Page 1 of 2 Greece - the mutating financial crisis
By Hossein Askari and Noureddine Krichene
Predictably, Greece finds itself at the epicenter of the constantly mutating
financial crisis, triggering shockwaves in financial markets with tumbling
stock prices and euro values.
Macroeconomic indicators for Greece have been moving deeper and deeper into the
red over the past six years as a result of the government's fiscal profligacy,
inept tax collection and the loose monetary policy of the European Central Bank
(ECB).
In the fiscal arena, government expenditures had been rising at a rapid pace,
with the overall fiscal deficit deteriorating to 5% of gross domestic product
(GDP) in 2009. Alarm bells were ignored because of unprecedented low interest
rates, overflowing liquidity
in eurozone banks as well as in other major capital markets, the unfounded
assumption that Greek public debt was akin to German debt within the eurozone,
and Wall Street's deception of the status of Greek finances.
The financing of the Greek deficit appeared unconstrained until the breakout of
the recent crisis. Greek government debt leapt to 109% of GDP in 2009. Very low
interest rates in the eurozone pushed annual domestic credit increase in Greece
to 30% per year during 2004-2008. Consequently, the current account deficit
widened to 10% of GDP and Greek external debt soared from 100% of GDP in 2004
to 160% of GDP in 2009; Greece became overwhelmed with external debt.
In contradiction to the Group of 20's strong call for unorthodox fiscal and
monetary policies to stimulate growth and employment, real GDP in Greece
contracted and unemployment exceeded 10% of the labor force in 2009. In spite
of very low interest rates, interest payments on public debt represented 5% of
GDP in 2009. Including amortization, debt servicing could be unmanageable for
the Greek government, as well as for the Greek household and corporate sectors.
The European summit meeting in Paris in early February, with the expressed goal
of finding a solution for Greece fiscal impasse and debt crisis, was more of an
exercise to calm markets than to bailout Greece. Eurozone leaders were divided,
with German Chancellor Angela Merkel calling on Greece to cut down on its
public spending and increase tax collection.
If you believe the numbers, with taxes accounting for over 40% of GDP, it would
be tough to call for higher taxes, since an economy with a tax rate at 100% of
GDP means a total death for the economy. In other words, if you produce 100
tonnes of wheat and you are forced by tax laws to surrender 100% of your output
to the government, then you and your workers would starve and will not be
around next year to produce wheat!
Luckily for Greece, however, Greeks have been underreporting their incomes and
thus underestimating official GDP figures. But enhancing tax collection in a
country that has a long tradition of avoiding taxes may be a long-term
struggle. Cutting expenditure is easier said than done.
Governments that are hit with budgetary impasses face an unpleasant arithmetic:
either run the money printing press overtime, as the US and UK have been doing,
or simply default. As a member of the European Central Bank, Greece does not
have the freedom to run its own printing press - it gave up that right of an
independent monetary policy (and exchange rate policy) when it joined the euro.
The option is default.
A government with a fiscal impasse would consider defaulting on the payment
obligations that have the least political and social risks. Defaulting on
government salaries could send the country into turmoil, leading to widespread
strikes, collapse of real GDP, and the free fall of government revenues and
deeper fiscal deficits. The easiest default for any government has historically
been that on external debt. Foreign banks, as in many past sovereign debt
crisis, may negotiate significant haircuts, realize that they can no longer put
good money after bad money, recognize their big losses, and turn to their
respective governments for bailouts or simply disappear from existence.
The Greek financial crisis is not entirely a Greek manufactured event. It has
been preceded in the past two centuries by many similar crises, and in the
1990s, by the Asian, Russian, and Long-Term Capital Management crises. Iceland
in 2008 was an excellent example that illustrated the magnitude of the effects
of abundant credit availability in foreign capital markets. An abundance of
liquidity and cheap loans allowed governments and domestic corporations to
borrow from foreign banks and continue their profligacy as long as foreign
financing was forthcoming. Iceland’s borrowing from foreign banks was for all
practical purposes unlimited with foreign debt exceeding 1,000% of Iceland GDP
in 2009.
Latin American countries borrowed heavily in the 1970s when New York and
European banks pushed abundant money to their doors. Of course, unsolicited
money could not be repaid, and many banks went out of business.
Why not increase government salaries and other government expenditures when
cheap money is being shoveled to your door? Facing easy access to cheap loans,
Greece availed itself from this financing and expanded concomitantly its
government salaries and other spending at 12% a year.
As to the very high domestic credit expansion, both to finance the budget and
for the consumers and corporate sectors, and very low interest rates, Greece
cannot be held as the only responsible party. Greek monetary policy is
determined by the ECB. Greece must, however, bear responsibility for servicing
an external debt at 160% of GDP in 2009 (and could top 200% of GDP in 2014). It
would be unbelievable that Greece would become an exception to the long history
of external debt default and service its foreign debt.
Greece's fiscal and external deficits started to worsen during the period of
the ECB's very easy monetary policy (2002-2009) that followed the relaxation of
monetary conditions in the US. Abundant reserve currency liquidity and very low
interest rates forced by major reserve central banks, such us the US Federal
Reserve, the ECB, and the Bank of Japan, led to a huge expansion of credit, not
only to domestic subprime sectors, but also to governments and corporate and
consumer sectors in many countries, a phenomena dubbed carry trade, with banks
borrowing money from low interest reserve centers and lending it to governments
and corporations in higher interest-rate countries.
External current account deficits in many eurozone countries widened to 10-15%
during 2004-2009. External debt in many European countries that had easy access
to credit grew rapidly to an average of 160% of GDP, excluding Ireland and
Iceland, where external debt exceeded 800% and 1,000% of GDP in 2009,
respectively. Many eurozone countries that had budgetary surpluses in 1990s
were deeply in the red during 2004-2009, with overall deficits ranging between
2 to 8% of GDP in 2009.
Greece was not the only country to borrow the abundant loans made available by
reserve currency central banks and their banking systems out of thin air. So
many countries have enjoyed the same cheap loans as Greece, both in Europe and
elsewhere.
Unlike earthquakes or natural disasters, financial crises are predictable. In
2009, we stated that the private sector debt was mutating to a public one. The
problems of Greece are no way unique. Greece is only a new phase of the
financial crisis. Contagion to countries that have similar fiscal and external
balances as Greece cannot not be discounted. The grandiose scheme mounted by
the G-20 in 2009 to push cheap loans to developing countries in a bid to
stimulate industrial country exports would lead to disorderly fiscal policies
in countries that are availing themselves of cheap money and are expanding
their fiscal and external deficits to absorb cheap loans.
Debtor countries borrow heavily now, enjoy high consumption, only to default
later and impoverish their future generations. As in the case of Greece or
Iceland, most of the foreign borrowing financed consumption, impairing economic
growth and contributing little to the material capital base that would generate
cash flows for debt servicing.
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