The Problem with Greece
February 14, 2010
There's this dinky little country in the "where's that?" region of the
eastern Mediterranean -- south of Albania and Macedonia, and west of
Turkey. The population is 10 million, a little less than Los Angeles
(13m). Greece has a debt/GDP of 107%, and a budget deficit of about 13%
of GDP. Figures not too far off from the United States, actually. The
basic problem with the Greek government, and practically all
governments today -- just look at what has been going on in California
or Illinois -- is that they are politically incapabable of reducing
their deficits without some sort of default process. The lenders have
to say "no more." These governments aren't going to cut themselves off.
Even if the politicians tried, they would be faced (and are faced) with
pressure from entrenched interest groups, whether in the form of
striking public employees, government departments that don't want their
budgets cut, pork recipients who don't want to be cut off, and the
beneficiaries of various government programs.
Without outside support (a "bailout"), Greece would probably now find
it difficult to impossible to issue debt. If it did issue debt, it
would be at yields and maturities (high, short) that would likely force
a default in the near future. If the government is unable to issue new
debt, then it will be unable to pay maturing debt. They kicked the can
until they ran out of road.
So what? What would happen next is that the government's checking
account would finally run out. This would, unfortunately, be rather
shocking, but politcians are not much for subtle hints.
First, the debt itself. Contrary to popular belief, debt doesn't go to
zero just because someone misses a payment. All kinds of things could
happen. The existing debt could be paid at a later date, or at a
reduced rate of interest. It could even be paid in full, after a brief
payment delay. (I think the Russian debt was paid in full following the
Russian default in 1998.) The debt would immediately trade on the
market at a price reflecting the likelihood of future payment, full or
partial, and the potential timing of those future payments, discounted
to the present. I would guess this would be around €0.80 to begin with.
So, holders of Greek government debt might take an immediate €0.20
loss. OK, so what. Anyone who owns that debt today, after all that has
happened thus far, is not exactly unaware of the risks.
How about in Greece itself? The government would have to balance its
budget. How horrible is that? This might not be so hard as it sounds,
because the country won't be making payments on the existing debt, at
least for a while. If debt/GDP is 107%, and the average coupon on the
existing debt is 5%, then you'd be saving about 5.35% of GDP right
there, at least in terms of cashflow. Then, of course, all the various
parasitic hangers-on (unions, pork recipients) would -- I hope -- get
kicked off the gravy train. Basic government services would likely
continue. Government employees aren't going to stop showing up for
work. They know better than that. (In California, most government
employees showed up for work on their unpaid "furlough" days.)
Contrary to popular belief, a government doesn't just go poof because
there's a default. Just like a company doesn't disappear when they go
bankrupt. The U.S. airlines have spent probably half of the last 20
years in bankruptcy, but the planes still fly. However, while a company
can certainly be liquidated, nobody is going to liquidate a government.
The main practical effect is that the government won't be able to
borrow, and also won't make debt payments -- two things which,
arguably, might be good.
Apparently, Greece has been in some form of default for 105 of the past 200 years! They are no strangers to this process.
The next thing that would likely happen is that other at-risk
governments (Portugal, Spain, Ireland, possibly Italy) would also have
a funding crisis. This is not really because of "contagion."
"Contagion" is a metaphor.
The metaphor is of an infectious disease. It's not as if Greece was
"healthy" and then became "sick" through no fault of its own. Nor is Spain is "healthy" right now.
Government bureaucrats (and their pet economists) love these sorts of
metaphors because it helps them avoid blame. Spain and Greece have been
chronically ill for years, because of their own internal decisions.
What would really happen is that the problems that both have finally
got too big to ignore. A better metaphor would be a non-infectious disease.
Like gross obesity combined with diabetes, caused by a constant diet of
Doritos and Red Bull. Both Spain and Greece are in the "too far gone to
save" ward of the local hospital, weighing 450 lbs each and unable to
get out of bed. Then, one week, they both died. Big surprise.
Let's just assume that all of these countries go into default,
including Italy. We would have a similar sort of dynamic, although on a
larger scale. So what?
