We’ve been hearing so much on the news recently about the Greek and European debt crises, the decline of the Euro, and of protests across Europe, especially on the streets of Athens. The European Union and its common currency appeared for a while to be a great success, a major economic powerhouse built from an amalgam of tiny neighbours. So what happened, and why should we care?
Europeans have been talking about an economic union for over 100 years. They believed that by cooperating they would all benefit economically, and more importantly, it would help to prevent the wars that had ravaged Europe throughout history. After the devastation of World War II, Europeans began to consider this seriously. It took over 30 years to agree on and implement, while politicians, economists, and central bankers tried to balance the many complicated factors and competing interests. Together they believed that Europe could be another superpower in our multi-polar world (along with America, Russia, and China).
Prior to the Euro, doing business in Europe was inefficient. The overhead of so many small countries each with their own currency resulted in increased costs. A trip of only a few hours might require the crossing of several borders, each with their own immigration, customs, and currency conversion requirements.
The reality is that Germany, France, England, and Italy dominate Europe’s economy. Germany in particular has been the primary economic engine of Europe, even while absorbing the massive costs of German reunification. Germany was optimistic that moving to an economic union would expand its markets to more European consumers, but insisted that the other countries adopt conservative economic policies similar to its own and meet strict economic criteria for membership. Most of all, Germany wanted to ensure that Euro would be a stable currency so they would never again experience the hyper-inflation they did prior to World War II.
Greece and the many smaller countries of Europe wanted the benefits of Eurozone membership so they could share a single strong currency with Germany. At the time, several countries didn’t meet the fiscal criteria for membership but they were so anxious to participate that they did whatever was required to become members, like cut spending and raise taxes. Greece in particular, had an almost miraculous turnaround, bringing their economy into line in short order. But, as we’ve seen, it was too good to be true.
The European Union became the largest economy in the world. Its GDP was over $17 Trillion US dollars in 2011 (compared to the United States at $15 Trillion and Canada at not quite $2 Trillion). Of this, Germany, France, United Kingdom, and Italy together make up $11 Trillion (approx. 65%) of the total GDP of the EU. On January 1, 2002, most of Europe began using a new currency, the Euro. The Eurozone (which is basically the subset of European Union countries that use the Euro), became the 2nd largest economy in the world after the US.
Greece was one of the EU countries that began using the Euro in 2002. The people of Greece were very happy to be in. Greece had (and still has) a small economy (GDP of 300 Billion in 2011, or one-sixth the size of Canada). When it joined, it was one of the least developed members. As a result, Greece was a net recipient of EU money for government and infrastructure projects, resulting in a lot of enhancements to public services. Later, with the admission of even smaller, poorer countries like Romania and Bulgaria in 2007, these funds reduced considerably.
A greater benefit came from the fact that lenders gave the many small countries of Europe (e.g. Greece, Ireland, and Portugal), the benefit of being part of the larger club. They, incorrectly it turns out, viewed the risk of lending to these small countries as being much less now that they were part of the European Union. But that wasn’t really the case.
There were some real issues in Greece then and now that make it very different from countries like Germany and France. Greece has a small economy with limited exports. It has relatively low productivity, and a low (currently negative) growth rate. It has a huge annual deficit and debt compared to the size of its economy. Greece’s largest industries, tourism and shipping, were particularly hard hit by the global financial crisis (down 15% in 2009). The Greek government isn’t good at controlling its spending, even once its budget has been set, resulting in overruns, especially in election years. There is widespread tax evasion and corruption in the Greek tax system, and government revenues are much lower that they should be.
Despite these issues, cheap money began flowing into Greece. Prior to joining the Euro Zone, interest rates in Greece had always been relatively high (10 to 20%), a reflection of their higher risk relative to other European nations. After joining the Eurozone, interest rates in Greece declined to under 5%. For Greeks, it was like an economic miracle. They borrowed money euphorically to buy consumer items like houses and cars, and to grow their businesses. The Greek government could now also borrow money cheaply, and began to spend wildly. They hired many new government employees, raised salaries rapidly, and spent a ton of money infrastructure and other projects. These were things that they couldn’t afford to do before joining the Eurozone and, it turns out, couldn’t really afford to do after joining either.
Greece elected a new government in October 2009. Like most new governments, soon after they gained power and got access to the books, they claimed that things were much worse than the previous government had let on. But in Greece, it was much worse. The Greek statistics agency had played fast and loose with the numbers, greatly under representing how bad the situation was. The annual deficit relative to the GDP ratio was not 6% as previously reported, but somewhere between 12 and 16%. In 2010 it was learned that for 10 years successive Greek governments had deliberately arranged transactions so as to hide the actual level of borrowing. This set off a dramatic chain reaction. The foreign investors, European banks, and Greek banks who loaned money to the governments of Greece and to other small European nations (like Iceland and Ireland) got spooked, leading to a confidence crisis in Europe, the European Debt Crisis.
