Greek debt crisis, as of summer 2011

Here’s an update as to what is happening with Greece. First, some numbers from the 2011 Greek budget:

  • Total revenue: €128 billion
    • Real revenues from taxes etc. €55 billion
    • Aid from the EU €3 billion
    • Borrowing from the market, including rollover €70 billion
  • Total expenses: €128 billion
    • Real expenses such as pensions, health etc. €63 billion
    • Debt rollover and interest payments €65 billion

And another pair of interesting numbers

  • Interest rate charged by the market for German bonds, 2 year maturity: 2%
  • And for Greek bonds: Around 25%, rising

So, what does all this mean?

Real deficit

In summary the Greek state is like a business that takes in €55 bn in sales but pays €63 bn in salaries and what have you, so it makes a real loss of €8 bn, or 14%. To recover, the state needs to increase revenue by extracting more taxes or running profitable businesses, or it must cut the amount that it pays to the Greek people, or some combination thereof. If it doesn’t the Greek state will run bankrupt anyway, abruptly cut expenses to €55 bn, and go on living in a hand-to-mouth way.

That much is wrong with the real finances of the Greek state. It’s a combination of a long-running competitiveness problem (where the economy as a whole is not strong enough to yield high taxes) and a long-running management problem (where the state is failing to collect taxes, handle revenues, invest, etc. honestly and efficiently). Both are serious problems, but they’re not disastrous. On a global scale, losing €8 bn a year is not a big number. General Motors lost €3 bn in 2009. BP, with a turnover four times that of the Greek state, lost €12 billion in the spill incident. The bank bailouts came to trillions, with the US giving roughly €125 bn to AIG, for example. The Greek state at the time gave €28 bn to its private-sector banks. For perspective, the size of the Greek economy (GDP, not the state budget) is around €230 bn.

As it happens, Greece gets a grant of €3 bn from its parent, the EU, leaving it €5 bn in the red. If that much goodwill remains, the Greek state has to reduce its deficit by €5 bn on €55 bn a year, or 9%. This is not easy, but it’s feasible. There are certainly good and bad ways of doing it. One of the worst ways is to sell off assets, since that will divert annual revenues from state-owned firms to privately-owned firms. One of the best ways is to provide socially motivated services, such as transport, health, and even food at rock-bottom prices so that the cost of living in Greece falls and the population can tolerate lower income, as well as becoming more competitive. Currently the government is speeding along the wrong route and people are loudly complaining.

Financial speculation

Now, enter debt and the global financial markets. That is the bigger problem, and it’s about financial speculation against weak Eurozone countries. It’s not particularly about Greece.

Greece has accumulated some €340 bn in debt. This debt is borrowed from the private capital market, basically banks in Europe and elsewhere, and it’s in the form of bonds that have a fixed term, usually 2 to 5 years. That means the every year approximately a fifth of the debt comes due so Greece has to borrow new 5-year bonds to pay off the old 5-year bonds (capital plus interest). That’s how Greece ends up borrowing €70 bn a year, of which it pays €65 bn immediately to settle old debt and spends the other €5 bn on its deficit.

This “rollover” cycle is the norm, and would be no problem if interest rates were consistently low, as they normally are for states. The market normally gives rates around 1% to 2% to states, which is a bet that states will repay. That’s because of three factors:

  • States usually keep up their payments.
  • If states do decide to stop paying there’s little the banks can do about it.
  • States normally issue their own currency, so they can run their internal economy even if they’re externally in default.

Not so with Greece. Since Greece is in the euro the Greek state is more like a loss-making business. When it runs out of euros it’ll have no more euros to pay Greek pensions, public sector salaries, etc. and people will be very, very angry. Thus the government is desperate to keep borrowing. To borrow the €5 bn it actually needs, it has to roll over €65 bn or so. Since it’s desperate, the market can charge it whatever interest it wants. Currently the market is charging 28%, an absolutely ridiculous, exorbitant rate of interest.

This is a bet that Greece will default, but not immediately. The bond speculators are betting that Greece will extract what it can from the Greeks (which is not much) but mainly that France, Germany and other rich EU countries will back up Greece with several billion from their budgets. The high interest rate is trying to predict when a default will happen and price in the risk, so that the speculator makes a profit before Greece defaults. Of course with each rollover at higher interest rate the debt becomes less and less likely to be sustainable, the interest spirals further to cover this new risk, and the cycle pretty much ensures a default. It’s as if you had a mortgage where each year the bank said “Hey, we think you’re a risky borrower, so we’ll crank up the interest on you”.

