2015: The Greek Odyssey

Jun 30, 2015

- By Vivek Kaul

Vivek Kaul
I am writing this column sitting in a coffee shop near the Siddhivinayak temple in Mumbai, on late Monday afternoon. I have just finished reading a news-report which tells me that the Athens stock market is shut. And so are the Greek banks. Ordinary Greeks are lining up in front of ATMs to withdraw cash.

By June 30, 2015 (i.e. Tuesday, when you, dear reader, will be reading this column) Greece needs to repay 1.6 billion euros to the International Monetary Fund (IMF). The country is broke. It doesn’t have the money to repay the loans it has taken on. Greece owes 240 billion euros in total, to the troika of European Central Bank (ECB), European Commission and the IMF.

If Greece defaults on its payment to the IMF, chances are it will have to leave the euro. And no one really knows what will happen next.

The question to ask nonetheless is how Greece ended up in the state that it has. In order to understand this we will have to go back a little in history.

The European Union (EU) was established by the Maastricht Treaty signed on December 9 and 10, 1991. After the formation of the EU, the members became bound to start a monetary union, which would share the same currency, by January 1, 1999.

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The name of the new currency was decided in December 1995, at a meeting of the European Council in Madrid. It was to be called the euro. Esperantist Germain Pirlot, a Belgian and a former teacher of history and French, is credited with coming up with the name.

The EU introduced the euro first in non-physical form (traveller's cheques, electronic transfers, banking, etc.) on January 1, 1999. On this day, 11 member countries of the EU started using euro as their currency. Their individual currencies ceased to exist independently even though they were being used for transactions.

One euro was worth around 6.56 francs. So even though the French were using the franc to buy and sell things, they were effectively using euros. The same logic stood for other European countries who had taken the euro as their currency.

The euro paper notes and coins were introduced on January 1, 2002. Meanwhile, Greece joined the euro zone, as countries which decided to use the euro as their currency came to be known as, on June 19, 2000 and gave up its currency, the drachma.

Before countries in Europe came together to start using euro as their currency, the German deutschemark was the strongest currency in Europe. Germans did not want euro as their currency. Some polls suggested that nearly 70% of the German population did not want euro. But the German politicians went ahead nevertheless and led Germany into entering a monetary union which would have a common currency.

The German central bank, Bundesbank, was genuinely independent of the German government and worked actively towards ensuring that the deutschemark continued to remain a strong currency in the eyes of the world. That was not the case with other central banks in Europe. In fact, the Bank of France, the French central bank was directly under the control of the French government till 1993, and was used to print money and finance government expenditure. Same was the case with most of the other countries in the EU like Spain, Italy etc.

Thus the Bundesbank and the deutschemark became some sort of a benchmark for the rest of Europe. Hence, when the German central bank raised interest rates other countries had to follow. This happened because money moved into Germany with higher interest rates on offer and led to the deutschemark appreciating against the other currencies.

It also led to other currencies like the French franc falling in value against the deutschemark, which was not always a good thing. Hence, in order to attract money back into France the country had to raise interest rates as well.

Hence, the difference between the interest rates in Germany and other countries in Europe, which ended up using the euro as their currency, was huge. . The difference between the return on long term government bonds for what came to be known as the PIIGS (Portugal, Italy, Ireland, Greece and Spain) countries and Germany, averaged at around 550 basis points (1 basis point is one hundredth of a percentage) between 1980 and 1990.

Hence, Germany enjoyed the lowest interest rates in Europe. With the formation of the euro and the European Central Bank (ECB, which was modelled along the lines of Bundesbank and was headquartered at Frankfurt in Germany) to manage the monetary policy of the Eurozone, the prestige of the Bundesbank and the deutschemark was rubbed on to the ECB and the euro.

Given this, other countries which used the euro as their currency also started to enjoy low interest rates. In fact, the interest rates of Germany and the PIIGS countries began to converge even before the euro came into existence. The difference which had averaged at 550 basis points between 1980 and 1990 fell to 10 basis points in 1999, the year in which euro started to be used as the currency.

As Neil Irwin writes in The Alchemists-Inside the Secret World of Central Bankers: "In 1992, when low-inflation Germany could borrow money for a decade at 8 percent, Greece had to pay 24 percent."

As George Provopoulos, who was the governor of the Bank of Greece, the Greek central bank, between 2008 and 2014, explained: "With the adoption of the euro, Greece gained the credibility of the European Central Bank, which itself was modelled after Germany’s Bundesbank...Gaining credibility meant low interest rates and inflation rates, which is what happened."

With the credibility of the Bundesbank rubbing off on the ECB and the member countries of the Eurozone, interest rates started to fall in the weaker Eurozone countries. After adopting the euro the weaker countries of the Eurozone would no longer be able to print money to finance their fiscal deficits like they had done in the past. Fiscal deficit is the difference between what a government earns and what it spends.

With the power to print money out of the hands of the government, it was widely expected that inflation would come under control. And with inflationary expectations lower, interest rates came down.

Take the case of Italy. It paid 110 billion euros as interest on its debt outstanding in 1996. This fell to 79 billion euros by the time the euro came into existence in 1999. The other reason for a fall in interest rates was the fact that the market assumed that in case there was any trouble with the weaker countries in the euro zone, the stronger ones (read Germany) would come to their rescue.

