Somewhat surprisingly, Greek Prime Minister Alexis Tsipras managed to
hammer out a deal with the leaders of the rest of the Eurozone after a 17-hour
marathon session in which there was actually a fear at one point that Tispras
had fled the proceedings. More
surprisingly, the Greek Parliament responded to the deal – which is worse than
the deal that the Greek people could have had but voted down – by approving it
by a vote of 229-64 (with 6 abstaining).
The terms of the agreement (or the few that I could very easily find)
were hardly surprising for a country in a budgetary crisis: increased revenues
and decreased expenses. In order for the
bailout package to be sent to Greece, various tax rates will have to be raised,
various tax loopholes will have to be closed, and retirement expenditures will
have to be cut through the elimination of early retirement and raising the
retirement age.
While there are still hoops to be jumped through, it appears that a
Grexit has been avoided…
-
Quick Tangent – Why do we need a catchy nickname
for everything these days? It bugs the
you-know-what out of me. I think it
started several years ago when people responded to a (relatively) mild economic
downturn by calling it the Great Recession.
I will say that it was the worst downturn the United States has had
since the Great Depression and therefore it’s almost worthy of such a nickname
but was that the best we could do? From
the Great Recession to everything ending in –gate to #Grexit, we search far too
much for something to fill up a hashtag so we might be able to someday say that
something we said is trending… and I think it’s stupid. Rant over.
My goal here is to examine what happened, why it happened, who came out
ahead, and who didn’t (spoiler alert: Greece) and I’ll try to put it all in
context for you based on what I know about the global economy.
GROSS DOMESTIC PRODUCT
Yep, we’re going to start there.
I always start with GDP because when you peel back the first layer of an
economic situation, it’s the first thing you see. It can be good or bad or “meh” but
diagnostically, it’s a good place to start.
Slightly more specifically, it’s the change in GDP that we’re more
concerned about. If I say that the
United States produced $17.4 trillion in inflation-adjusted goods and services
in 2014, that doesn’t tell you very much.
However, if I were to tell you that the world produced $75.8 trillion in
that same year and since 2003, the US GDP has grown between 1.66% and 6.67%
(with one exception) and 2014 fit that pattern (3.88% higher than 2013) it
paints the picture of a healthy economy.
Yes, despite what anyone is telling you heading into the 2016 election
cycle, the US economy is healthy.
Moving on.
Sorry, I lied. Before I move on,
a quick note. The European Union consists
of 28 countries but for this analysis, we’re more concerned with the Eurozone
which is comprised of 19 countries that all use the Euro as their
currency. They are, in very particular
(alphabetical) order:
Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece,
Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands,
Portugal, Slovakia, Slovenia, and Spain.
When you look at the same picture for Greece, it doesn’t look quite so
rosy.
While the entire Eurozone took a hit from 2008-2010 (like the rest of
the world did), it managed to recover to some extent and stabilize their
GDP. Greece, on the other hand, peaked
in 2008 and has dropped 33% from then until 2014 and that doesn’t even include
any inevitable drops that have happened in the past year or so.
Unfortunately, as we peel back the layers, the picture only gets
worse. If you plot their GDP from
2002-2012 (no debt data was available for 2013 or 2014) and compare it to their
total debt, it looks like this:
Compared to their GDP, Greece’s debt reached 164% a full three years
ago and again, the picture hasn’t gotten any better in the past several years.
This is where we separate a little bit from the numbers and go to a
place where economists (including me) would rather us not go. The truth of the matter is that economics is
based on many things that are concrete (or “scientific” if you prefer) but the
most accurate definition of economics that I’ve ever heard starts like this:
“The science of human behavior…”
Human behavior is only so scientific and it’s one of the reasons why
assertions from economists come with a laundry list of assumptions. This isn’t to say that these are bad
assumptions but they do exist.
There are countries in the world with worse debt/GDP ratios and all
we’re talking about is Greece. What
gives? Why is the debt in the US which
is about 40 times larger than Greece’s so much more viable? In many ways, the answer is simple; investors
trust the US (a lot) more than Greece.
DEBT… HOW MUCH IS TOO MUCH?
When a country spends more money than it raises in taxes, it must
borrow the money to make up the difference.
In a (mostly) free market global economy, that means that the United
States is going to the same place as Valero or Microsoft do when they need to
raise money. If we assume that there are
a finite number of dollars (or any other unit of currency you prefer), then
that means that private companies have to compete for investment dollars with
governments and in fact, this is exactly the case.
