“The
European Monetary Union, as many of its critics maintain, looks a lot like the
pre-1913 gold standard, which imposed fixed exchange rates on extremely diverse
economies.”
Greece
was not a member of the gold standard for most of the gold standard
period. The situation among the
economies in the periphery (Greece one among them) varied. These economies were
financially less developed and, therefore, needed access to international
financial markets in order to finance both private and public investments. At
the same time, their fiscal policy institutions lacked credibility and
international investors were reluctant to lend to them at low interest rates
without gold or foreign exchange clauses in loan contracts. Thus, for the
capital-scarce peripheral economies, participation in a system of hard pegs,
such as the gold standard, addressed the problem of dynamic inconsistency in
monetary policy, providing them access to international capital markets at
lower interest rates than would otherwise have been the case. Countries such as
Greece, the fiscal institutions of which could notconform to the system’s
fiscal requirements, were forced off the gold standard. The price they paid for
fiscal profligacy was much higher interest rates than the peripheral
participants of the gold standard.
In
contrast, under the euro, Greece was able, upon entry, to borrow at near-core
interest rates and at the same time, in the absence of an adjustment mechanism,
remain a member without undertaking fiscal adjustment. Indeed, the case of
Greece between 2001 and 2009, the year in which the Greek crisis erupted,
illustrates the absence of an adjustment mechanism.
While the
stock of government debt rose by €147.8 billion from 2001 through 2009,
domestic holdings of that debt declined by €22.1 billion. Foreign holdings of
Greek government debt rose by €169.9 billion, accounting for more than the
overall increase in debt. Consequently, the share of Greek sovereign debt held
by Greek residents fell from 56.6 percent to 21.3 percent while the share held
by nonresidents rose from 43.4 per-cent to 78.7 percent.
Greek
banks were large net sellers of Greek government debt. At the time of Greece’s
entry in the eurozone in 2001, Greek banks held very large portfolios of Greek
government bonds, a result of the requirements of the country’s highly
regulated financial system of the 1980s and 1990s rather than the banks’ free
choice of portfolio composition. This fact is demonstrated by the winding-down
of the banks’ holdings of Greek government paper following the liberalization
of the financial sector that was completed in the mid-1990s. They used the
proceeds received from the sale of the Greek sovereigns, in part, to lend to
the private sector. Consequently, credit to the private sector surged,
especially from 2001 until 2008; credit growth to the private sector accounted
for the bulk of the large expansion of total credit during 2001 to 2009.
As the
Great Recession that began in the U.S. in 2007–2009 spread to Europe, the flow
of FUNDS from the European core countries to the periphery began to dry up.
Reports in 2009 of fiscal mismanagement and deception increased borrowing
costs; the combination meant Greece could no longer borrow to finance its trade
and budget deficits.
A country
facing a “sudden stop” in private investment and a high debt load typically
allows its currency to depreciate (i.e., inflation) to encourage investment and
to pay back the debt in cheaper currency, but this is not an option while
Greece remains on the Euro. Instead, to become more competitive, Greek wages
fell nearly 20% from mid-2010 to 2014, a form of deflation. This resulted in a
significant reduction in income and GDP, resulting in a severe recession and a
significant rise in the debt-to-GDP ratio.
In
February 2010, the new government of George Papandreou (elected in October
2009) admitted a flawed statistical procedure previously had existed, before
the new government had been elected, and revised the 2009 deficit from a
previously estimated 6%–8% to an alarming 12.7% of GDP. In turn, the 12.7
percent figure would undergo further upward revisions, so that the outcome was
a deficit of 15.6 percent of GDP.
In
November 2009 DubaiWorld, the conglomerate owned by the government of the Gulf
emirate, asked creditors for a six-month debt moratorium. That news rattled
financial markets around the world and led to a sharp increase in risk
aversion. In light of the rapid worsening of the fiscal situation in Greece,
financial markets and rating agencies turned their attention to the
sustainability of Greece’s fiscal and external imbalances. The previously held
notion that membership of the eurozone would provide an impenetrable barrier
against risk was destroyed. It became clear that, while such membership
provides protection against exchange-rate risk, it cannot provide protection
against credit risk.
The major
factor underpinning Greece’s large and growing current-account deficits was the
decline in net public saving (what the govt saves from its tax revenue). Net
private spending is what the households save from their disposable income.
