(the first Audrey Prouty Challenge Event benefitting Dartmouth-Hitchcock Norris Cotton Cancer Center)
Over the last 60 years Greece has become one of the most developed and prosperous countries in the world, ranking 23rd in the world in per capita GDP in 2010, and enjoying a UN ranking in Human Development of 22nd, above Italy the UK and Austria. Greece built this bit minor economic miracle since WW II largely on services (78.5% of GDP) rising from the ranks of a subsistence agricultural economy to a full member of the EU in 2000. Greece funded this growth largely through debt – quite an achievement for a country with a long and uniquely troubled credit history.
Greece has been in default or in restructuring 50.6 % of the time since its independence in 1829, with 5 separate episodes of default. This is a record among all countries in the World – nobody else even comes close.
Greece has been in trouble with its EU partners from the very beginning of their relationship, with pretty clear evidence of accounting irregularities associated with its original admission documents in 2000. In one particularly notorious episode in the last decade, the Greek Government teamed up with Goldman Sachs to use derivatives to “hide” $1 billion in borrowings. While the amount was not material relative to its current debt of $469.8B (142.8% of GDP), it sure set a bad precedent.
Government regularly constitutes over 40% of GDP in Greece, versus 20-24% in the US, creating an insatiable appetite for debt, and an unparalleled font of corruption. Beginning with its admission to the EU, Greece substantially increased its total debt and annual average budget deficit rising to 7.2% of GDP from 2001 to 2010 – the highest among comparable countries and double pre-admission levels.
Beginning in 2009 the Greek government officially declared itself to be in recession, and reclassification of a number of Government accounts (shifting accounts from expense to capital a la WorldCom) led to a fiscal crisis and the need for emergency funds to meet demands on existing and required additional external and internal debt. In short – it hit the fan.
The response from the EU members has been a series of additional emergency loans in exchange for an increasingly painful set of austerity packages, cutting government expenses and raising taxes. Greeks have a fairly difficult problem in collecting taxes, with the worst record in the EU. Recently, the Greek government put a property tax on electric bills in the hope of raising 4 B Euros per annum – with the theory that people will always pay their electric bills rather than lose power. Personally, I expect a run on generators in Greece.
A steady increase in GDP, but a spike in Debt after admission to the EU
Odious Debt is the concept by which governments legally repudiate debt incurred by predecessor governments, and declare the former debt to be null and void because it was incurred for fraudulent and/or criminal purposes. The concept was first proposed by the Russian émigré economist Alexander Nehum Sack in 1927, while the Soviet Union was actively repudiating Tsarist debt, and generating its own. There has been a lot of discussion about odious versus Illegitimate debt (the latter being of more benign origin), but I regard it as a distinction without a difference.
This concept has been invoked repeatedly, and with good reason in Latin America, where kleptocratic regimes incur large amounts of sovereign debt and the leaders then flee the country, with the proceeds secure in some offshore account (See Ecuador Climbing, a Primer, July 24, 2011). Odious debt is a concept of lender culpability for the fraudulent incurrence of debt by a sovereign state, and the economic powerhouses of the EU need to be very careful of this in the case of Greece.
Greece is not a kleptocracy in a Latin American sense, but its entry into the EU was shrouded in allegations of fraud, its financial reporting has been inaccurate for years and corruption is rife throughout its economic/governmental system. The current government is doing its best to comply with its foreign obligations, but popular unrest threatens the feasibility of any externally imposed austerity programs. Given the scale of the fiscal deficits, the total debt burden and the economic contraction that such austerity programs will mean for Greece, servicing its existing debt will be impossible. This is clearly a case of caveat creditor.
Confrontation in the streets is only one election away from confrontation in government suites. A new Greek government may find itself in a position of surprising power if it forces the EU and IMF to defend themselves for their actions to date. A new broom sweeps clean, and there are a large number of economic dust bunnies in the corners of the IMF’s closet that are better left in the dark. Remember, Dominique Strauss-Kahn used to run the place.
The long-term reduction in interest rates worldwide over the last 25 years has dramatically reduced the cost of debt to governmental borrowers, thereby inducing them to borrow yet more. This has worked beautifully as a basis for building a doomsday debt machine in Greece, Japan and possibly the United States. As long as rates are low, and creditors are liquid and can/will roll the debt, the machine works perfectly. When rates run up, or creditors balk – watch out.
Creditors always demand increased interest rates to compensate for increased credit risk, frequently resulting in a downward spiral in the ability to service total debt as interest charges increase. Consider that Greece was borrowing at rates of 1.78% two years ago. Applying that interest rate to its total debt today would produce a total annual charge of around $8.4 B, or 6.9% of government revenue – a perfectly manageable level of debt service. Due to credit downgrades and declining creditor appetite, interest rates today are over 26%, and if applied to outstanding indebtedness would total over $125 B, or 103% of government revenue – simply an impossible level.
Interest rate increases have made the existing debt burden intolerable
My wife was taking a look at this article from an editorial point of view, looked up at me and asked, “How does this end?” That was it- instantly I was frozen in my tracks. The question was both about the blog piece and the underlying problem, and answering it was a lot more than I planned to bite off here. After a week or so of acute writers block, I’ll take a stab at answering the question with what will certainly happen – a Greek default – and what should happen in response within the Monetary Union.
The EU has to be able to deal easily with defaults and restructurings of member states. This is a reality of the next 10-15 years, and we’re just going to have to get used to it. The concept that counties such as Greece, which has spent over half of the last two centuries in default, will become stellar credits and never suffer political and economic upheaval is simply idiotic. In the US we are faced with the same issues as a number of States, led by California, have come ever closer to the need for debt restructuring, and there is no legal framework for doing so other than voluntary creditor participation – not a happy prospect.
Instead of trying to prevent the default of Greece, the ECB should be directing and controlling the restructuring of Greece’s external debts, much as Secretary Brady did with the famous Brady Bond format for the restructuring of Latin American debt in the 1990’s. If the ECB fights this to the bitter end, and loses, it will throw into question all of the other marginal credits in the EU, particularly Italy, Spain and Ireland, and will have no credibility or resources to forestall a massive bout of short selling of bonds and stocks of those countries. Worse still, the G20 developed no real solution to the potential fiasco related to credit derivatives, which create a minefield of unknown risks in balance sheets of the world’s major banks in this scenario.
The response of the ECB must be economically viable and politically realistic. Its response to date has been neither. Greece needs to lower its total debt, pay a higher interest rate, and start growing again. If the ECB and its affiliates force a long term austerity program into the current Greek political environment, they will shortly thereafter face a new government, debt repudiation, the exit of a member state, and a potential financial collapse rippling through the Southern Tier of Member States – not a pretty picture. Just remember, any country –like Greece – that spent half of the last 200 years in default has gotten pretty good at it, and doesn’t mind it at all.
This blog is sourced from a large number of public sources, but I’d like to give special acknowledgement to Carmen M. Reinhart and Kenneth S. Rogoff for their excellent book, This Time is Different, Eight Centuries of Financial Folly.