZ A SAFE BET, YA HA DEEDLE DEEDLE, BUBBA BUBBA DEEDLE DEEDLE DUM

Our Leader Yorgo often says, in his more closely scripted statements, that Greece's biggest problem is its credibility deficit, not its Government deficit. This line goes down very well with world leaders because it seems to them to signal that we want to become a respectable country.

Now there's at least some evidence to help us measure how true the statement is. Although the source of this is a paper by IMF staff (which is admittedly suspect these days), it's a paper that sets out to discuss a very different issue, with regards to very different countries. Hence, I'm inclined to believe that there is no foul play involved.

The academic minds over at the IMF set out to discover whether being able to issue investment grade (i.e. not junk) bonds makes any difference for debtor countries. Investment-grade is a largely arbitrary distinction, but it generally means that, in a credit rating agency's opinion, you have a less than 10% chance of defaulting within 5 years. But investment grade issuers are also, in investors' minds, tantamount to the club of 'decent' debtor countries - the ones that frankly just don't default. It's not a conviction that's based on facts, but it is one that is hard to shake; Greece's ratings for instance held out long after investors had given up hope.

This illusion of 'decency' is in principle what Greece wants to regain. If, the reasoning goes, we could just get back into the cosy club of good debtors it would make a difference even if our fundamentals hadn't really improved. Credit ratings will of course lag this transition (indeed they lag everything), but the idea is that once we've got our 'credibility' back we'll go back to investment grade in no time. This begs the question: how big is the effect of investment-grade status? Apparently it reduces spreads (against US treasuries) by 36%.

Note that this is above and beyond what can be justified by fundamentals. It comes from investors' unwillingness to believe that such a country could ever default; however, even with this, the yield of ten-year bonds for a country with Greece's fundamentals would come in at 8.9% (calculations based on this). While this would still make Greek spreads higher than those of Portugal, it is just under my viability benchmark of 9.25% (which was, however, calculated before a further upward revision of our debt figures). This means that, if Greece could once again bask in the glow of investor confidence for a moment, as well as carry out all possible reforms successfully within three years, the suspension-of-disbelief effect would bring us back onto a viable trajectory.

This is essentially a vindication of the Vayanos et al case for avoiding a Greek default and I hope it comes to pass. The problem, however, is that the suspension of disbelief effect was a collective delusion of investors which has been shattered by the sovereign debt crisis. To paraphrase an old saying, even if Greece manages to get to the spring (of hopium, or cool-aid or whatever), will there be anything there left to drink?

So to conclude, fixing the 'credibility deficit' would, ceteris paribus, indeed put Greece on a potentially sustainable path as per Yorgo's observations. The problem is that the cetera are not paria and the investor-grade bonus probably just doesn't exist anymore, except perhaps (almost certainly) for triple-A rated sovereigns. Until of course, they too come into question.