Greece has been developing on a model that allowed huge budget deficits in order to sustain continuous annual growth, on the assumption that future revenues would repay the debt. In essence, a good scenario provided for government revenues that would continue growing and for expenses that at some point would level out. And that is what actually happened for many years: the country grew 4-5% annually and in 2008 reached a per-capita income of around $34,000, among the top PCI’s in the world. Greece was indeed dancing along, ranking, if I remember well, as the 17th richest country on earth.
The global financial crisis of 2008 left the Greek banking system almost unscathed as there was no exposure to subprime risk. But the credit crunch made everybody much more careful about whom they were lending money to, and this helped Greek banks. Because they were considered extremely solid at the time, they saw inflows of many billions of euros into their balance sheets. But the annual budget deficit kept piling up, topping 10% of GDP in 2009. In actual numbers it reached €25 billion, and the national debt climbed to staggering levels close to €300 billion. Then everything came tumbling down! The markets were suddenly unwilling to lend and the country slowly but surely slipped into the hands of the IMF and its European partners.
A massive bailout plan worth €115 billion was set up, and Greece was told to implement structural reforms in its economy. To a certain extent the reforms have been carried out. But now, 18 months later, the EU is faced with another Greek request, this time for €90-125 billion to prop up the country for the next couple of years. It is absolutely certain that without this assistance Greece will not be able meet its payment obligations and will default.
That is the tragedy, and it is Greek through and through! If the country defaults many European banks, pension funds and investment funds, the ECB, and all the European governments involved in the first round of the bailout will suffer serious losses. And if the country does not default, they will have to extend another €90-125 billion!
So it’s damned if they do, damned if they don’t, since no one today really believes that Greece will be able to start repaying down its debt in the years to come. To add to the confusion the political system in Greece is in limbo, and no one knows how long this or any other government can remain in power while applying extremely harsh and unpopular austerity measures.
The situation today is that practically the entire Greek economy is going through a demand implosion. Tax revenues are collapsing, salaries are down 20% in the public sector, the country is sliding into depression and the risk of political instability is increasing by the day. The privatisations supposedly needed to bring €50 billion into the treasury by 2015 have not started, yet plans call for €12 billion of additional revenues in 2011 and 2012…. We are quickly reaching the point where major decisions will need to be taken—and enforced—if Greece wishes to remain in the EU and honour its obligations as a hardcore member.
If not? Well, that is where the real trouble would start. If Greece for any reason opted to default unilaterally, we in Europe would be faced with such a crisis that 2008 would look like a kindergarten exercise. Here is what it would be like.
On day one Greece would need to freeze all bank deposits to defend against a massive bank run. All state and private pension funds would go bankrupt. Insurance companies, required by law to keep a certain amount of their capital in Greek sovereign bonds, would go bankrupt. Within two weeks the government would no longer be able to meet most of its payment obligations. The banks would need massive recapitalisations or would be sold for €1 to anyone willing to buy them. Business activity would come to a full stop and, in my view, the country would be prone to major social unrest that would spread like a bushfire outside the Greek boarders. In Europe banks would suffer heavy losses on Greek public debt and potentially similar losses on the country’s private-sector debt since no one would be able to repay it. European pension funds and investment funds would also suffer, and private companies would take major hits on their balance sheets. The EU would have to provide many billions of euros’ worth of state aid to banks or risk a cascade of failures. Liquidity would dry up in the interbank market and interest rates could go sky-high, creating greater uncertainty. Issuers of CDSs would have to honour them, creating potentially massive losses not only for EU banks but for US ones as well. In reality no one knows where such an event could lead us.
All this is unthinkable. It is something that anyone in his right mind must avoid at all cost, even if this cost is greater than the numerical exposure to Greek debt. If we allowed such a thing happen, we would open Pandora’s box on Europe. “Who’s next?”, the markets would wonder. Speculators would zero in on those countries suffering the most in order to short them to death. “How quickly can I sell my euros?” people would think. Etc., etc., etc.
So no, that is not a viable solution. The solution is for Greece to pull its act together and take the necessary steps to reorganise its economy, curtail its notorious and huge black market (estimated to be worth 30% of GDP), downsize the public sector and make regulations transparent to allow free competition. Meanwhile the EU will have to continue supporting the Greek economy with fiscal measures and direct investments. Let’s hope for our sake that they are all capable of doing this.
Thanassis Gontikas