The main fear here is that something would happen to the euro.
Presumably, it would go down. Why? Here's the crux of the matter: because the ECB doesn't know how to properly manage its currency. What
should be the simple cause-and-effect of capitalism -- rotten
governments have to shape up, holders of their debt get smacked around
too, and maybe everyone learns a little lesson as a result -- becomes a
currency issue, when it shouldn't be.
Why should a default by Greece on its euro-denominated debt cause a
problem with the euro? Russia (population 142 million) and Brazil
(population 192 million) defaulted on their dollar-denominated debt in
1998 and ... nothing happened to the dollar. Argentina (population 40
million) defaulted on its dollar debt in 2002, and Turkey (population
73 million) defaulted in 2001. Mexico would have defaulted in 1995, if
not for a U.S. bailout. Dollarized Ecuador (population 13 million)
defaulted in 2008. Practically all the Latin American countries default
on their dollar-denominated debt about once a generation. It's a common
Indeed, the best thing is usually for these governments to just default
fair-and-square, and avoid any entanglement with the bloodsucking IMF.
The U.S. dollar didn't have much problem during these past episodes of
governments defaulting on dollar-denominated debt. But, let's say there
is indeed a bit more turmoil for the euro. This is the point where the
ECB would have to bring a little bit of managerial expertise to the
table -- by reducing the euro monetary base in unsterilized intervention (or
actually by any means) in response to declining demand for euros, if
that materializes. Unfortunately, the ECB doesn't have any expertise to
bring to the table. They are incompetents. You can see the problem.
People have the impression -- from many bad experiences in the past --
that a government default causes all sorts of economic problems. But
why should this be? Let's say you own a little resort down by the beach
in the Greek Isles. The sun is still there. The beach is still there. The pretty girls keep
showing up. Your hotel hasn't fallen down. Pasty-white office workers
from Britain and Sweden are still willing to visit for their week off.
Why do you care whether or not the government made the payments on some
of its debt? Does it matter?
It shouldn't matter. But, it often does, because government defaults are often accompanied by:
1) Currency turmoil. However, since Greece uses the euro, this shouldn't be a problem unless the ECB screws up.
2) Higher taxes, fees,
appropriation of property etc. Governments often go completely insane
when they have money problems, and start grabbing all the wealth they
can lay their hands on. Tough going if you are a private businessman.
Ideally, Greece would not raise taxes, but rather lower them.
If Greece sticks with the Magic Formula -- even in a default! -- the effect on the private economy would be minimized.
Thus, the best solution for Greece and the rest of euroland, in my opinion is:
1) The ECB should properly manage the euro via the adjustment of base money supply so that there is no unwanted currency turmoil.
2) Germany etc. tell Greece that they have to bear the effects of their prior decisions. Greece defaults.
3) Greece then cleans up their
internal finances and politics. Maybe they could ban the government
from issuing debt, as the Japanese government did in 1950.
4) Then, Greece adopts a flat-tax system to ramp up the economy.
5) The combination of a
relatively stable currency (euro) and a flat tax system makes Greece a
"tiger economy" for the next twenty years. Remember our Magic Formula: Low Taxes, Stable Money.
You probably think that #4 is sort of unlikely, right? Remember, it's what Russia did right after their 1998 default. It's
only unlikely because you think it's unlikely. Russians didn't see it
that way. They thought it was necessary. Indeed, you could even say
that they needed to default
to finally get to the point where they were ready to say: "We're not
going to put up with this crap anymore. We're Russians! We deserve
better!" When they got to that point, it was very clear to them that a
13% flat tax was necessary.
This is more-or-less the way that capitalism is supposed to work.
"Capitalism" is a system.
is not "whatever happens happens." It is not "we blew stuff up with our
incompetence." It is not "we stole a bunch of money from the
government/taxpayer, and whaddya gonna do about it?" It is not the lack
of a system, or chaos. The system of capitalism depends on a stable currency, taxes low enough that people can prosper, and failure where it is due.
* * *
Unfortunately, a lot of people today just don't get the idea of the euro. This includes the eurozone leaders themselves.
