Friday, March 27, 2015

Greek Tragedy Nearing its Final Act

Despite occasionally falling out of the news for certain periods of time, the Greek debt problem has never gone away. In fact, the problem has grown continually worse.

Greece remains in a full blown depression. The economy suffered through a six-year recession (meaning output continually contracted), from which it only emerged last year. The unemployment rate is a staggering 26 percent, while youth unemployment stands at a whopping 60 percent.

That always leads to societal unrest, and rising crime. Leaving so many young men idle for so long is a recipe for disaster.

The European Commission, the International Monetary Fund (IMF) and the European Central Bank (the so-called Troika) have been granting loans to Greece for the past few years to keep it afloat.

Further increasing Greece's debt as a means of solving its debilitating debt problem is no solution at all. It is madness. It's akin to a son asking his parents for $100 to repay them the $100 he owes them.

Greece hid the magnitude of its debt problem prior to its entry into the European Union.

The 28 Member states of the European Union agreed to the Stability and Growth Pact in 1997, which limits government deficits to 3% of GDP and debt to 60% of GDP.

Greece was well above those limits at the time, which should have precluded it from inclusion. But no one outside the Greek government knew this back then. In fact, the Greek government didn't admit the falsifications of its predecessors until February 2010, years after the fact and well into its national crisis.

It is now known that by 1996, the Greek debt-to-GDP ratio stood at 95 percent. By the end of 2009, Greek government debt had reached 130 percent of gross domestic product, or more than twice the agreed upon limit. And by 2013, the debt-to-GDP ratio had soared to 175 percent.

About three quarters of Greek debt is owed to the EU and the IMF. In other words, Greece's creditors have given it just enough rope to hang itself.

Greece recorded an enormous government budget deficit equal to 12.7 percent of the country's gross domestic product in 2013.

While the country is expected to post a small budget surplus this year, that is before its debt payments are taken into account. Debt service won't allow Greece to get out of its cavernous hole. It is a country on its knees.

With such a weak economy, Greece cannot be expected to ever grow its way out of debt. During a recession, tax revenue shrinks along with economic output. Even in the absence of further annual deficits (which were still mounting), Greece hasn't possessed the means to service its existing debt for years.

Yet, it was continually adding to it, with the help of the Troika.

The IMF predicted the Greek economy would grow as the result of its 2010 aid package. Instead, the economy has shrunk by 25%. Wages are down by the same amount.

Meanwhile, Greece has a notorious tax evasion problem, which only makes its fiscal and debt problems worse. Greeks are fearless and defiant about not paying their taxes, yet the government lacks the resources, or infrastructure, or authority to do anything about it. The Greek government appears to be neutered.

Tax revenues so far this year are more than 1 billion euros below target; that's a lot of money for an economy that totaled just $179 billion last year.

The reality is that Greece has no means to ever repay its debts, and the Troika surely knows this. But the hope of central bankers everywhere is to create unlimited debts that can never be repaid, with interest payments continuing in perpetuity.

What we have right now is a game of chicken between the Troika and the new Greek government, which was elected on a mandate to rebel against the crippling austerity and debt payments imposed by its creditors. So, who will blink first?

Greece represents just 1.4% of the EU economy, so it really amounts to a bit player. If Greece were to leave the EU, economically it wouldn't be missed.

The trouble for the EU is the legal unwinding of a Greek exit. There is no mechanism in place for this because no one imagined such a scenario when the EU was created.

The other problem is that a Greek exit would set a precedent that could allow a much bigger economy, such as Spain or Italy, to make a similar exit. Such a scenario would be crippling, and it would set off a cascading series of government defaults and bank failures.

At present, there is no concern about either Italy or Spain exiting, as they are both enjoying cheap and easy access the debt markets, as seen below.

10-Year Government Bond Yields

United States 2.05%
Italy 1.26%
Spain 1.24%

It is patently absurd that yields in Italy and Spain are substantially lower than those in the US. There is no good reason for that. In a normal world, those yields would more than twice as high as the US. At some point, reality will set in and the bond market will realize that Italy and Spain are nearly as bad as Greece, with unsustainable debts and weak economies.

That's why the possibility of a Greek exit is so worrisome to EU leaders. It would set a very dangerous precedent.

This is the leverage the Greek government wields over the Troika.

At best, Greece's leadership failed its people through years of mismanagement and continual debt spending. At worst, they were a bunch of lying, duplicitous crooks and frauds.

The new government is trying to come to grips with the sins of the past, and it seems to have remembered an age old principle: The first step to get out of a hole is to stop digging.

A recent report says that Greece may run out of money as soon as April 9. Without another round of loans, the Greek government's coffers will soon run dry.

It's not simply a matter of it being unable to service its debt payments; Greece won't be able to pay government workers or retirees. Furthermore, Greek banks are running out of money. Fearful depositors are withdrawing their money en masse.

In other words, if Greece runs out of money, there will be societal chaos.

This is the leverage the Troika wields over Greece.

Under the current terms, there is no way for Greece to get out of its debt crisis. Yet, its creditors cannot stomach the notion of a debt write down.

The day of reckoning is near. Everyone involved has tried to avoid some uncomfortable realities, but those realities are now becoming unavoidable. The can has been kicked down the road for far too long, and they have finally run out of road.

So, who prevails and who buckles?

Well, it can be easily argued that Greece needs the EU more than the EU needs Greece. The Greek economy is so small that it is hardly important to the larger union. And the Greek crisis will reach entirely new levels of social catastrophe without further loans.

On the other hand, if Greece stops repaying its loans, its financial position would be greatly improved. That money could then be redirected into the Greek economy. Greece would have to go back to its former currency, the drachma, and it would lose access to the international debt markets for a few years. But keeping that money at home might be enough to at least help it get back on the road to solvency.

That said, not servicing its debts won't correct Greece's tax evasion and corruption problems. That requires a strong government committed to genuine reform.

The new Greek government is in a desperate situation, with its back is against the wall. That makes its response unpredictable. Since it is a new government with new leaders, elected on a platform of resistance — even defiance — there is no precedent to predict how they will act or what they will do next.

This Greek tragedy is at last entering its final act. Like all good dramas, it is both riveting and unpredictable.


  1. Anonymous1:18 PM

    you write…"At best, Greece's leadership failed its people through years of mismanagement and continual debt spending. At worst, they were a bunch of lying, duplicitous crooks and frauds."

    And the Troika aren't lying, duplicitous crooks and frauds?

    1. The Troika has actively sought to permanently indebted Greece, as is stated above. They are indeed crooks.