The eurozone is in serious trouble and Greece is just a symptom. Whether or not they default on their debt may not matter as similar problems plague Spain, Ireland, Portugal, and even Italy. The European Monetary Union is built on a house of cards and they don’t have the time for needed radical reforms. Like all sovereigns who owe more than they can pay, they will resort to monetary inflation to bail themselves out. This article explains how the EMU works, why it is failing, and why they will resort to fiat money printing to solve it. This is Part I. For Part II, go here.
It may not matter if Greece is bailed out by the powerful EU economies because they are just one of many problems that the eurozone faces. While George Papandreou’s socialist government survived a no confidence vote, they are just postponing the inevitable. For while Greece may be temporarily propped up with loans, it is likely that they will ultimately default on the massive loans the EU and IMF have poured into it. This may have the unfortunate consequence of spilling over to the other PIIGS and jeopardize the entire eurozone.
The basic problem that the eurozone faces is the unworkability of the monetary system envisioned by the European Monetary Union (EMU). They are now paying the penalty of having a central bank that is subject to political pressures. Make no mistake: the purpose of the EMU was political more than economic, created to foster further political integration of the EU. Looking back on this faulty system the economically powerful countries perhaps regret having given up their monetary independence. It will be they who will pay for it.
The end result of this faulty system, the PIIGS’ (Portugal, Ireland, Italy, Greece, and Spain) deficit spending, will result in the euro’s devaluation against other currencies, including the dollar. While the printers of dollars have nothing to brag about, the U.S. has the benefit of being the world’s reserve currency and having a semi-capitalist country that is still the most powerful economy in the world. The Europeans have not integrated as well as we, and have not achieved that monetary status. With all our faults, the U.S. and its Treasury bonds are still the preferred port in a storm.
What the EMU has created is a Europe loaded up with debt financed by a banking system that has been given almost unlimited credit by the European Central Bank (ECB).
The worst part of the system is that it has given profligate countries an almost blank check to spend. To use an analogy, it is as if the Fed were to bail out all the U.S. states that have spent too much. Greece came into the EU as a corrupt socialist country with a huge bureaucracy and a moribund economy. Their political system, as we can see from the protests and riots, caters to a large public sector that keep voting in politicians who will support their lifestyles. They don’t care who pays for their benefits as long as it isn’t they.
Contrast this with a well run fellow EMU country, Germany, with a large and productive private sector whose sovereign debt is relatively modest in relation to its GDP:
The socialist PASOK party run by Mr. Papandreou and his father and grandfather before him, ran a political model familiar to Americans: an expanded central government, a public sector that consists of about 40% of the economy, a perpetual majority in parliament that serves their bureaucrat voters, a decline in the economy, massive corruption and tax cheating, and deficit spending to pay for the benefits. Greece ranks 37th out of 43 countries in Europe in terms of economic freedom. They have run up about €360 billion in debt ($518 billion).
To put Greece in perspective, at about 11 million people they are comparable to Ohio, but with a GDP of about $330 billion they are smaller than Ohio (GDP of about $480 billion). Ohio’s local and state governments spend about $106 billion per year. Greece spends $152 billion, but it has been running a deficit equal to 10% of GDP (down from 15% in 2009).
Now Greece needs another €100 billion or so on top of €110 already pledged to them by the EU.
This need for a new bailout was a bit of a surprise to many European observers. They didn’t count on the intransigence of the socialists and their rather half-hearted attempts at budget cutting. They didn’t count on the stagnation of the Greek economy which would further diminish government revenues. They didn’t count on the backlash of Greek citizens who are famous for their inventiveness at evading taxes.
The big question about Greece is whether or not they can repay their massive debt even with bailouts.
“Euro-zone governments are still pretending that they are dealing only with a liquidity problem, and that Greece and Ireland will emerge creditworthy from their programs,” says Thomas Mayer, chief economist at Deutsche Bank in Frankfurt.
“But what happens if these countries can’t return to the capital markets? If more austerity programs are needed, will voters rebel? The message is missing that a country that can’t pay its debts must restructure,” Mr. Mayer says.
While he survived his no-confidence vote, Mr. Papendreou has to convince his party members to make €28 billion more in budget cuts by July 3 or the next installment of the May 2010 bailout money (€12 billion) will be held up.
The market is betting that Greece will default. Insurance on their debt has gone up more than 47 basis points. Here is the chart on credit default swaps for Greek bonds:
The picture for Greece is grim:
Young people are still the hardest hit by Greece’s deepening economic woes, with 42.5% of those between ages 15 and 24 without jobs in March—a sharp increase from 29.8% a year earlier.
The decline in industrial output accelerated in April, falling 11% from the year-earlier level after an 8% drop in March.
Greece has promised the EU and IMF that it will implement €28 billion in fresh spending cuts and new taxes to bring the country’s budget deficit below 1% of gross domestic product by 2015, down from 10.5% last year.
Although the final details have yet to be announced, the government is considering several highly unpopular measures, such as new taxes on the poor, an extraordinary 3% levy on all Greek wage earners, new property taxes and cuts in retirement bonuses.
Spending cuts include deep cutbacks in welfare payments and possibly even layoffs in Greece’s long-cosseted public sector.
On June 5, 2011 some 100,000 people gathered in front of parliament to protest spending cuts and reforms:
Protesters and even rioters appear every day to confront parliament. This environment will make it very difficult for the Papandreou government to survive to the end of the year.
For Part II, go here.