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29 Δεκ 2014

Is leaving the euro a suicide ?

By Prof Anastassios Retzios

There are statements that Greece leaving the Euro would constitute “suicide”.  I will try to discuss this matter clearly and without undue emotional exaggerations. First of all, let me state that those who argue that,“leaving the Euro is suicide” actually lives in an EU country that does not participate in the Euro!  He may argue that this policy makes sense for the said country because it has a “strong” economy and extensive industrial base but it does not for a “weak” country such as Greece.  I hope that I can prove that exactly the opposite is true: that the Euro suits countries that are at the same level of development and industrial activity, but it is a poverty-inducing straight jacket for poorer and weaker economically countries such as Greece, forcing them into what really is a fixed-exchange rate trading block that lacks fiscal adjustments.

It is important in this conversation to first understand the causes of the crisis in Greece.  Let me list what was NOT the cause of the crisis:

(a)   The public debt (just considered on its own) – at the onset of the crisis, Greek public debt at 97% GDP was not dramatically out of line with that of other EU countries.  In fact, Belgium and Italy had similar levels of public debt; on the other hand, another country enveloped in the crisis, Spain, had a much lower public debt.  Thus, various countries with high debt did not experience problems and others with low debt were enveloped by the crisis.
(b)   The “corrupt” politicians: there is no evidence that Greek politicians are more or less corrupt than those of other western countries.  In fact, in the beginning of the crisis period, the German President had to resign for influence peddling.  Somehow, corruption in high places in Germany had little impact on its economy.  Political corruption is rife in China (and not just there) but this has no effect on the amazing rate of economic growth
(c)    “Corruption” in public life: levels of corruption in Greece are far below those of certain Asian countries that have booming economies.
(d)   Overspending by consumers:  The average debt of Greek households is the lowest in the EU-15.
(e)   Tax evasion: although a problem for the fiscal management of the country, tax evasion had nothing to do with the crisis.  In fact, prior to the crisis, receipts by the Greek exchequer were on a steady and sustained rise. 
(f)    Out of control spending:  Greece had a spending per capita in social welfare at about 50% of the equivalent spending in Germany; in general, Greek welfare expenditures were among the lowest of any country in the EU-15; Greek programs were hardly out of line with the economy; average retirement age at 62 years of age was higher than in many other EU countries, notably France, where the average retirement age is 60. 
(g)   The number of civil servants:  The number of state employees in Greece at 17.4% of the workforce (by the accounting of the summer of 2010).  This was on par with that of the EU-15; France, at approximately 21% of its workforce on public payrolls, leads this metric without fears of bankruptcy.

We are treated here by daily long litanies as to what is “wrong” with Greece and what is causing the crisis.   Usually, these are posted by self-flagellators and garment renderers who are trying to find a moralizing story.  At no time have any of them tried to show a mechanistic relationship between these failings and the current crisis.  In fact, there is none.  It is very important to understand that none of the problems listed above have caused the crisis. 

So, what has actually caused the crisis?  Well, here are the reasons:

(a)   The “great recession” and the  financial crisis of 2008
(b)   The adoption of the Euro
(c)    The participation of the country in the EU

Here is the story in summary:

(a)    The Great Recession of 2008 caused Greek fiscal deficits to explode (as in many other western countries), as economic activity receded and tax receipts fell well below expected levels.  Thus, a deficit of 6.5% GDP in 2009 soon reached 15.4% GDP in 2010
(b)   By April of 2010, it became evident that Greece would have been unable to auction the requisite number of bonds at a decent yield rate (<7%).  The reason for this was that bond traders became convinced that the Greek economy had become uncompetitive and it would have been unable to grow at a rate adequate to pay back the borrowed money.
(c)    Greece, as a member of the Eurozone, lacked a central bank to act as the lender of last resort.  Thus, in May of 2010, the country declared effective bankruptcy and requested assistance from the EU
(d)   The EU resisted the notion and requested the inclusion of the IMF in any scheme that involved the “rescue” of Greece.  Thus, the “troika”, constituted by representatives of the EU, the European Central Bank (ECB) and the International Monetary Fund (IMF) was assembled.  The “troika” advanced a loan of 110 billion euros to Greece under specific terms, usually referred to as the “memorandum” (mnimonion) concluded on May 6, 2010. 

These are the key facts. In anticipating key questions, let me state here that the Greek fiscal deficit in the beginning of the Great Recession was not out of line of what was recorded in other countries.  For example, the same year that Greece recorded a fiscal deficit of 15.4% GDP, the US had a deficit of 11% GDP (a humongous sum).  Such fiscal deficits are expected in recessions, especially one as severe as the 2008 one.  Unfortunately for Greece, two key factors were operating:

(a)   The bond market had concluded that the Greek economy was “uncompetitive” and the risk was high enough to require substantial yields (>7%) for the purchasing of Greek 5 – 10 year bonds.   Greece was even forced to pay a yield of 5% for short-term (6 month) borrowing (for which, Germany usually pays a rate close to 0%). 
(b)   Greece, because of its participation in the Euro, did not have a central bank to act as a lender of last resort.

Thus, from the moment that the country was unable to sell bonds in the “open” market, and it was unable to use its central bank as a lender of last resort, it was bankrupt.  In fact, the country continues to remains bankrupt “de facto”.  The only thing standing between fully-declaredd bankruptcy and normal operations is the continuing funding by the troika. 

In the next installment, “Part 2: The Uncompetitiveness of Greek Economy”, I will examine the reasons that the bond traders, the financial markets and the finance press decided that the Greek economy had become too uncompetitive and that investing in Greek debt had become too risky.