Originally published spring 2015
I had one of those mornings where I said hi to the internet, just for a second, and next thing you know it’s four hours later and I’ve gone from knowing nothing about Greece to just slightly more than nothing.
A few hours ago Greece voted ‘No’ and rejected its creditors’ demands, more on what that means towards the end. Here’s my attempt at a quick, objective outline of what’s been going on over the past five years, with some subjective thoughts/observations at the end. This is based mostly on a fantastic primer I found by Booth’s Anil Kashyap, as well as some observations by other prominent economists I’ve come across. So here we go.
Since the 1990s, Greek spending has been greater than its tax revenues. This was misrepresented by the government, and incoming governments would routinely revise the entire financial picture so they wouldn’t be blamed for previous blunders.
In 2009, the new government revised numbers going all the way back to 2006, and creditors started to get suspicious, doubting that Greece would ever be able to get its house in order.
You probably heard about the first Greek ‘bailout’ in 2010. The long and short of it is that most of the money Greece took in really just went to pay off French and German creditors. An IMF (International Monetary Fund) report said that if Greece undertook drastic reforms and started to grow, the deficits would be manageable.
Later, the IMF itself showed this report to be deeply flawed, and the consensus is that the Troika should have taken losses then.
What’s the Troika? This is the group of three parties that lent money to Greece — the IMF, the ECB (European Central Bank), and a third newly established fund supported by various European governments. They all bought Greek bonds and started meeting with the Greek government regularly to ensure reforms were on track.
In 2012, Greece needed another bailout. There were supposed to be some asset sales to retire some debt, but that never really happened. The IMF ended up loaning more, but without a new reform plan. The ECB continued to let banks use Greek debt as collateral.
At this time, French and German banks finished unloading their Greek debt, completing a pretty impressive stealth rescue of the largest creditors. It has to be said that Greece has achieved a pretty amazing reversal of systemic deficits in five years, despite most of the Troika’s money going to creditors.
So why all the fuss now? The Greek budget was actually finally balanced in late 2014 (not including interest payments). The economy did seem to be on the mend, despite no new growth, high taxes, and low government spending. At this point, however, the public had lost confidence and ousted the government — 25% unemployment (60% for some youth groups) for years was just too much.
You’ve probably heard of the new coalition government, Syriza, run by a guy named Alexis Tsipras. Tsipras is asking for a few things now: Higher spending, lower taxes, and some debt forgiveness. He wasn’t making a lot of progress, so he called a public referendum for today (July 6, 2015) to vote on whether Greece should accept the creditors’ new bailout package.
Creditors have a couple of objections to this plan. First, other European countries have had to undertake similar adjustments — namely Italy, Portugal, Spain, and Ireland. If it turns out electing a radical government helps Greece, voters in other countries may do the same. The money needed to save Greece is small on the European scale, but the money needed to save these other countries is not. Second, No one trusts Greece to follow through on any plans, especially after Tsipras called a referendum just to accept a continuation of prior policies. Also, the IMF and ECB now seem to believe that, unlike before, spillover from a Greek default can be managed.
Greek defaulted on the IMF, its lender of last resort, on June 30. This is the first time a developed country has defaulted on the IMF. The IMF must be repaid in order to be effective in future crises. Interestingly, Greece did make a small payment to the ECB, so they’re not in default there yet.
Still, the ECB is no longer accepting any collateral from Greek banks guaranteed by the Greek government, hence why Greek banks are now closed and daily ATM withdrawals have been capped at 60 euros. The ECB, however, has not yet recalled its loans or demanded more collateral.
So what now? Greece must either find a new lender or survive without credit for a while. Some think that Russia may enter the picture, but given its own financial woes and the fact that some of that money would likely go to other European creditors, it seems unlikely.
It is likely that Greece will stop all debt payments, attempt to balance the budget, and then issue some IOUs to cover government employees, vendors, and pensioners. These IOUs will circulate alongside the Euro, at a discount. Its unlikely that Greece would introduce its own currency, the Drachma, at least in the short term. There would likely be even less confidence in a new currency than in IOUs, and since Greece is still part of the EU, issuing a new currency would be illegal and would lead to an even quicker exit, which would mean tougher restrictions on international travel and work, new tariffs, and the like.
Some worry that the crisis may spread to other countries and lead to bank runs. The ECB can continue to lend to head off this concern, but if Greece emerges stronger in the medium term other countries may follow its path.
So that’s where we’re at. Random thoughts:
- If Greece had voted Yes today, it seems possible that the bailout talks might have been salvaged, maybe with help from the World Bank, but it might have taken a decade or more at the current pace to reverse the great depression that the Greek people have endured.
- Today’s No vote, however, makes a severe recession more likely, and it’s tough to see Syriza staying in power for too long. Greeks are, however, in charge of their own destiny.
- Recovery will probably start with a tourism uptick once travel to Greece becomes cheap.
- The IMF must be repaid before Greece can borrow from anyone, which may take years.
- The ECB can easily survive Greece, but if Italy or Spain follow suit it might have a hard time.
- The biggest conclusion is that Greece should have defaulted in 2010 and its creditors should have taken losses. Instead, moral hazard for lenders is still running rampant. The consequences of extending bad credit are supposed to fall on creditors, not debtors. That’s how you get rid of dumb money.
- Lending to nations should be thought of as equity, not debt. States can’t be liquidated, just reorganized. Greece’s lenders are acting like private creditors running a fire sale, trying to get whatever they can quickly, even with significant haircuts, instead of trying to encourage long-term growth with monetary policy, fiscal stimulus, and debt relief.
- So why are creditors behaving like this? The only answer seems to be that they’re putting on a show for other countries, trying to head off other showdowns.