Wednesday, February 22, 2012

Debt Deal Will Leave Greece Permanently Indebted

After much debate and delay, Eurozone finance ministers have finally agreed on a second bailout for Greece, granting the struggling nation loans worth more than 130 billion euros ($170 billion).

A first rescue package of 110 billion euros in 2010 was not enough to halt Greece's deepening crisis.

After five straight years of recession, Greece's debt currently amounts to more than 160% of its Gross Domestic Product.

Yet, in return for these new loans, Greece has only pledged to reduce its debts to 120.5% of its GDP by 2020.

So, under this plan, eight long years from now Greece's debt will still be more than 20% bigger than its entire economy.

Does that sound like a solution to you?

Within the next two months, Greece will also have to pass legislation that gives priority to paying off the country's debts over funding government services.

That won't go over well with a Greek public that is already rioting. The citizenry will feel that it is paying taxes and getting nothing in return.

Many Greeks don't even bother to pay taxes, which only compounds the country's problems.

That said, after raising taxes last year, Greece will raise them yet again next year. But all this has done, and will continue to do, is shrink demand and drain money from the economy. Greek consumers have less to spend, which is shrinking GDP. And the situation will only worsen next year when taxes are raised yet again.

Given the country's massive debt burden, it seems reasonable that the government would spend less and collect more taxes in an attempt to get out from under all that crippling debt.

However, successive rounds of deep budget cuts (or austerity measures), which were demanded by Greece's international creditors, have failed to restore growth. In fact, the economy has continued to shrink considerably. Last year, Greece's GDP fell 6.8%.

This sets up the likelihood that Greece will remain unable to service its debts in the future.

In fact, a February 15 report obtained by Reuters says that the Greek economy will likely remain unstable for many years and that Athens will likely need international aid for an indefinite period.

Most worrisome, the report states that continued delays in highly unpopular structural economic reforms and privatizations could worsen the already lengthy recession.

"This would result in a much higher debt trajectory, leaving debt as high as 160 percent of GDP in 2020," said the report's authors.

That would put Greece right back where it is today; facing a nearly insurmountable calamity.

Despite all the austerity measures already undertaken, the Greek government still spends more than it receives in taxes. That's because the contracting economy is shrinking tax revenues. Government spending is the last cylinder still firing in the Greek economy.

And therein lies the problem: as the Greek economy continues to contract, tax revenues will continue falling, thereby increasing the deficit.

Additional budget cuts are in the works, and though necessary, they will just cripple the economy even further.

The government plans to dramatically cut the minimum wage. Some 30,000 public sector workers are to be suspended. Pay will be cut. Many bonuses will be scrapped. And monthly pensions of above 1,000 euros will be cut by 20%.

But all of this may be for naught.

The only solution to Greece's problems are grants that never have to be repaid. Anything short of that will leave Greece in a hole it can't climb out of. But no one is going to give the country a free ride of that magnitude. Greece created this historic mess, and now it must clean it up.

Yet, these loans merely push Greece's debt further off into the future, with the added burden of interest. The only chance Greece has to repay these loans is to undergo a massive social and political restructuring, and then hope it's economy somehow manages to experience robust growth.

However, that is highly unlikely.

This Greek tragedy should serve as a cautionary tale to the rest of the world's heavily indebted nations. When sovereign debts become this cumbersome, they become unserviceable. The treatment often worsens the symptoms, and things generally don't turn out well.

The Greek economy is small enough to bail out. But there's a likelihood that more than just the private bond investors will eventually take losses.

The larger issue is what to do if an economy the size of Italy's needs a bailout? Italy is simply too big to rescue. There isn't enough money in the European Stability Fund to save it.

What if Japan, the world's third biggest economy and the biggest debtor of any industrialized economy, needs to be rescued? What then?

Such scenarios were previously unthinkable, yet it is time to start thinking of them.

Debt is like the unrelenting monster at the end of a horror movie; it just keeps coming back.

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