As to why France and Germany would prop up Greece, there is some goodwill but mostly it’s to protect their own banks. French and German banks, even while participating in the bet, have relatively low capital and would get into serious trouble if they lost the few tens of billions Greece owes them. Thus what we see is a speculative attack where the main parties are European and international banks on one side, and rich EU states and their taxpayers on the other. The banks are attacking Greece, as a hostage, and forcing states to either pay the ransom for Greece or bailout the banks.

Greece just happens to be the weakest economy in the Eurozone with debt and a deficit, and therefore the first victim. The fear that after Greece it will be Portugal and so on is in this sense accurate. However the implication that the Greek government’s poor fiscal management will spread out like a disease around the Mediterranean and beyond is false and misleading. State finances are fairly well contained. It’s market speculation and inadequately capitalized banks that threaten to spread the problem.

Commentators, especially in the English-speaking press, like to cite the crisis as evidence that the euro is vaguely and generally a bad idea. I sense some bias. The single currency makes the EU stronger and as such is essential for its global competitiveness. The Eurozone is also not properly integrated, and that allows the market to speculate against the weaker members. That is genuinely broken and needs fixing.

Financial solutions

The quick and easy solution to the problem of financial speculation is for someone to lend to Greece, or the next troubled Eurozone country, at very low rates – essentially below market. If a lender with bottomless pockets agreed to finance Greece at the normal 1%-2% for decades to come, the speculators would have to go away.

The simple and obvious lender to do this would be the ECB. As the issuer of the currency the ECB can absorb or delay any amount of nominal losses. If the ECB were set up to serve the political interests of Europe, the issue would have been resolved some time ago in this way. The fallout would have been mild devaluation of the euro, which would be a correct and useful adjustment in any case. Unfortunately, the ECB is set up to further the interests of European capital, and it’s prevented by its charter from lending to states directly. Instead it provides capital to banks, so that they can speculate on crises such as that of Greece and later get bailed out by their governments. The ECB is desperately in need of reform.

The latest French proposal is a mixed blessing. As far as I can tell, it rolls over short term Greek bonds into 30-year bonds, which will dampen down the cycle of speculation. It tries to achieve some voluntary settlement of the speculative bet rather than let it stack up until the bluff is called. All of that is good. On the other hand, the plan is pretty obviously designed to disentangle French banks from the mess, by floating off their Greek assets in a way that protects their balance sheets.

If the current proposal fails, the cycle of speculation is likely to accelerate until Greece defaults in some way. Disorderly default would mean not paying bonds when they come due. Debt would stay on the books but frozen, and Greece would be unable to borrow for a while. Depending on timing some speculators would make money and others not, while EU governments would have to bail out their banks. After several years, there would be some kind of settlement. Unlike a business, Greece would keep control of its affairs and isn’t going to be run by creditors, at least in the current legal framework. There are hawkish voices, mostly from the German and UK finance lobby, to change the legal framework so that states do go into receivership like companies.

There is no quick solution to the €8 bn real deficit of Greece. The Greek state can reduce and maybe even balance its own books, but there’s an underlying competitive difference between the Greek economy and that of Germany. In an open economy the German region will have a trade surplus and the Greek region a trade deficit. Currently, the Greek state borrows on behalf of the Greek people fo finance the difference. The extra €8 bn that the Greek state spends circulates, through private consumption of imported goods, to German, Dutch, and other EU firms – or at least much of it does; it’s hard to find bilateral balance of payments numbers. If the Greek state aggressively balances its books, as it’ll do if it defaults, Greek demand will shrink to a much lower equilibrium. Similar logic applies to Portugal and the other weak euro economies in relation to the industrial center.

For this reason, some form of redistribution from the more competitive to the less competitive states makes sense for the EU as a whole. In the case of Greece the €3 bn of aid from the EU is well spent and could be increased. A direct, tax-funded transfer is useful as a subsidy for demand. Productive investment in the periphery would be even better, as the goal is of course to narrow the competitive gap between western and peripheral Europe over time. The same happens in the US where the federal government both subsidizes and invests in the economically weaker states. Otherwise a combination of hardship, migration, protectionism, and other less attractive forces will eventually solve the competitive imbalance in a way that leaves the total size of the EU economy smaller.

