Economics · International Affairs

A Nine-Question Course In The Greek Economic Crisis

This insightful article on the Economic crisis in Greece is written by Kuwar Singh.

Greece is to Europe as to what Lindsay Lohan is to Hollywood: the bad child, the media magnet, the one behind on her bills, the fallen queen. Except Greece’s problems happen to be much worse than a bunch of DUIs. Simply put, the country is in debt involving lots and lots of debt. Figures in 2013 stood at $400,000,000,000, which was about 170 percent of Greece’s GDP. So to even a layman, it would be clear from the start that Greece will never be able to pay off its debt without some kind of international support.

What is this international support, where does it come from, what strings are attached to it, and several other pertinent questions crop up.

And here are some of the answers:

1- To whom does Greece owe so much money?

Lion’s share of the Grecian debt is owed to The European Financial Stability Facility (EFSF), which has lent the country about 47 percent of its debt. Apart from this, 19 percent is owed to other nations in the Eurozone, 12 percent to private investors, and 22 percent to European Central Bank (ECB), International Monetary Fund (IMF), etc.

2- What happens when Greece fails to pay its debt, i.e., ‘defaults’?

One thing to be clear about is that national debt is little like individual debt; ergo national default too is not quite the same as individual default. There is no authority forcing the debtor to reimburse its creditors, and international regulation on such matters is still in beta-mode. A strong defiant country might just as well refuse to pay up or even acknowledge the debt, like Russia did in 1917, but that would be rather improbable today, more so in Greece’s scenario.

Failing nations nowadays generally restructure their debts (or give their creditors what is called a haircut), which is precisely what Greece did in 2012, downgrading the value of Greek bonds held with creditors to as low as 50 percent. Haircuts and/or debt-repudiation severely undermine a country’s borrowing capacity (since it gets out that the nation cannot be trusted), inducing a fall in economic activities which leads to severe unemployment. In this case, the nation would generally be left with the painful option of currency-devaluation, but even that is not possible for Greece (refer to Question 8 below), at least not while it is part of the European Union.

The situation with Greece is also unique because of the near-total interconnection among Euro-nations. Most of the Grecian debt is owed to foreign institutions, meaning that if Greece defaulted, these institutions would fail to get their money back, leading to their own potential default. This might have caused a domino-effect, due to the fear of which was precisely why the country was bailed out by its Euro-partners back in 2012. Europe has consistently tried and forced Greece from defaulting on its debt, and today the situation is better contained.

3- So wait a second, is it possible for Greece to “not default”?

Umm, there’s good hope. If Greece does to itself with less severity what a default would do, i.e., if it cuts down heavily on government spending, bringing about rampant unemployment and benefits-loss, then that may help. First, it would obviously save the government some money. Second, it would satiate potential lenders’ (read Germany) thirst to see the economy hit the rock-wall of reality before they grant Greece more debt/grant to repay its old ones.

4- Why are the Germans being so stuck-up?

Because they have good reason to. This is not the first time Greece is close to a default. And this crisis is- at least partly- Greece’s own fault. As mentioned earlier, the massive chunk of the total debt is owed to EFSF, which mainly grants loans to countries unable to pay their standing debts. Therefore, almost half of Greece’s debt was caused precisely due to the nation’s inability to pay its previous debts. It serves as testament to Greece’s poor decision-making and the inherent weakness of its economy. Greeks have enjoyed some of the best welfare in the world, with early retirement age and high pensions, without an actual economic growth to back it up. In fact, “Greece has never collected the majority of taxes it imposes on its citizens.” (Bloomberg Business)

What Germany wants now for Greece is ‘austerity’, that is, for the country to stop stretching its legs to where its blanket does not reach. This would translate into severe reduction in government spending and increase in taxes. Though any sympathizer with Greece would probably come to detest Angela Merkel’s obsession with putting Greek elders out on the streets, Germany, after having faced its own financial crisis in 1931, cannot be blamed for its stance. The hard-working nation has toiled with its citizens to create a model economy that sustained growth even during the Great Recession. It will not lend any more money to Greece without assurances that a similar situation won’t arise in the future.

It may be important to note that Greece and Germany are two nations too different in their cultural values. While Greeks value their welfare, Germans value their work ethic, and there seems little common ground for the countries to settle their differences.

5- How can the Grecian situation be avoided in future? How was it caused in the first place?

It all began with introduction of the Euro in 1999. The countries that adopted the common currency got tied not only with a single monetary policy, but also a single monetary reputation. Greece, a weak economy with little financial security, could after becoming a part of the Euro- avail loans at interest rates much lower than it would have been charged otherwise. This was because of the golden financial reputation of countries like Germany and France which uplifted the poor reputation of the PIIGS nations.

This opportunity was heavily abused by Greek politicians who promised rosy benefits to the citizens and were able to deliver on them by borrowing more and more. Even Greece’s loan-payment strategy was largely to borrow some more money, which seemed quite comfortable given the low interest rates. And no one really cared until the beginning of the recession in 2007, which is when the disaster surfaced.

