The situation in Greece has become more widely recognized while not necessarily more widely understood. Most understand the bottom line: Greece owes other countries and institutions money that it does not have. Many in the US wonder why they owe the money and how it ever was allowed to become a situation wherein a national default may be the best long-term solution for Greece, if not for her creditors.
The fiscal situation of contemporary Greece is similar to that of many young adults recently out of college embarking upon a professional career. At a decent starting salary in the big city, the young man or woman is determined to live a little after the hardships of schooling. The problem is that human nature over-corrects. Given a credit card, they will almost inevitably max it out. Needing a car, they will buy new and expensive.
Greece got her ECB Credit Card on January 1st, 2002, as 12 European countries rolled out their new Euro currency. The previous domestic currency that Greece had, the drachma, was a very weak currency, as Greece historically has had a rather low economic output compared to major countries. Think of currency as a whole as a measure of a country’s ability to borrow from other countries. Risk relative to other countries (or I suppose “currency zones” is more appropriate because of the Euro) weakens currency, whether it is massive debt levels or political unrest. An economy that is earning more money (GDP measures the value of goods/services a country produces, think of it as a country’s wage) or paying off more of its debt will have a strengthening currency.
To give some perspective, Greece’s 2001 GDP was $136 billion: $25 billion less than Ford Motor Company’s 2001 revenue. Because of the low “earnings” of the country, loans from other countries were charged at high interest rates, and those high rates were passed on to the private sector. The prime rate for loans, given out to the individuals with the best credit and income, was around 18% in 1998, and still around 12% in 2000, the last year that Greece’s foreign debt was less than its GDP. When Greece entered the Eurozone, she cosigned for all subsequent loans with the credit of the Euro and the combined “purchasing power” of the Eurozone. Greece’s currency went from being based on $136 billion GDP, or .4% of the world, to reflecting the $6.5 trillion GDP (20% of global) the single currency countries boasted. It is similar to if I were to marry Oprah Winfrey and have her cosign all my new loans.
The Greek government spent and spent, on the Olympics in 2004 ($13 billion), on public projects like a new electric railway system and expanded metro, and internally, nearly doubling the wages of workers in the private sector in the next decade. They did this at the expense of the debts that they had already, which in 2000 were already substantial at over 100% of GDP. But money was flowing so debt could wait. Greek GDP surpassed $300 billion in 2008, as the world economy boomed. It seemed Greece had shaken off its lethargy and arisen into a golden age.
In the private sector, Greek citizens were over-the-moon. The days of 20% interest rates were over; for the five years from 2002 – 2006 the interbank rate for lending was around 2.5% – 2%. The Greeks went out and bought up those German Porsches and Mercedes they had always wanted but could never afford, just as the Greek government imported millions of tons of steel from Germany for its metro and railway programs.
By the end of 2009 Greece was clearly heading toward fiscal suicide as global recession grounded Greece back to economic reality. The easy lending Greece had enjoyed provided a stimulus to the economy as long as times were good. When the lenders became uneasy and looked at how much money Greece owed, the credit started an ongoing spiral that brought Greece’s sovereign credit from A to CCC, from “upper medium grade investable” to “substantial risks non-investment grade” from December 2009 through most recently April 2015, and it isn’t done yet.
So what’s the bottom line? What’s wrong with Greece? It’s simple: improper fiscal policy implementation for many years, i.e. not enough money in and too much money out. In addition, the lack of effective tax systems led to widespread tax evasion by businesses. Imagine you are a small business owner, liable to pay 23% on the VAT as of 2010. You see your competitor not paying the tax and not getting in trouble. You feel that if you pay the tax you’re at a 23% disadvantage to your competitor, so the idea becomes universal practice in an endless cycle of “but he’s doing it too!”
The Wall Street Journal article entitled “Greece Struggles to Get Citizens to Pay Their Taxes” gives a succinct example of how it works on a practical basis:
“A 32-year-old chef in Athens says his income taxes are automatically deducted from his monthly paychecks. But every time he buys something and is given an option to pay less if he doesn’t ask for a receipt, he says yes. ‘It is a win-win situation,’ he said. ‘I pay less for the products and the store pays less in taxes.’
…And the government can’t pay its debts, so you lose your job is the second part of that cycle.
When Greece entered the Euro it could have been an opportunity to pay down its debts with the newfound easy-access money. Instead its books became more and more lopsided in the debt column versus the asset column. When the GDP started dropping in 2010, the seemingly healthy and vibrant early 2000’s Greece was revealed to be a corpse-wearing sunglasses propped up by French and German money pouring in from loans.
What can Greece do? In May 2010 the IMF and the EU gave Greece €110 billion euro, because giving a child in debt trouble more money always solves problems. In February of 2012 they gave them another €130 billion in a second bailout. Now we are back to the same situation. Greece’s debt is 178% of its GDP. The only thing that Greece can do is cut back on spending money, as its ability to raise its Gross Domestic Product is almost out of the question with growing unrest and 28% unemployment. The reason there is so much unrest is that Greece is finally doing exactly what they must do, and the people hate it. Just like the debt-strapped teenager, the only thing you can do is put your head down, stop eating out, and subsist wholly on raamen noodles for a long period of time. That is what austerity is all about. It isn’t supposed to be fun.
The IMF and EU made Greece agree to “austerity measures” (which mean government spending cuts) in both previous bailouts, and are calling for the implementation of more for this third round. These may seem cruel, but cutting the infection out is the only way Greece can ever recover and regain strength. As much anger as the Greeks are showing against the Germans, blaming them for taking advantage of them and leading to the austerity they now have in place, the Germans have been in the same situation 25 years ago. When Communist East Germany fell and Germany reunified, the country had to impose similar austerity measures in order to rebuild the country (read here if you would like to learn more). The Germans also remember the post WW2 days, when the German Mark was so worthless the people wallpapered their houses with it. The Germans are no strangers to austerity, and the reason they are now the dominant European economy is discipline and low debt as a nation.
So the easy question is should Greece default instead of cutting pensions and accepting other austerity measures that would cause civil unrest? Returning to the drachma, their currency they previously minted (which has a much cooler name than Euro) would be going back to a fairly valued currency. The strength of Germany and France is reflected in the strength of the Euro. Re-adoption of the Greek drachma would be going back to a very weak currency, and would be building from the ground up through exports to rebuild Greece. Whether Greece obtains a bail-out or not, things will continue to be very bad for the citizens of the country, and austerity will be the status quo for as long as it takes for the proper reforms to heal the country. Rioting and casting blame isn’t going to change that hardship, but neither will attacking the problem at the leaves instead of the root with more money and no budget cuts. The ECB and IMF know this, and that is why they will not accept any Greek proposal that doesn’t contain the proper tax increases, budget cuts, and privatizations that will allow Greece to move forward with payments instead of the vicious cycle of constant loan restructuring.