Greece is unlikely to exit the euro as a result of this crisis. To do so would be pretty impractical. Banks would have to close for about two weeks to freeze euro deposits while the state prints new Drachmas. The Drachma would then suffer massive inflation. There’s no particular public sentiment against the euro or the EU, although everybody wants to see the EU reformed. Most likely if Greece defaults the state would issue some kind of limited IOU or in-kind coupon to cover its deficit, while continuing to use the euro as currency.

Politics and the people

Finally, about the sentiment of people in Greece. They’re obviously angry, but there are shades to it. Some are selfishly angry that they’re getting pay cuts and refuse to adjust to reality. For example they’d like the state to somehow keep paying high salaries or maintain obsolete jobs. Would the same people also favor protectionism, so that for example they could buy quality, cheap, local produce but no iPhones? Maybe. Especially among middle-aged and working-class people an appetite for common-sense protectionism exists. It’s justified, given their true prospects.

The greater number of people are angry because they perceive fairly accurately that Greece has been the victim of awful governance internally and financial speculation from outside. They see the prime minister as spineless or in the service of creditors, which mostly he is. Modern Greece has had lousy governance as a rule but current statesmanship is at a low point for both major parties. People are calling for direct democracy rather than elections.

The feeling toward creditors is that Greeks don’t want to suffer to pay French and German banks, especially when the banks are acting as loan sharks when it comes to rollover of debt. Greeks are especially unhappy about the government’s moves to sell assets such as ports, telecoms, etc. Asset sales will reduce the accumulated debt but damage Greece’s balance of payments and state deficit, as the profit from these businesses will go to foreign shareholders rather than the state. The people sense that it’s like selling your car to the loan shark to pay off part of your debt, but then having to pay them for transport.

Surrounding this there is a class and ethics conflict. Especially since the 1980s, Greece has had an economy that encouraged the middle class to participate in petty corruption: Tax evasion, informal employment, lax regulation, and the like have been the norm. Now that society is being squeezed the majority find they can no longer eat from that pie, which is now reserved for the upper middle and upper classes. They are not happy, and there are very forceful calls for cleaning up taxation and in general fighting corruption at high levels.

The political maturity of the Greek people has risen markedly due to recent events. There’s a sense of camaraderie and involvement in the commons not seen for decades. A continuous town meeting has been running in the central square of Athens, outside parliament, for some months now. They manage to organize expert panels, which come up with lucid analysis and demands such as for independent oversight of government fiances. An unofficial commission for fiscal control has formed to do just that. There’s serious discussion as to whether Greece should default, when, and in what way exactly. The will for better governance, as well as the skills for it, are definitely there.

So far, the movement is promising but not crisp enough. The main slogan is “we don’t owe, we won’t sell, we won’t pay”. The first part is unrealistic – it appeals to justice, which doesn’t apply here. Whatever poor governance or personal complicity got Greece here, Greeks owe. However it’s correct that they shouldn’t sell and would be better off refusing to pay now than being saddled with exorbitant debt and going bankrupt later. So far there’s no new political party or clear enough grass roots movement to take that message, evolve it, and make it into a governing mandate. I’m optimistic that that may emerge.

On the dark side, hate is on the rise. Greece has always had neo-fascists but they’re getting more visible and more bold. They show up as violent gangs with simplistic messages and symbolism and hold rallies, or try to pick fights with immigrants or perceived liberals.

The police has been enlarged several-fold, in spite of savings in every other part of government, and their expanded presence is repressive rather than related to crime fighting. They patrol on bikes or stand at street corners in riot gear reminding people to stay in line. The vast majority of the public take a mature, peaceful stance in their protests and sit-ins at the square, and the crowd usually contains or fends off violently disruptive small groups. On most days there is no confrontation. On important days, such as when finances are debated in parliament, the police strikes the demonstrators by using gratuitous amounts of tear gas and beating random people, sometimes severely. Escalating violence by police against ordinary people inflames anger, sometimes to the point of riots, and undermines what is left of the state’s legitimacy.

2 thoughts on “Greek debt crisis, as of summer 2011

  1. Thanks for this. It’s an interesting and useful summary, which the press seem to have been incapable of producing.

  2. Pingback: Greek debt crisis update » Greece on WEB

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