This is where the term “crowding out” comes from. If the government runs a budget deficit, they
are taking up dollars that could go to capital investment in the private
sector. Overall, not a great thing. While deficit spending isn’t the worst thing
in the world, doing so year after year can be a very bad thing because of all
those dollars that could be going to the private sector where they know how to
spend a dollar efficiently. I may
identify myself as a Democrat, but when I look at the ledger of the US for the
past six or seven years, the economist in me cringes.
Ok, private companies don’t get the investment dollars they should, so
what? When a company or a country goes
to the market and borrows those dollars, people do not give them the money out
of the goodness of their hearts; they expect a return. As is often the case, the return on these
investments is inversely proportional to the quality of the investment. While this may not make sense, it comes down
to supply and demand (doesn’t it always in economics?). Let’s say you are the US government and you
need to borrow some money to cover your indulgent spending. Given the fundamentals of your economy, lenders
are tripping over themselves to lend you money and this drives down the
interest rate that you’ll have to pay on the loan. Meanwhile, in Greece, far fewer people want
to loan you money since it’s riskier.
Sure enough, if we look at the rates that you could get for investing
in Greek or American government debt over the past year or so, you’ll see
exactly that difference. The rate on a
10-year piece of debt in this country has been between 1.7% and 2.6% while in
Greece, it spiked up to just over 19% before settling lower in the past few
days. The lowest rate on Greek debt was
nearly a year ago when it was just under 6% and it’s only climbed since then.
OK, WE’VE GOT THE BACKGROUND NOW…
The best analogy that I can come up with at this point is that of a
mortgage. You go to a lender and come up
with a loan and a payment plan for your house.
The payments are monthly and are based on the interest rate which is
based (in part) on your asset and income situation and your credit score. You, as the homebuyer (or as the country in
this little metaphor) have an income that is in excess of your required monthly
payments so you go about your business normally. In this scenario, for curious reasons, your
credit card debt gets added to your mortgage every month. While you have enough to cover the mortgage
payment on your income, when you add the credit card expenses, now you’re
spending a bit too much money and have to go borrow more money (see where this
is going?). As you borrow more and more
money, the interest rates keep going up and therefore the monthly payments keep
going up. In the middle of all this, you
lost your job and had to find another one that paid about 85 cents on the
dollar.
Left unchecked, this is the problem with large enough government
debt. We’ve become basically numb to the
fact but it is a fact that if debt and interest rates get high enough, the
payments that are due exceed a country’s ability to pay them. When you combine the fact that Greece is not
an economic powerhouse that produces huge quantities of goods that everyone wants
with their increasing debt and then you throw a global economic downturn into
the mix, you get to the point where they literally cannot pay their bills and
then default on their loans. This hasn’t
actually happened yet but it is a very real possibility.
AREN’T THEY A MEMBER IN A MULTI-NATIONAL ECONOMIC UNION OF SOME SORT?
Why yes, they are, fantastic question!
However, that union exists between 19 different countries with 19
different sets of laws and sets of fiscal policy and national income profiles. That’s where the rubber hits the road. Greece has largely said through this that
they want an infusion of capital (give us money!) with no strings attached. Other countries with the ability to transfer
this capital on short notice (*cough, cough*, *Germany*) have balked at bailing
out Greece unless the loans are tied to fiscal reform in Greece. In other words, Germany is saying something
to this effect: “Why should we pay your
credit card bill when we know how to balance our checkbook and you don’t?”
So far, Greece hasn’t come up with any sort of a good answer although
they did bring up the fact that they once were invaded and ruled by Germany and
that they didn’t want to do that again… yes, they compared Chancellor Angela
Merkel and the rest of Germany to Hitler and the Nazis.
A few years ago, Greece elected a number of officials that saw that
they would have to seriously reform their spending habits and their tax laws in
order to remain solvent as a country… and their measures, which might have turned
around the Greek economy over time, were so popular that they were booted out
of office in favor of a group of officials that seem to be flipping the bird to
the rest of the Eurozone while asking for a blank check at the same time.
All of this posturing left Greece and the rest of the Eurozone with two
options; bailout or (<sigh> I can’t avoid it> #Grexit. Either some deal would be struck or Greece
would have left/been forced out of the Eurozone and would have had to start
printing their own currency. Given the
possible ramifications if Greece had indeed left the Eurozone, it’s likely for
the very, very best that a deal was struck (even as tentative as it is right
now).
WHAT WOULD HAVE HAPPENED IF THEY LEFT?