International lenders stopped lending money to Greece and some other nations, and interest rates in these countries increased dramatically. The smaller countries of Europe (and their citizens) found it almost impossible to borrow money. It became apparent to lenders that these countries would have great difficulty or wouldn’t be able to pay back what they owed. Due to its large debt, low creditworthiness, and the much higher interest rates it was therefore required to pay, Greece was effectively bankrupt.
There are only 4 ways for a nation to deal with its debt when it can’t pay it back — (1) have the lenders forgive the debt (2) increase the money supply leading to surplus inflation (and therefore making it easier to pay the money back), (3) achieve dramatic economic growth (leading to increased tax revenues), or (4) default on the debt.
Because Greece shares a currency (the Euro) with the rest of Europe it does not have an independent monetary policy, and other European countries, especially Germany, do not want that currency debased (leading to inflation). Although Greece plans to grow its economy, the world is a competitive place, and new austerity measures will likely slow their growth. Not only has their economy not been growing, but it’s been shrinking for the last 2 years. Greece and the rest of Europe are trying desperately to avoid Greece from defaulting on all their debt, because they’re worried it will trigger a European economic collapse. They are worried about a chain reaction of bank and government failures starting in Greece and spreading until it collapses one of the larger economies of Europe (e.g. Italy).
This European debt crisis has had significant impacts through Europe. The Euro has fallen relative to other world currencies and to the US dollar (down 25% from its peak in 2008), despite the fact that America has had its own share of economic problems recently. It has prompted government changes in Italy, Spain, and Greece. The European Union also began to more closely monitor its members and to enforce its rules to ensure that this doesn’t happen again. In December 2011, the governments of Europe agreed to austerity measures that would result in them spending less money, much to the chagrin of their citizens. The European Central Bank propped up the European banks with a huge infusion of money in March 2012, but Europe is still in a recession.
The other countries of Europe and the European Central Bank agreed to bail out Greece with some major conditions – that Greece’s creditors agree to forgive some of their debt, and that the Greek government implement severe austerity measures. This angered the people, who were facing job losses for civil servants, reduced government services, significant impacts to their pay, pensions, taxes, etc., all of which resulted in protests on the streets of Athens. After much negotiation, Greece’s creditors did forgive about half of its debt in February 2012, and Europe provided the latest of the multiple bailouts that have kept Greece going on life support.
A Greek election in May failed to form a government so another election was held on June 17 (3 days ago). The biggest issue in the election was whether to honour the commitments made by Greece just a few months ago upon which their partial debt forgiveness and latest bailout had been conditional. Many of the parties running were anti-bailout, and intended to try to renegotiate the terms of the deal. Prior to the election in May, the EU made it clear that rejection of the bailout conditions would result in Greece being forced out of the Eurozone, something that would have devastating effects on Greece, other small European nations, and potentially all of Europe. This time, from the many factions running, pro-bailout parties received just enough seats to form a coalition government, something that is expected to be announced today (June 20). Greece voted by the slimmest of margins to try to stay in the Euro club. It is disconcerting though that the second place party in Sunday’s election was Syriza (27% of the vote), an anti-bailout party who has tapped into the anger of many Greeks over their declining living standards, and who pledged to magically return Greece to their unsustainable lifestyle. This is wishful thinking on the grandest scale and probably not even possible, but many Greeks voted for it.
Even with the debt forgiveness and multiple bailouts, it may not be feasible for Greece to remain in the Eurozone. It is impossible to row against the tide of global sentiment forever. Fearful that a potential departure (a ‘Grexit’) would result in a devaluation of their money, Greeks have begun moving their savings to the banks of other European nations. Eventually, this could collapse the Greek banking system and force Greece’s withdrawal from the Eurozone. Of course the transitioning Greek government encourages people to be calm and reminds them that their deposits are ensured by the Greek government, but when that government is effectively bankrupt and relying on the handouts of other nations, that warranty is not reassuring. Many economists think that it is an inevitability, that what we are witnessing are just the stages of grieve prior to the final death throes.
The European Union treaties are silent on the matter of states leaving the Eurozone, neither prohibiting nor permitting it. Likewise there is no provision for a state to be expelled from the Euro, although the other states could make it so difficult for Greece that they choose to leave voluntarily. There is virtually no precedent for a country leaving a monetary union, and in modern world of electronic fund transfers and financial speculators, this would be extremely difficult and potentially devastating.
There is a lot of ill will toward Greece in Europe right now. The other countries blame them lying about their economic situation to gain membership to the EU, for not working hard enough, for retiring too early, for spending too much money, and for not collecting enough taxes.
Greece is a tiny country on the other side of the world. Until recently it was more famous for its antiquities, beaches and food than for anything else. The reason we should care is that a debt default in Greece could lead to a chain reaction of collpases that would eventually impact the larger economies of Italy or Spain, destroy the European Union, and plunge the world into another major financial crisis when we haven’t yet recovered from the last one. In today’s globally integrated world the actions of one small nation can impact ordinary citizens on the other side of the globe.