It's been a big week for news. Terrorist atrocity in Charleston by a young white supremacist. Coordinated terror attack against France, Tunisia and Kuwait, carried out by ISIS. Supreme Court decisions upholding Obamacare and allowing gay marriage across the United States. The President finally got his Fast Track Authority. And the economic crisis in Greece is causing the European Union to destroy itself, which could lead to a new economic meltdown in Europe and perhaps the world.
Wait, did you miss that last one? Want a quick primer on European austerity and Greek economics so you can follow the action in Europe this week? Keep on reading below the fold . . .
First the basics. The Euro was a stupid idea to begin with, one that many economists thought was a bad idea, including Paul Krugman who said it was ill-conceived at the time and continues to think is a bad idea.
The United Kingdom, Sweden and Denmark are EU members that kept their own currencies. A handful of East European countries are pledged to join the Euro but haven't yet done so and if they are smart never will. But the other 19 EU countries formed the Eurozone, a monetary union from hell. EU unemployment is much higher than the U.S. at 9.7%, but in Italy it is 12.4%, in Spain 22.7% and in Greece it is 25.5%. Essentially Great Recession numbers in Southern Europe and the pain has been going on for years.
The reason the Eurozone is a bad idea is because it is an economic union without a political union. The economic union part means that everyone gave up their own central bank along with their own currency and instead rely on the European Central Bank (ECB) to issue euros and set interest rates. Not having your own currency means that if you have a relatively weaker economy, like Spain, Italy and Greece, your money is over-valued, because the ECB is adjusting things for the entire Eurozone, at least in theory for the entire Eurozone. So a week's vacation on a Greek island costs much, much more than if Greece still was on the Drachma. The reality is even worse because the ECB is located in Frankfurt and policy is mostly made to keep the Germans happy. And from 2003 to 2011 the ECB was run by Jean-Claude Trichet, which would be about like having Mitch McConnel running the Federal Reserve.
After the Great Recession hit in 2008, Trichet decided inflation was the big worry and raised interest rates. The Neo-liberals of Europe (Trichet is only one of many) have done a job on Europe's economy that makes the Tea-party crowd in Kansas look successful. Look at those Great Depression unemployment rates in Southern Europe again.
But the EU is nothing like the U.S., where Florida can have an economic crash from the sub-prime melt-down but retirees still get social security. Money is shared among the States in the U.S. in a way it is not in Europe. Many people are advocating a closer political union in Europe, but that would also be a disaster because there is no effective democracy in the EU. There is a European parliament, but it has relatively little power. There is a European President but he is not elected and instead is chosen in an arcane way that would take me more than 500 words to explain. On the whole, EU decisions are done in a way that would make the U.S. Chamber of Commerce giddy with delight if we were to introduce the same system here. Remember that no democracy part, because that's exactly the fight that is now going on, between the political elites of the EU who function in a democracy-free zone and the democratically elected left-wing government of Greece.
The current crisis starts with the fact that Greece cheated in order to get into the Euro back in 2001. It's debt was too high according to the rules. So what did it do? It asked Goldman Sachs for help, and they arranged a debt swap deal that hid $10 billion of debt. Except there are those who claim it wasn't hidden from the EU, that they knew about it. (Yes, Goldman Sachs really is a vampire squid)
Subsequently the center-left and center-right governments of Greece lived beyond their means (remember those fancy Olympics the Greeks put on?) and when the Great Recession hit, Greece went bankrupt although the problem wasn't discovered until Pasok, the center-left party got back in power and discovered that there was no money. Three institutions stepped in to bail them out, now known as the Troika – the EU, the ECB, and the IMF. You should know you're in trouble when you ask the IMF for money, but actually the EU and ECB were even worse. A lot of money was loaned to Greece for a “bail-out” but it wasn't actually a bail-out of Greece, it was a bail-out of the French and German banks (and a few others) that had loaned Greece all that money. As a condition of the bail-out, Greece had to cut pensions and other government spending and raise taxes with the goal of lowering its deficit. At the time its debt to GDP ratio was 130%. After five years of taking the Troika medicine, the Greek debt to GDP ratio is well over 170%.
After years of Troika punishment, the Greeks voted for a new left-wing party, Syriza which promised to renegotiate the terms of their austerity agreement. Alexis Tsipras became the new Prime Minister and spent months negotiating with the Troika only to have them insist on not just continuing austerity, but increasing it as the condition of any further loans. And without further loans, Greece cannot make a crucial payment to the IMF next week, which will trigger a default in EFSF loans (European Financial Stability Facility) held by the European Central Bank. At that point the ECB stops supplying liquidity to Greek banks, at least according to the rules and then the Greek banking system collapses.
The debt chart comes from
Edward Hugh's blog.
Greece and the Troika are not that far apart in their negotiating positions, but the EU wants to crush Syriza to roll back the new upstart left-wing parties of Europe.
Europe's old Social Democratic parties support the austerity that is killing the continent, having mostly become conservative light parties, very similar to the third way of Bill Clinton and Tony Blair.
Is Syriza perfect? No, they are a new party going through growing pains, and their negotiating style has not made many allies. But I concur with Thomas Piketty, the French economist who wrote Capital in the Twenty-First Century:
You can argue that, in Syriza’s case, their policies are not as clear as they might be, but you have to offer them support because they want to build a democratic Europe, which is what we all need.