The notion that every country should have its own currency -- the
Keynesian paradigm of "currency management" -- still hangs heavy in the
air. This is particularly true among English-speaking people. There is
a lot of talk now that Greece should be "kicked out of the eurozone,"
or that Greece should voluntarily withdraw from the eurozone and issue
its own currency, which presumably floats. All of this seems rather
bizarre to me.
Why is it that Greece somehow needs its own currency, when Illinois (population 13 million) does not? There is no reason.
Just imagine if Illinois had its own currency, managed by its own
central bank. There is a foreign exchange market between the Illinois
peso and the U.S. dollar. Everyone in Illinois gets paid in the
Illinois peso. Companies there have peso-denominated accounting. To do
business with entities outside of Illinois, they have to go to the
foreign exchange market. Anyone who wants to borrow or lend to entities
outside of Illinois faces all sorts of forex difficulties. Of course,
there are occasional "currency crises" because both the peso and the
dollar are mismanaged by their respective central banking incompetents.
We can easily imagine all the completely stupid, unnecessary problems
this would create. This is roughly what Europe looked like before 2000.
There were so many stupid, unnecessary problems that they all agreed to
use a currency issued by the ECB, which is to say, the Germans, who are
(relatively) good at managing currencies.
Less incompetent, anyway.
European countries used to get by -- in 1910 for example, or 1960 -- with their own currencies because they were all pegged to gold. Thus,
their exchange rates didn't fluctuate. You could say they were all
actually using the same currency, gold. The euro is really a return to
the normal European way of doing things, which is to have a single
monetary standard (gold or euro) in use continent-wide. It's so hard to
do business otherwise.
A few countries understand the problems of having their own floating,
mismanaged currency, and have adopted the dollar or the euro
unilaterally, without being part of the eurozone or United States. For
Ecuador, El Salvador, Panama, East Timor, the British Virgin Islands,
the Marshall Islands, the Federated States of Micronesia, Palau, and
Turks and Caicos all use U.S. dollars as local currency. There is no
In several countries, dollars circulate as a de facto
local currency, although there is no official dollarization policy.
This includes Peru, Uruguay and Cambodia. You can buy things and get
change in dollars, just as if you were in San Diego.
A number of other countries use dollar pegs, including China, Hong
Kong, Malaysia, Kuwait, Syria, certain Gulf states, Lebanon, and a few
Kosovo, Monaco, Andorra, San Marina, Vatican City and Montenegro use
euros, although they are not part of the eurozone. Plus, there are
another 23 countries and territories (mostly in Africa) which use a
currency pegged to the euro.
Liechenstein uses the Swiss franc. Bhutan uses the Indian rupee. Tuvalu
uses the Australian dollar and Niue uses the New Zealand dollar.
Let's imagine what might happen if Greece were "kicked out of the
eurozone," presumably against their will by irate Germans. Would the
government then issue their own currency? They might, or they might
not. Maybe they would just let Greeks use the euro, as they have
becomed accustomed to. The Germans might complain: "No, you can't use
the euro! That's our currency!" So what. Greece is no longer part of
the eurozone. That means that they don't have to do what the Germans
say anymore. Greece could be just like Montenegro, and use the euro
Ha ha ha.
(Actually, this probably wouldn't work so well, because although it's
hard to stop Greek citizens from using euros if they wish, the ECB
could make it hard for Greek banks and other institutions to do
business in euros. There could be an outside-the-eurozone euro market.
Like the eurodollar market, but it would be the euroeuro market.)
Or, maybe the Greek government would issue its own currency, which
would probably blow up in no time at all. Then, Greeks would still be
using the euro, but it would be on an informal basis rather than an
official basis. Just like the U.S. dollar in Peru (population 29
million) or Cambodia (population 15 million).
Now, let's consider if the Greek government decided to voluntarily
withdraw from the eurozone. The Greek government could still use euros. But, we will assume that
they replace euros with their own currency, the "crapatski."