Thomas
Friedman said in New York Times, “Greece, alas, after it joined the European
Union in 1981, actually became just another Middle East petro-state ― only
instead of an OIL well, it had Brussels, which steadily pumped out subsidies,
aid and euros with low interest rates to Athens.”
Interest rates on long-term government debt soared
from the low single digits prior to the crisis to a peak of 42 percent in early
2012.
To whom does Greece owe money?
Greece owes around €56bn to Germany, €42bn to France,
€37bn to Italy, and €25bn to Spain.
The Greek government also owes private investors in
the country around €39bn, and another €120bn to institutions including Greek
banks.
The role of France and Germany in the Greek Crisis
The
majority of the Greek debt was owned by private banks before the Troika bailout
to which the German and French taxpayers didn't owe a thing. And yet the French
and the German governments converted in essence of what was a private-sovereign
arrangement to a sovereign-sovereign agreement, in
essence artificially making the Greek situation into a sovereign debt crisis.
The effects of that were massive, because previously Greece would have declared
bankruptcy and had its debt rearranged in a deal with its creditors, and then
within weeks the economy would return into normalcy and music would have
started playing as it was before.
However
the effects of that agreement and converting Greek debt into a sovereign debt
was that now the IMF got involved which meant that austerity measures were
imposed. Now, whenever IMF intervenes, it does so using its facility for
purposes like these, called the IMF Stand-By Arrangement. The arrangement is
for jump starting the economy and get it out of a slump. This happens by
applying austerity measures, which is accompanied by readjustments in the debt
position of the country which is being jump started. However in Greece's case
there was no readjustment in Greece's debt profile. There was no adjusting the
cash flows for debt payments being done in a way to ebb the repayments' effects
on drastically altering the economy. Iceland, Hungary all used the same
facility, and saw readjustments in their debt situations, but not Greece. So in
effect those austerity measures' benefits got swamped completely by the massive
debt payments, which collectively resulted in the shrinking of the economy.
Impact of the US banking crisis on Greece
In 2008,
when the U.S. housing market collapsed, the European banks lost big. They
mostly absorbed those losses and focused their attention on Europe, where they
kept lending to governments—meaning buying those countries’ debt—even though
that was looking like an increasingly foolish thing to do: Many of the southern
countries were starting to show worrying signs.
By 2010
one of those countries—Greece—could no longer pay its bills. Yet despite clear
problems, bankers had been eagerly lending to Greece all along.
That 2010 Greek
crisis was temporarily muzzled by an international bailout, which imposed on
Greece severe spending constraints. This bailout
gave Greece no debt relief, instead lending them more money to help pay off
their old loans, allowing the banks to walk away with few losses. It was a
bailout of the banks in everything but name.
While the Greeks have
suffered, the northern banks have yet to account financially, legally, or
ethically, for their reckless decisions. Further, by bailing out the banks in 2010, rather than Greece, the
politicians transferred any future losses from Greece to the European public.
Along
with the common currency came a wave of regulatory changes that provided the
banking sector with more opportunities for growth—and the chance to become the
fool. The rule changes enabled the banks to treat the debt of all euro zone
countries equally; Greece, as far as the rules were concerned, had the same
risk as Germany.
The
markets had thought differently, with Greece having to pay more to borrow than
countries such as Germany. The northern banks, seeing easy money, started
lending to Greece, happily receiving higher fees for the “same risk.”
It was
the beginning of a self-fulfilling feedback loop with the banks at the center.
Southern Europe (especially Greece), started borrowing more, allowing them to
buy more, which caused them to grow, which collapsed the cost of their
borrowing, with led them to borrow more, and so on.
The
buying spree benefited everyone, especially the northern European countries.
The South boomed as things got built and bought, and the North boomed as
factories churned out products to sell to the South. The banks sat in the
middle, happily taking a spread.
This
feedback loop was uniquely European, dependent on the false sense of stability
provided by a common currency, which amplified the bankers’ naive belief that a
country could not default.
This loop
kept going until the sheer weight of the debt amassed by Greece became too huge
for the markets to ignore. It kept going until the markets, shocked by the U.S.
housing crisis, prompted skepticism, which forced Greek borrowing fees to rise.
The European banks, in too deep to stop, were still willing to lend, but others
less so.
By 2010
this could go on no more. The markets refused to lend more to Greece and a
bailout was necessary.
References
The Gold Standard, the Euro, and the Origins of the Greek Sovereign
Debt Crisis