This is entirely supposition but my guess is without an infusion of
capital from other countries, Greece would have gone into a depression that
would have lasted more than a decade.
The first thing they would likely have done is defaulted on their loans,
attempting to wipe their debt off the books.
That means that somewhere between 300 million and 400 million Euros that
were owed to other countries and organizations would have evaporated. Not a great first step when it comes to your
newfound economic independence.
Greece would have started printing their own currency but how can
creditors take their currency seriously when they have shown little political
will to build a viable economy? Interest
rates on Greek debt would have skyrocketed; it would likely be nearly
impossible for Greece to borrow any money until they can prove that they can
balance their checkbook. On top of that,
their population base would flee to greener pastures (as has already happened
to some of their educational elite over the past few years) and there would be
nobody left to help build that economy.
Couldn’t they just print more money?
Go Google “hyperinflation” and then get back to me.
This is definitely the worst case scenario but I find it thoroughly
plausible and apparently, Prime Minister Tsipras thought so as well given that
he agreed to draconian terms to get this deal done with the Eurozone. The single greatest cause for concern moving
forward is that the Greek people vote the government out of office in favor of
a further left-wing party that essentially reneges on this deal and puts them
back on the brink. If they go through,
these austerity measures will be painful for Greece but I have a hard time
feeling too sorry for them considering how long this has been looming. Before you accuse me of being an elitist
American snob, I will say the exact same thing if someday, we are being given
unfavorable terms by our creditors.
Right now it may be farfetched but it’s not too farfetched to completely
dismiss the possibility.
IF GREECE IS SUCH AN ECONOMIC DRAG, WHY DOES THE EUROZONE WANT THEM TO
STAY?
There are two main reasons for keeping them in the fold and (more or
less) forcing them to accept these sorts of terms. First of all, if Greece leaves the Eurozone
and defaults on their loans, the odds are good that the Eurozone will get back
pennies on the dollar for the money that is owed to them. Secondly, there was some speculation that
there was some uneasiness within the Eurozone about Greece breaking away and
doing well, free from the crippling burden of being in debt past your eyeballs
to your neighbors.
Why should that matter? Because
the situation in other countries, specifically Ireland, Portugal, and Italy,
aren’t that much better than it is in Greece right now. If Greece broke away and was somewhat viable,
it might encourage those countries to hold out for better terms from Berlin or
they might also try going out on their own.
Personally, I don’t think this likelihood was very high but in holding
their ground, Germany and Greece’s other creditors have sent a loud and clear
message across the Eurozone; shape up or else… you need us more than we need
you.
WHAT ARE THE NEXT STEPS?
Phenomenally, it sounds like the bailout package will help Greece get
by and pay their bills for the next three years which means that they have that
long to seriously overhaul their entire economy or face this exact same
situation (though probably worse) in a few years. Greece came out of this the biggest loser by
far simply because as I understand it, there was no debt relief in this
deal. They are not getting off easily by
any stretch of the imagination.
The wildcard in all this is the Greek people. Twelve day ago, they collectively flipped the
bird at the rest of the Eurozone by voting down austerity measures as part of a
bailout plan (actually, only 61% of Greeks flipped the bird… 39% voted for the
measures). I’m assuming they thought
that confronted with that overwhelming display of solidarity, their creditors
were going to fall over and give up the fight and forgive the debt (or at least
give them the bailout with no strings attached). To say they overplayed their hand is a gross
understatement. Germany and the other
creditors moved the other way, further away from the compromise that had been
on the table, realizing correctly that they had the (infinitely) stronger
negotiating position.
How are the people of Greece going to react? Are they going to realize their mistake and
accept this bitter pill? Are they going
to burn Tsipras in effigy and throw the government out in favor of one that
will ignore this deal?
The most exciting part of this saga for me is that these are the types
of situations that economists can’t cook up in a lab to study (apparently it
would be “unethical” or something). What
would happen if Greece split off? Would
their economy truly reach rock bottom or would another country pounce on their
desperation and more or less annex the country (I’m looking at you, Putin)? How many more times can Merkel be compared to
the Nazi Party before all is said and done?
These are difficult questions to answer in normal, everyday life but
this situation allows the possibility of finally getting answers.
PREDICTIONS?
One of two things will happen, in my opinion. Either this will end very anti-climactically
and Greece will agree to the austerity measures and the Eurozone will stay
together (boring… good odds) or the Greek government will become the former
Greek government and Greece will truly crash in a way that makes the past few
years look like a cakewalk.
My bet is the former…
