Scenes from Greece Part 2

Greece will probably default in some way on its sovereign debt.  Is this really important to us?  Yes, and here's why:  this default is going to be expensive.  It will be more expensive for European taxpayers and investors than it will be for anybody else, but it will still be expensive for American taxpayers and investors, and probably also for many others around the world.  And there are some lessons to be learned that have value in the American context.

By the time you reach the end of this posting you might want to pour yourself some of that potent Greek ouzo.  Drink it cold and neat and let it settle for a lengthy time before trying to get up and move again.

This is not going to be like Argentina defaulting on its debt a few years ago.  Argentina's financial system stood on its own, even though its debt was owned internationally; Greece's financial system is intimately and intricately tied into all of Europe's financial system by way of its sixteen partner nations in the euro zone, as well as having debt owned by banks all over Europe and perhaps elsewhere. 

And some of that debt--whether through direct ownership or indirectly via investments in institutions that themselves own that debt--will drag down American banks.



A disorderly default by Greece would increase the likelihood that Portugal, Spain, Ireland and maybe even Italy could follow with their own versions of sovereign debt defaults.  

If default is inevitable, then the way in which Greece defaults is now the biggest issue because the method used will determine how much damage is done to Greece and to the rest of the world, including you and me.  And there is another issue which is just as big--that would be ensuring that policy-makers and leaders of financial institutions learn some lessons from this experience that can be used to prevent future such occurrences.

There has been no pre-existing euro zone mechanism for financial crisis mitigation.  An appreciation of a crisis of this nature was not a part of the euro-psyche.  German and French and other European policy-makers are putting lots of effort into developing a rescue strategy for Greece.  But European leadership is fractured, indecisive, inconsistent and uncoordinated.  They have been putting energy into strategy development for a year and a half now and have little in the way of results to show for it.

Germany is the biggest player, and they want things done in the "German way."  The Germans want to serve the Greeks sauerkraut and potatoes because it's in the German nature to like those things; the Greeks want souvlaki and tzatziki sauce with pita for the same reason. But those are different things and they do not mix well together, and they do not substitute well for each other.  Whatever strategy is developed will have to encompass the other at-risk countries, too, so the project becomes more complex.  This is all new territory because the creation of the euro never envisioned the possibility of events of this kind.

Greece will default for the simple reason that its economy is shrinking.  According to a graphic shown in The Economist (issue dated October 8 - 14) and citing the Greek Ministry of Finance as the source, Greece's economy shrank by more than 4% last year, and will shrink again this year by almost 6%, and will continue to contract--by something over 2%--next year.  Doing the mathematics yields this result:  by the end of 2012 the Greek economy will be roughly 88% of the size that it was at the end of 2009, which is about when this whole story on its sovereign debt became headline news.  (You might suspect, as I do, that the Ministry's predicted numbers could be a shade on the optimistic side, too, which if true would just make matters worse.)

During our time in Greece we saw no sign of anything new.  Naturally, as tourists we were focused on old things.  But a look at our photos taken of the city from the Acropolis reveals no evidence of new construction within what was probably a ten mile clear-view radius.  Likewise with our travels in the less-populated areas of the country, where we observed some signs of dilapidated housing, farms and town buildings.  These are signs of national economic stagnation.

The same article in The Economist says that by the end of 2012, Greece's economy will have been reduced by 14% over the prior five year period.  And, of course, unemployment is high:  it is currently at or above 16%, and there seems to be no reason why that figure will improve in the near future.

Presumably, as the economy shrinks, so too does the government's revenue, even with a new property tax and a surtax of between 2% and 5% on last year's income.  Note that the new property tax is on top of a prior property tax that The Economist--and other sources--report has yet to be paid by most property owners, and also that there is a certain Greek skillfullness in understating income, so "good luck" to the Greek government in actually gaining anything from that surtax.

And, by the way, the Greek government has recently put in motion the actions needed to dismiss 30,000 more public sector workers over the next few months, and has committed to cut another 120,000 public sector jobs by 2014.  According to The Economist, there was an across-the-board civil service wage cut of 20% last year, and a further reduction for some of these employees of 15 - 20% this year.

More unemployment and lower taxable income must mean lower tax revenues.  Probably a lot of potential VAT goes uncollected, too, especially as the rate rises and merchants become ever more reluctant to impose it upon fellow-citizens who are all experiencing the same deterioration of living standards.

