Nov 13 2011

Explainer: The Greek Economy – Better Value Elsewhere

Ernie Morcombe: I Say, I Say, I Say, What’s a Grecian Urn?

Eric Wise : Oh, about 3 Drachmas a week?

The Greek Government has been spending more than it earns for many years, particularly since the rapid expansion after it entered the Eurozone in 2001. 

“Public spending soared and public sector wages practically doubled in the past decade. It has more than 340bn euros of debt – for a country of 11 million people, about 31,000 euros per person.” [BBC News]

It has an economy based on tourism (the service sector is 79% of the economy) and shipping. The international downturn has hit Greek income particularly hard. And it appears that paying tax has always been ‘optional’ in Greece – tax evasion is estimated to cost the government $20 billion a year.

[Greek Government Debt Crisis]

Of course, its not unusual for governments to run up deficits.The Greek government has been borrowing particularly heavily, and public debt now stands at about 150% of GDP. (Australia is about 20%, USA about 94%, Italy about 120%).

[List of Soverign States by Public Debt]

Governments borrow money by issuing bonds. You can purchase a bond from a government for a fixed period (Say, $1000 over 5 years at 4%). You receive your interest payment (of $40) each year, and get your $1000 back when the bond ‘matures’ at the end of the 5 years.

Twice the Greek government has not had enough money to pay back maturing bonds, and has twice been ‘bailed out’  through the purchase of more bonds by other European nations (particularly Germany and France)  – to the value of €100 billion each time . The money from this has largely been used to pay the interest owed, as well as paying back the maturing bonds.

One of the strange things about this is that Greek owes most of it debt to the European banks, which are the same banks that are loaning it more money – so that Greece can pay them back.

If sounds a bit like paying off your credit card with the same credit card – a good gig if you can get it. Some say that buying greek bonds is the same as investing in a Ponzi Scheme.

The situation is somewhat similar to this story.

A rich German tourist is driving through a small Greek town.

He stops at the local hotel and lays a €100 note on the desk, telling the hotel owner he wants to inspect the rooms upstairs in order to pick one to spend the night.

The owner gives him some keys and, as soon as the visitor has walked upstairs, the hotelier grabs the €100 note and runs next door to pay his debt to the butcher. The butcher takes the €100 note and runs down the street to repay his debt to the pig farmer. The pig farmer takes the €100 note and heads off to pay his bill at the supplier of feed and fuel. The guy at the Farmers’ Co-op takes the €100 note and runs to pay his drinks bill at the pub. The publican slips the money along to the local prostitute drinking at the bar, who has also been facing hard times and has had to offer him “services” on credit. The hooker then rushes to the hotel and pays off her room bill to the hotel owner with the €100 note. The hotel proprietor then places the €100 note back on the counter so the rich traveler will not suspect anything. At that moment the traveler comes down the stairs, picks up the €100 note, states that the rooms are not satisfactory, pockets the money, and leaves town.

No one produced anything. No one earned anything. However, the whole town is now out of debt and looking to the future with a lot more optimism.

Because of the increased risk of loaning money to a county in trouble, the interest rate Greece has to offer to encourage people to buy their bonds is going up – 2 year bonds are now available at an interest rate of 23%!

Greece cannot just devalue its currency or ‘print more money’ to pay back the bonds, as has been done in the US and elsewhere, because it does not control the Euro. (The technical term is Quantitative easing) For example, the U.S. Federal Reserve expanded its balance sheet by over $1.3 trillion USD since the global financial crisis began, essentially printing new money and injecting it into the system by purchasing outstanding debt.

As always, John Clarke and Bruce Dawe offer the best explanations of the Greek Situation and the European Currency Crisis.

“Lets face it, they have some very serious structural problems with the Greek economy”

“They’re broke”

“They would be if things improved out of sight”

And the rest of Europe?

“How can broke economies lend money to other broke economies who haven’t got any money because they can’t pay back the money the broke economy lent to the other broke economy and shouldn’t have lent it to them in the first place because the broke economy can’t pay it back?”