Saturday, May 8, 2010

Greek Debt Crisis--Wider Implications

by Richard Crews
Greece does not have a strong industrial (or post-industrial) economy. In terms of its place in international finances, it has some shipping and tourism but no strong manufacturing or other base. And it has been poorly managed politically and financially with rampant nepotism and corruption.

Nevertheless, Greece has developed standards of living comparable to its European neighbors including expectations for expensive government services. It has financed this by going into debt, a debt which it now cannot pay, leading to a $147 billion bail-out provided by the European Union and the International Monetary Fund.

This bail-out plus severe austerity measures within Greece (increased taxes, decreased government pay and services, raised retirement age, etc.) are expected to postpone Greece's need to "restructure" (that is, to partially default) on its sovereign debt for three or four years. Then the same problem will arise for Greece again--hopefully in reduced, better organized, and better anticipated form.

But Greece is a small country economically--its gross domestic product (GDP) is about 2.5% of that of the U.S. or of the combined European Union countries; it is less than 10% of Germany or Japan--so that Greece's sovereign debt problems are not directly very significant to the wider world economy.

However, there are two important wider implications. One is a cascade effect: if Greek bonds and Greek banks appear weak, money will flow out of them into financially stronger countries such as Germany and the U.S. And other countries seen as financially weak such as Portugal, Spain, Italy, and Ireland may suffer the same fate--they will have trouble (and extra costs) borrowing money to continue to finance their debts; there will be turmoil in international financial markets which could lead to financial, and hence political, crises around the world. Today there is rioting on the streets of Athens; tomorrow it may be far, far wider.

But disturbing as this prospect is, there is an even more ominous question: does the enormous expansion of sovereign debt around the world represent the ultimate financial bubble? A financial bubble--be it "dot-com" or "sub-prime mortgage" or any other--arises when a sector of the economy finances current needs through the expectation of future growth. Modern post-industrial economies such as those in the U.S.and U.K. (but also many other countries) have developed massive government debts based on the requirement that the economy will expand at least several percent a year.

But--as with dot-com stocks or real estate prices--national economic growth and expansion simply cannot continue indefinitely. Ultimately taxes must be high enough to pay the ongoing costs, and government services and expenses must be curtailed--and this is very politically unpopular. What will happen if major, first-world countries default on their debts? Worldwide bankrupt governments with spreading political firestorms is not a pretty picture.