With such happy tidings, money poured into the weaker Eurozone nations. As Irwin writes: "Greek inflation hovered around 3 percent through the first decade of the 2000s. The cost of borrowing plummeted. Without the perceived risk of inflation, investors were willing to hand money over to the Greek government for pretty much the same interest rate they received for giving it to the German or French governments. In 2007, on the eve of the crisis, German ten-year borrowing costs averaged 4.02 percent. Greek rates were 4.29 percent. Investors had become complacent, viewing Greek debt as an essentially risk-free substitute for bonds issued by better-run countries like Germany, France, or the Netherlands."

So interest rates fell in the PIIGS countries including Greece. This led to the governments as well as citizens borrowing big time. Most of the lending was done by foreign banks and international investors who had discovered newer markets with the advent of the euro. These financial institutions lent to the governments and they also lent to the local banks who in turn lent to the citizens of these countries.

Take a look at the following table. Between 2005 and 2009 the external debt of PIIGS countries rose by 82% to €8.61trillion. The increasing debt was in some cases because of the government borrowing more to continue to finance their extravagant ways leading to fiscal deficits.

PIIGS: Gross external debt (in billion euros)
  2005 2006 2007 2008 2009 2010
Portugal 302 381 484 485 549 529
Ireland 1,136 1,763 2,267 2,356 2,385 2,303
Italy 1,676 2,108 2,549 2,395 2,551 2,435
Greece 263 330 454 505 588 547
Spain 1,350 1,805 2,302 2,327 2,539 2,317
Total 4,727 6,387 8,056 8,068 8,612 8,131
Source: World Bank

The following graph shows the fiscal deficit of Greece as a % of its GDP. The fiscal deficit of Greece went up over the years, as the Greek government borrowed more and more, making use of the low interest rates that prevailed.

Greek Fiscal Deficit

The fiscal deficit of Greece started to shoot up from 2001, soon after the introduction of the euro. It reached 7.5% of the GDP in 2005, and fell slightly after that. But it remained well above its 2001 fiscal deficit. The fiscal deficit was primarily on account of profligate public spending to finance the Greek welfare state.

As Satyajit Das wrote in an essay titled Nowhere To Run, Nowhere to Hide in July 2010: "Profligate public spending, a large public sector, generous welfare systems, particularly for public servants, low productivity, an inadequate tax base, rampant corruption and successive poor governments created the parlous state of public finances." By 2009, the total Greek debt amounted to 129% of its GDP.

It is this profligate spending that landed Greece in trouble. As mentioned earlier, the country owes around €240 billion to the European Commission, the European Central Bank (ECB) and the IMF, together referred to as the troika.

The Greece government ended up borrowing too much money after joining the Eurozone. They have not been in a position to repay that money. The troika has been lending money to Greece for a while now. As Mark Blyth writes in Austerity-The History of a Dangerous Idea: "In May 2010, Greece received a 110-billion-euro loan in exchange for a 20 percent cut in public-sector-pay, a 10 percent pension cut, and tax increases."

The troika now expects Greece to start paying back this money. And that is where all the problems lie. Because Greece has no money to pay back.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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4 Responses to "2015: The Greek Odyssey"

Winchil Vaz

Jul 1, 2015

I'd just like to re-enunciate an age-old principle: In any "borrow-lend" situation fiscal responsibility lies with both the borrower AND the lender. When either one of them does not take their responsibility seriously enough, both have to pay the consequences: the borrower gets a bad name and has to live with that as long as the memory lives, the lender has, in the ultimate instance, to cut his losses - he made a bad choice on whom to lend his capital to. The author of this article cites Mark Blyth's book "Austerity - The History of a Dangerous Idea" (great book, by the way!). He forgot to cite that the same book points out that the main creditors of the Greek lending fiasco are German, French and Dutch banks! And their respective economies would be incapable of bailing them out if they were forced "to cut their lending losses"! That, not Greek profligacy (for which I make no excuses) seems to me the main problem in the tragedy that Greece is living through today.

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ram kumar

Jun 30, 2015

here in some Indian states also situation is same. lavish freebies, corruption, unaccountability of politicians, too much money going out in CSR schemes of some PSUs which are unproductive. fortunately people's saving habit is still intact, some companies are really productive. but too much welfare schemes and free distribution had spoiled the mind set of public, which will result later in exactly " no where to run, no where to hide" situation here also on day.

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amit

Jun 30, 2015

And once again, what a well-written article. I really look forward to your analysis letters. They are concise and erudite and they make me the wiser for the reading. Thanks!

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Lakshminarayanan

Jun 30, 2015

Vivek,

You have left the note incomplete by leaving out the important part of the story. That is how ECB saved German and French Banks by lending Greeks money so that the Greeks could pay the banks. With this masterstroke, Drachi ensured that tax-payers are left holding the bag instead of the bankers who had lent the Greeks the money. So as usual one set of criminals sorry bankers are able to stuff losses into the poor tax-payers throat aided and abetted by the other set of criminals sorry regulators with politicians watching and abetting from the sidelines and telling the same tax-payers that it is for their own good. Only thing is using propaganda these bunch of thieves are able to make out that it is all Greeks fault. Great going indeed!

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