Greece: the next ashes to be spread across Europe?
Talks over what should happen about the Greek debt situation were recently delayed by the impromptu eruption of the Icelandic volcano Eyjafjallajökull. In the meantime, analysts and commentators continued missing the essential problem engulfing the country. Its problem lies in the past, not the future. The seeds have been sown, and there is no way now to escape all the hardships that must be endured. While short-term relief may come, this will quickly be exhausted and leave an imbalanced situation.
Greece’s accession into the Eurozone caused an immediate reduction in the implicit risk on its government issued debt. Secured by a robust European community committed to supporting weaker members befalling hard-times, interest rates on Greek bonds were commensurately reduced.
Interest rate reductions are generally promoted endogenously through high saving rates. The exogenous support of friendly European neighbours created an atmosphere of proliferate credit expansion in the face of reliably low interest charges – charges which were not complemented by any form of spending restraint. This problem has come to the fore now as a burgeoning public sector is unable to be supported at higher interest rates, and any increase in taxes to sustain the situation will place undue pressure on an already strained (and shrinking) private sector.
The situation may well prove fatal to Greece’s economic prospects.
International hesitation at providing a bailout has created further uncertainty as to what the future holds for the country. Lacking both private and public savings to address its financial woes, any short-term relief must come from an international consortium – fellow European Union members, or the IMF.
Yet it is important to remember, as Philipp Bagus has outlined, that Greece has already been bailed out by the EU for many years. The European Central Bank (ECB) has accepted as collateral most government bonds – including Greece’s. Consequently, European banks have been purchasing Greek government bonds to pledge as collateral against loaned ECB funds at historically low interest rates. This already highly profitable deal has been magnified as the crisis continues as Greek bond yields have crept higher, making the spread relatively more profitable. This increased demand for Greek government bonds has already provided the Greeks with a bailout through artificially low interest rates.
The ECB monetizes Greek debt by printing new Euros against the collateral of the pledged Greek government bonds. This allows the government to spend beyond its means, comforted in knowing that spending shortfalls can be papered over by issuing more bonds for the ECB to monetize. Inflationary pressures originate in Greece as the new liquidity is spent, but quickly spread to other European nations. As the domestic purchasing power for Euro-using citizens decreases, there is a latent transfer of wealth to the Greek government.
The moral hazard signalled to other EU member states by a further Greek bailout would have massive ramifications. While details are still being ironed out, the Eurozone will tentatively fund the Greek government with a €30bn loan, with the IMF contributing an additional €15bn. While this package has provided some immediate calm to the markets, the long-term effects look much less positive. The reasoning can be seen in the support given to the bailout.
While Spanish and acting-EU president José Luis Rodríguez Zapatero welcomed the bailout, Germans remained much more sceptical. Spain will fund about 10 per cent of the EU’s bailout – a noble contribution. However, the precedent set will almost certainly be repaid to the Spanish government in the future. By pushing for a bailout, Spain has almost assured that European support will be forthcoming for itself when the time arises. As the 2nd largest economy of the PIIGS (Portugal, Ireland, Italy, Greece and Spain), and with an unemployment rate hovering around 20 per cent, Spain is sufficiently large, interconnected and troubled to raise the expectation that it could be the next Greece. By supporting its troubled ally today, Spain increases the odds that it will be aided in the future.
Any bailout to Greece now will do little to remove its previous excesses, and may well exacerbate the problem elsewhere in the EU.
One analyst jokingly tweeted: “It was the dying wish of Iceland’s economy to have its ashes spread across Europe.” Luckily, Greece’s own Mount Olympus is not volcanic. If continued assurances of a bailout continue, the adjustments necessary to save the Hellenic nation – less spending, lower wages and more saving – will fail to materialize. Europe may well have to contend with the financial fallout anyway.