The World This Week: Greek Crisis Marks End of Debt Era
The Greek debt crisis signals the beginning of the end of the current debt-fueled global financial system.
Once upon a time, a Greek named Aristotle purportedly wrote a treatise called Economics. This title literally means “household management” and is derived from οἶκος, which means household. This work deals with issues like private property, duties of a wife and management of slaves. It describes different kinds of economies, but states that all of them have one principle in common: income must exceed expenditure.
The modern world economy has come a long way from the days of Aristotle. The world is awash with debt. The national debt of the US is now over $18 trillion, while its gross domestic product (GDP) is a touch short of $17.5 trillion. The total debts of Italy and Portugal hover around 130% of their GDPs. The comparable figure for Spain is 93.9% and for France is 97.5%, which has debts totaling $2.3 trillion. Greece is only the most extreme example of a pervasive global phenomenon. Its debts total $367 billion, 180% of its GDP. With aging populations, chronic unemployment and anemic growth in all these countries, these debts are not payable. With the Greek crisis, the chickens have come home to roost.
As with most crises, there is a back story. During the 1990s, Greece spent more than it earned. Budget deficits were high and so was inflation. When the euro was launched in 1999, Greece was not invited to the club. In 2001, it was let in but only after a tough austerity program that included deep cuts in public spending. Yet this austerity was not enough. Many publicly fretted that Greece had been let in despite failing to meet the Maastricht criteria—the membership conditions for the euro.
Truth be told, Greece was only emulating Italy. This land of Luca Pacioli, the man who first recorded the system of double-entry bookkeeping, used Goldman Sachs to hide its debt. Voilà, it sailed smoothly into the euro in 1999 itself. Two years later, Greece did the same and again Goldman Sachs duly obliged, indubitably for a fat fee. The Italian and Greek shenanigans epitomize the fundamental problem with modern finance. The system is too convoluted, frighteningly opaque and compulsively shortsighted. It is creating growing mountains of debt that can never be paid back.
Because of the Greek debt crisis, the euro project is now in question. The project was conceived by Jacques Delors, the big boss of the European Commission (EC) from 1985-95. He pushed through the internal market and the Economic and Monetary Union (EMU). The culmination of his work was the Maastricht Treaty, which led to the creation of the euro. Delors was a French socialist who was incongruously Catholic and at odds with the secular French tradition of laïcité, which imposes a strict separation of church and state. His idea of one currency for all of Europe was in some ways a Catholic idea. It was based on the premise that one set of agreed principles would usher in an era of peace, prosperity and harmony. That premise has proved false.
Delors went too far in pushing through the euro. The truth is that there is little in common with a tourist paradise like Greece and an industrial giant like Germany. Europeans point out that financial and liberal New York has little in common with agricultural and Confederate-flag-waving Mississippi, but they forget that New Yorkers are happy to subsidize their southern cousins. Are the Germans and the Dutch happy to support the Italians and the Greeks similarly? This is the multibillion dollar question.
Then there is another key question. What is the right interest rate for this motley group of countries with one currency? When the euro first came into being, the German economy suffered greatly. With classic British schadenfreude at the expense of their great rivals, The Economist dubbed Germany “the sick man of the euro.” Then, the country had recently reunited with its formerly communist eastern part and the costs of doing so were staggering. The interest rates set by the European Central Bank (ECB) were higher than what Germany would have set for itself. Yet these very same interest rates were too low for countries like Spain and Greece that started living off cheap debt and property bubbles.
For some time now, the interest rates set by the ECB have been too low for Germany. It has huge exports earnings and large savings. Hence, German banks have been chasing higher returns. They invested in the supposedly safe subprime market in the US where fancy derivatives were hiding dud loans made to people without incomes and jobs. They also invested in Spanish, Portuguese, Italian and Greek debt. The 2008 crisis shattered the status quo. The crisis began with the unraveling of US banks and turned into a panic regarding sovereign debt in 2009.
Greece was the worst affected of all European nations. The EC and the ECB decided to bailout the country and were joined by the International Monetary Fund (IMF), a de facto European club. Instead of admitting that Greece had taken on debts that it could never repay, the troika decided to kick the can down the road and maintain the illusion of the inviolability of creditors’ rights.
