Posts Tagged ‘ greece ’

Why Greece is stuck between a rock and a hard place

Greek debt wasn't that much higher than the Eurozone average

Greek debt wasn’t that much higher than the Eurozone average

Yes, Greek governments have managed the country poorly, there is a lot of corruption and it is difficult to collect taxes. However, before the 2008 crash, their government debt-to-GDP ratio was ok (or at least, not in crisis).

When Greece joined the Euro, the banks decided that Greek debt now had the same risk as German debt, and lowered interest rates accordingly.

When the crash happened, German and French banks found themselves hugely exposed to bad Greek debt. They had mispriced the odds of a default. In order to save their banks, the German and French governments turned the debt to their banks into a debt to their governments.

So the banks got bailed out, but the money did not reach the Greek people.

The creditors decided that to pay back its debts, Greece must run a budget surplus. This is very bad economics. The cuts knocked 25%-30% off Greece’s GDP – more than the German army managed in the 1940s. The Troika’s economic predictions assumed a recovery that never happened.

As a result Greece has less capacity to pay back its debts than it did at the start of the crisis. In fact, as currently structured, it cannot pay back those debts.

Interest Rate Convergence

Interest rate convergence before the Euro

Nonetheless, the Greek government has offered to continue to run a large surplus. They insist however on making their own choices about the balance between cuts and tax rises to accomplish that. The creditors insist that there must be cuts to pensions and a freeze in the minimum wage.

Greece’s biggest problem is that it is a net importer. Within a currency union, that means that Germany (with its export surplus) will get richer and Greece will get poorer and more indebted.

The only solution is fiscal transfers from importers to exporters. In the past (before the Euro), this happened by devaluation – the Drachma, and Drachma-denominated debt, periodically lost value. In the US, it happens by federal spending – New York’s trade surplus pays for Mississippi’s welfare and military bases.

Thing is, New York can’t exist without Mississippis, and Germany can’t exist without Greeces. One man’s trade surplus is another man’s trade deficit.

For an in-depth look at the economic problem (and the ideologies behind it), check out Mark Blyth’s excellent Google Talk:

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