This would leave a lot of existing contracts denominated in euros. For
example, bank deposits of Greek banks would still be in euros, and wage
agreements. The government would probably then have a mandatory
conversion of these obligations into crapatskis. So, if you are a
typical Greek citizen, your bank account is now payable in crapatskis,
and you are getting paid in crapatskis at work. If you are a smart
Greek citizen, you will probably drain your bank account and trade the
crapatski bills for euro bills on the black market as soon as possible.
However, most Greeks wouldn't be that smart. Too bad for them.
This is roughly what happened in Argentina in 2002, when the existing
currency board arrangement was replaced by a domestic floating
currency, which immediately cratered.
I was talking with a friend about this a couple days ago. What happened
in Argentina? This was a country where dollars and pesos circulated
side-by-side, with the pesos linked to the dollar via a fairly reliable
currency board. The government peso-ized the country. It appears that
the catalyst was bank funding. People were withdrawing their deposits
at Argentine banks in dollars. However, the banks then needed to borrow
dollars, and they couldn't. This was when the banks closed, and were
pesoized. Pesoization allowed the Argentine government to print pesos
to give to the banks. So, that is one road to the introduction of a new
What about that government debt amounting to 107% of GDP? Much of that
is held by foreigners. It still needs to be paid in euros. If it isn't,
that constitutes a breach of agreement, which is a default. So, either
way, the Greek government would default on its bonds, either by not
paying in euros, or by "paying" in crapatskis, which are also not
Let's say you own €2 billion of Greek government debt. The Greek
government says: "Don't worry about default! We're going to pay you in
these crapatskis we made on the laser printer last night." Whew! You're
not worried at all.
Even if the Greek government wanted to pay off the debt in euros, where
would it get the euros from? All of its tax revenues are now in the
form of crapatskis.
Probably, the crapatski would soon plummet in value. Indeed, I would
say the only reason for the existence of the crapatski is to have
something that could be devalued. What then? The Greek economy would
shrink, of course. This makes the debt even harder to pay off. If the
debt is 107% of GDP today, but GDP (in euro terms) falls by 50% because
the crapatski implodes, then the debt becomes 214% of GDP.
I think we can see that there are really no advantages to be gained by
having Greece leave the eurozone and issue its own currency. Maybe the
only apparent advantage is printing-press finance. If the Greek
government suddenly converted to crapatskis, nobody would buy their
bonds anymore -- including Greeks themselves. The result would be
exactly the same as a default on the euro debt. They would be shut out
of the debt market. Then, they would have that big 13%-of-GDP deficit
to finance. This could conceivably be "financed" by pure
money-printing. However, that charade would only last for a little
while -- a few months -- before everything collapsed in a heap of
hyperinflation. The end result would be much, much worse than if Greece
simply stayed part of the eurozone and defaulted on its debt. Also, the
end result would be that Greeks would stop using crapatskis, and use
euros instead, on the black market if necessary. This is what happened
I think European leaders understand this. People in Spain don't want to
go back to the peseta. Italians don't want to go back to the lira.
Greeks don't want to go back to the drachma. They know -- from decades
of experience -- how much it sucks to have a low-quality currency. This
is why I think this notion of "dropping out of the eurozone" and going
back to an independent floating currency is circulating primarily in the
English-speaking world. Because, if you look at the countries which haven't had generations of bad experience with crap currencies -- the countries which haven't learned their lessons yet
-- what are they? The U.S. and Britain, mostly. It is in the
English-speaking world that the Keynesian ideology of monetary
manipulation and convenient devaluation ("quantitative easing") is
ascendant. The English-speaking Keynesians are the ones braying: "those
Europeans should be more like us!" The Europeans themsleves don't buy
this baloney, at least not as much. That's why they set up the euro
project in the first place.
Sometimes you find someone who can just sum up the conventional wisdom
for you. Here's Steve Liesman of CNBC, on February 11, 2010:
"Isn't the difference between Greece
and the U.S. that the U.S. has a printing press and Greece doesn't. At
some point it is no longer any good for Greece to be part of a union
where it can't have any control over its monetary policy."
Do you see what I mean about the Anglophone economists?
The euro should really have been pegged to gold. I suppose it will be,
eventually. After the requisite period of bad experience, of course.