These creditors were largely French and German banks. As Karl Otto Pöhl, a former head of the Bundesbank, bluntly points out, the 2010 bailout “was about protecting German banks, but especially the French banks, from debt write offs.” He recommended slashing Greek debt by a third but was ignored by the powers that be. The 2010 bailout was followed by an encore in 2012. In both bailouts, European leaders were throwing good money after bad. Finally, even the IMF has accepted Greece’s debt dynamics to be “unsustainable.”
Syriza was elected because the Greeks were fed up with austerity. Greece’s unemployment rate is the highest in Europe at 25.6% and youth unemployment stands at nearly 50%. Syriza promised an end to the failed economic policies of the past. Needless to say, the new government is inexperienced and has handled the country’s creditors maladroitly. However, the creditors themselves have been breathtakingly arrogant. They asked Syriza to go back on its electoral promises and commit hara-kiri. Syriza was left with no option but to call for a referendum. Regardless of the result, this turn of events marks the end of the era of debt.
The Greek debt crisis is about to go global. First, other European countries are bound to be affected. Even France, la grande nation, will eventually come under pressure. Second, even states and cities will face pressure. Already, Puerto Rico’s government has declared that it cannot pay its $73 billion debt. In fact, all government-backed debt from sovereign to municipal bonds will come under pressure. Third, the US and China will eventually face a debt crisis too. The crisis is global and about to amplify.
The ballooning of debt is the biggest challenge facing the world economy. To stave off economic collapse, governments bailed out American and European banks. Central banks then released a torrent of money into the system by lowering interest rates and using quantitative easing, emulating the Bank of Japan. Those who own assets became richer, exacerbating already terrible inequality. Governments support creditors to boost economic confidence, while home owners in the US and ordinary citizens are fed to the dogs.
There is certainly a glut of savings in some parts of the world. China and Germany are awash with capital and are looking to park their money in assets that give them higher return. Yet there are limits to returns in a world awash with capital. The Chinese bubble in real estate and stocks has burst. Yet China is putting more money into its economy. It has made a fourth cut in interest rates since November and has reduced reserve requirements for banks, so they can continue lending. China has also lowered transaction fees and relaxed collateral rules on borrowing to fund share purchases. This is debt-fueled madness.
Like all parties, the Chinese one is coming to an end and stocks have lost nearly 25% of their value since the middle of June. Hence, Chinese money is flocking to the US in search of a safe harbor. Chinese buyers are now purchasing houses in California without even looking at them. China continues to fund US debt and shudders in horror as quantitative easing dilutes the value of its reserves. Unlike smaller countries like Greece, the US will never face default. It has the unique luxury of diluting its debt by simply printing more dollars. As the superpower in-charge of the world’s reserve currency, it can live off debt a little longer. It offers the greatest security to investors in an uncertain world. Yet the music will one day stop playing even for the US.
Once, Christianity and Islam enforced a ban on usury. This measure was aimed to protect the poor from creditors wanting their Shylock’s pound of flesh at a time of incredible inequality. A new era of inequality has now dawned. Some own too much, while others have little. And debtors cannot afford to pay back their debts. So, loaning more money to debtors in the manner of the EC, ECB and the IMF is little more than a Ponzi scheme to prop up a failed system. As Greek Finance Minister Yanis Varoufakis points out in a lecture of breathtaking brilliance in Berlin, this has to stop.
Finally, creditors could do well to remember that there are precedents for restructuring debt. In the case of private sector, the Chapter 11 bankruptcy protection in the US gives companies a chance to nurse themselves back to profitability. No less a corporation than General Motors went through this exercise in 2009. Even for nations, debts have been restructured on multiple occasions. After World War I, US creditors were hard-line in their demands on Germany leading to hyperinflation, financial collapse and the rise of Nazism. After World War II, the same creditors acted more wisely and consensual debt relief led to the rise of Germany.
The choice the world faces is simple. Either it continues to persist with the fiction that all debts can be repaid and keeps issuing new debts to pay back old debts while stimulating the economy with all kinds of ridiculous measures. Or it accepts realities of the day and restructures debt before another age of chaos engulfs the planet.
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