This sounds like a fiscal death spiral.

Further, the same issue of The Economist has on its last page a very dense table of numbers reporting on various financial characteristics of many of the world's countries.  One of the columns contains the interest rate that each country must pay when it issues 10 year bonds, which is a common method of financing the mundane operations of any government.  The rate for US bonds, for example, is reported as 1.90%; for China it is 3.88%; for Germany it is 1.84%; for Greece, it is a whopping 22.19%!

Stick with me a little longer here.

It's just my guess, but those Greek bonds are still being bought up by many, or all, of the same banks that have been happy to buy the prior Greek debt which is the subject of the current crisis.  And it is the same debt which those banks fear might cause them to eventually lose billions of euros and perhaps even drive some of them into insolvency.  And the nature of the marketplace is such that it forces the sick country to pay even more to finance its operations, which just makes matters even worse.

The patient becomes sicker, still receives the same medicine, but it costs more for each dosage.  And yet there seems to be no other option available.

The method of default will either be controlled and orderly, or uncontrolled and chaotic.  The latter option would be much more expensive than the former.

Here's another observation from visiting Greece:  it's probably an unusually expensive country to run.  This has nothing to do with tax avoidance or tax evasion; it's all of those beautiful islands.  Greece is not a country that is serviced and tied together by contiguous roads, power lines, sewer systems, water systems and so on.  Most of it is, but there are still a couple of hundred inhabited islands that have infrastructure which is geographically-separated from the mainland.  Much of this is provided by the government, some of it is provided by private enterprise, but in any case it is a relatively expensive way to use capital and resources when compared to the infrastructure needs of most other countries.

Bear in mind the fact that Greece is a democracy, and its elected government is currently making national austerity decisions that are apparently very unpopular with the citizenry.  This week's 48 hour general strike has hobbled the country and has shown that whatever national support there might have been for these fiscal frugality measures is fast eroding.  Germans and French and Americans and British and lots of other people might feel that Greece has a moral and legal obligation to pay off its debts no matter the cost to Greece, but it is not clear that the Greek people feel the same way.  The unnecessary violence associated with the strike and demonstration has detracted from the Greek electorate's message, but it has not changed the message.  The entire strategy that is being built by all of the players is an elaborate and fragile house of cards which could be knocked down by even a small breeze or tremor.

Don't spend any time on thinking that a possible solution lies in having Greece exit the euro community, or in the other sixteen euro members expelling Greece in some way.  Either is possible, of course, but not in the near term because there is no legal mechanism that would enable either action.  The treaties and laws that have established the euro as a common currency say that once a country is using the euro then there is no way for it to stop using the euro.

Unless there's a run of really good luck on this situation--well, there's been almost nothing but bad luck on it for the last year-and-a-half, so maybe some good luck will finally happen--then the best that can be hoped for is that Greece will go through a "Chapter 11" type of default and reorganization.  This will cause some portion of the debts to be repaid, and will probably cause all of the debt-holders to sustain great pain in writing off large chunks of debt value.

These are the lessons that our leaders in government, industry and finance ought to learn from this experience:

• Fear and destructive contagion on a massive scale will be the result of a laissez-faire attitude about money, so when dealing with significant amounts of money have available tools to manage and control that money, and use the tools without hesitation.  The current euro zone troubles are the spawn of a laissez-faire attitude that created an environment with insufficient tools and controls; the same should be said about the financial crisis in this country in 2008, and it will happen again and again until this lesson is learned and corrective policies and practices are developed and institutionalized.
• Banks and other institutions with lots of money on hand have a natural and visceral desire to want to use it to make more money, and when left too much to their own devices they will make unwise decisions which will have unpleasant national and international results, so governments must possess effective regulatory oversight and use it.
• In developing, implementing and enforcing public policy, a loose confederation of sovereign authorities--such as the European Union--cannot be as effective as a tighter union such as the United States.
• Governmental fiscal austerity intended to reduce a national debt burden will fail to achieve that goal with disastrous consequences unless it is combined with other actions that will immediately expand the national economy.
• People might never accept change that is imposed upon them; even if they eventually do accept it, the process to get to that point will be littered with the ruins of other things that unexpectedly become trash.

Now it is time for the ouzo.