The European elites have imposed blackmail terms on Greece that would make Syriza go back on everything it promised to the Greek people when they won the election. Syriza has refused to bend, and so has the EU and the rest of the Troika. Only Mario Draghi, an Italian who now runs the European Central Bank has acted responsibly, continuing to provide credit to Greek banks to buy time for the Eurozone to get its act together.
They didn't. Eurozone Ministers have now rejected any extension of the Greek bailout, and Tsipras has asked the Greek Parliament to approve a referendum on July 5, saying:
We won't ask Schauble [German finance minister] or Dijessbloem [Eurogroup Chief] for permission to protect democracy in the land where it was born.
So the Greeks will now vote on whether to accept the bailout terms demanded by its creditors – but Syriza will ask for a “No” vote to reject the terms. And if they vote no, Greece will likely be forced out of the Euro and perhaps even the EU. On the other hand if they vote yes, the bailout extension is already off the table, so its not clear what it will mean. And if the ECB cuts off credit to Greek Banks, they will immediately collapse, which will mean credit controls and perhaps a quick return to the Drachma. No one really knows what will happen.
On June 1, Paul Krugman wrote an article called That 1914 Feeling in which he said:
But they are making a terrible mistake. Even in the short run, the financial safeguards that would supposedly contain the effects of a Greek exit have never been tested, and could well fail. Beyond that, Greece is, like it or not, part of the European Union, and its troubles would surely spill over to the rest of the union even if the financial bulwarks hold.
Finally, the Greeks aren’t the only Europeans to have been radicalized by policy failure. In Spain, for example, the anti-austerity party Podemos has just won big in local elections. In some ways, what defenders of the euro should fear most is not a crisis this year, but what happens once Greece starts to recover and becomes a role model for anti-establishment forces across the continent.
But what if the Greek people vote yes to accept the austerity terms on the bail-out, and the EU provides another bail-out? Will that solve the problem? Edward Hugh is a brilliant English economist who lives in Barcelona and has looked closely at debt issues in Europe. He is
very skeptical that a bail-out extension without debt write off will work.
So you reach a point where extend and pretend hits the proverbial fan. You can, of course, do more extend and pretend till the next time it happens, but at this point the IMF seems reluctant to do so. On the other hand austerity-type spending cuts which only make the economy smaller and the growth path lower simply don't help in this context, since what they give with one hand (debt reduction) they take away with the other (in the form of lower GDP).
And
he thinks a Greek default could trigger higher borrowing costs for Spain and Italy.
Certainly the most notable feature of the current Greece crisis is the way in which bond yields in the other Euro periphery countries have continued to head downwards, leading many to conclude that the “contagion” threat is now a thing of the past. But doubts remain: how much of this bond yield stability is due to the ECB QE programme? And what will happen if the ECB eventually terminates the bond purchases, or even tries to end them early under a Federal Reserve type “tapering” process? What will happen to bond spreads then? And what about the growing political instability in the region, as unemployment remains unacceptably high despite the apparent recovery.
The reason is that traders will look at the default in Greece and the fact that the EU let it happen and decide that maybe Spanish and Italian and Portuguese bonds aren't such a great investment after all.
A run has already started on Greek banks and there is a chance they won't survive the week, regardless of what anyone in the EU does.
The story put out by the Neo-liberals of Europe is that the Greeks have been lazy and profligate and deserve what is happening to them. David McWilliams is a very sharp Irish economist who has been following this drama closely. He says this:
Not only does the EU creditors’ approach show no grasp of economics or human nature, but in the past few months we have seen ridiculous double standards from Germany, the main driver of this nonsense.
And what about debt forgiveness, which is what Greece really needs? McWilliams points out that the Germans got debt reduction when they needed it after World War II.
And yet they now refuse to consider it for the Greeks.
Why doesn’t someone remind Germany that in 1948 the introduction of the Deutsche Mark (backstopped by American capital) wiped out most of Germany’s domestic debt?
Or what about the fact that in 1953 half of Germany’s external debts, including their interest payments, were wiped out at the behest of a bankrupt Britain?
And furthermore, are we not aware that the Americans insisted the remaining debt payments could be spread out over a term of three decades?
If you think the Greeks are guilty and the Germans upright and innocent, I strongly recommend you
read McWilliams on this. Total debt forgiveness that Germany received from 1947 to 1953 was 280% of GDP. And that was after they destroyed Europe in World War II.
All Greece did was dabble in about 100 billion Euro worth of political corruption while listening to Goldman Sachs.
So what happens next? Truly no one knows. I'll limit it to four possible scenarios because this post is already too long.
Option A: Greece leaves the Euro and perhaps the EU –GREXIT, and its economy melts down and the Greeks face years of depression. But the Eurozone is unaffected because of new financial mechanisms that prevent the contagion from spreading.
Option B: GREXIT becomes a new Lehman Brothers moment when everyone discovers that the new financial mechnisms don't work. The European banking system melts down and both the EU and Greece suffer enormous pain for years to come.
Option C: GREXIT happens, but after initial crisis and economic pain, a return to the Drachma results in a devaluation of Greek money, which causes tourism to surge because its cheap to go there. The Greek economy revives and the country ends up in much better shape than the Eurozone.
Option D: Greece votes to accept the austerity terms of the Troika in the referendum, the IMF decides to wait on triggering default, the EU extends a new bailout but the Greek economy shrinks by another 7 to 12% as a result of the added austerity. Greek debt soars another 50% and in another year or two all this drama returns, except this time the Greek people have just elected Golden Dawn, the Greek Nazi party.