When the American housing bubble burst, it became harder for Greece to secure further loans to pay back old ones. The picture turned more pessimistic when it was revealed in 2008 that Greece authorities had been lying about the budget deficit and the situation was worse than previously estimated. Greece’s credit rating plummeted right after and it became nearly impossible for the country to secure new loans. It started failing to make due payments and that started this skirmish between bailout and austerity.

Now, the most visible way to avoid such situations in long-run is to hit the rock- wall of reality. If Greece were to follow a solution plan like Argentina’s, it would have to devalue its currency, cut down on spending and live like a Scrooge till a better financial model developed. But again, Greece can not devalue its currency (Refer to Question 8).

What Germany can do in all this is soften the fall for Greece. It is willing to give the necessary aid to Greece in return for cuts on spending (though not as severe as it would have to do otherwise).

6- But I’ve watched Game Of Thrones, so I know everything has to be a lot worse than it already seems, doesn’t it?

Yes, of course. There’s more bad news. It is possible that Greece is unable to save itself from economic depression even after austerity. Imagine this scenario: if Greece implements austerity measures, jobs will disappear, incomes will go down, leading to a decrease in tax revenue, which will only increase the budget deficit, and thus defeat the entire purpose of all the pains. There would also be a growing restlessness among masses, which would make the country prone to civil violence. Greece may, thus, never recover and fall into mayhem. But that is really the worst case scenario.

7- Why don’t they just print more money bills to pay the debt?

Note: The following question has been answered assuming a system of floating exchange rates, which is true for Greece and many other countries, but not all countries. I can’t believe how many of us have actually asked this question. Allow me to break your hearts. Firstly, it is impossible to pay off a foreign debt by printing more money. The moment a nation’s central bank prints more money, the value of the national currency falls in the international market as the supply of the currency increases. The exchange rate changes to assume a new figure and everything retreats to square one.

Also, even if for some misinformed reason Greece did decide to print more money, it would not be able to since it shares its currency with eighteen other nations. The European Central Bank, which prints the Euro, is based in Germany and Greece has little influence over the Bank’s policy.

8- Has Greece been hurt in being a part of the Euro group?

Yes. Although Greece itself is to blame for the quagmire it pushed itself in by borrowing more and more, it definitely is not to blame for whatever ensued after. Monetary reforms are a great way to pull an economy out of recession. When there is economic inactivity in a nation, the central bank can print more money bills, which- though would not have little impact in the long run- would boost economic activity in the short run, reducing unemployment and thus giving the much-needed pump to the economy that might just get it going again. There is a higher price to pay of course, IYKWIM. Printing more bills leads to inflation, which is not desirable. But with dangerous levels of unemployment, this trade-off becomes easier.

Now if you are wondering why the European Central Bank didn’t do Greece a favour on this one, it is because there needs to be a single monetary policy for the entire Eurozone, and the tendency of each nation to allow inflation in their markets is different. So the needs of stronger countries like Germany and France overshadow those of the PIIGS.

Devaluation is another huge problem. Many nations have defaulted on their debts in the past, but it is easier (comparatively, that is) for them to do so and get back in the game after a while because they can “devalue” their currency. When the defaulting country is left in tatters, they can devalue their currency, i.e., deliberately bring down the value of the currency in the international market, causing an increase in exports and decrease in imports which- along with a whole gamut of changes- increase the country’s real GDP. Yet again, the Euro cannot be devalued as it would hurt the other countries more than it would help Greece.

These are the inherent problems with the idea of Euro. For an economy to function smoothly, fiscal and monetary policies need to go hand-in- hand. While the Greek fiscal policy of borrowing and spending contrasted heavily with Germany’s and hence caused two very different scenarios for the two nations, their monetary policy needs to be effectively the same. This dichotomy will potentially be the death of the Euro, though sadly it also had the potential of being the birth of a new united world order.

9- What does Greece want?

The famous referendum conducted on July 5 over the proposed austerity reforms has shown that a significant portion of Greek population (61 percent) is not willing to budge from its long-held anti-austerity stance. There were several concerns about the legality of the results, but certain facts are now clear as the crescent moon: Greeks do not want austerity at any costs (though they obviously will have to face it at all costs), a strong Grecian population still aspires to stay in the Eurozone, and Greek Prime Minister Alexis Tsipras has launched his country in a race against time, given that payments due to IMF and other creditors are overdue for weeks. Greeks have been ecstatic about rejecting the austerity measures, but it needs to be understood that the country has to face tough reforms, one way or another. Mr Tsipras has introduced a new reform bill in the Greek Parliament which still implements several of the measures mentioned in the referendum bill which the country has already rejected.

Mr Tsipras enjoys popular support, so his bill will likely become the law and-momentarily- satiate the nation’s wary creditors, but many experts believe that Athens might just be worse off now than it would have been had it accepted the proposed reforms in the first place, instead of prolonging the inevitable.

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