Wednesday, April 28, 2010

The World Focuses on Greece

As the world focuses on the financial problems that are becoming apparent in Greece, I am pulling back in order to understand the implications from a more global perspective. Considering that Greece represents 2-3% of the European economy, it is not in itself much of a threat to global stability. In fact, I have seen those with an optimistic bent suggest that this issue will go the way of the Dubai situation, making it a non-event. I am more concerned than that.

Let’s begin with a review of the problems at hand. The government in Greece has succumbed to the same pressure evident in many other countries, namely, they have promised more payments and services to citizens than can be paid for given current and future tax receipts. This was a somewhat minor issue prior to the Great Recession, but has now become front and center because tax receipts have declined precipitously while costs have gone up, and investors that would loan Greece funds have become skeptical and therefore, scarce. In addition, Greece has crossed a tipping point, much like a consumer with excessive credit card debt, whereby it can’t grow its economy enough to avoid being overwhelmed by its debt obligations. Said another way, it is in a spiral that it can’t pull out of. The final compounding factor is that as a member of the European Community it can’t use currency manipulation to save itself and will likely have to default on promises made to debt holders and its citizens. A default to debt holders means investors receiving some fraction of the amount owed to them, while a default to Greek inhabitants equals reduced payments and services, and I am told, likely social unrest (read rioting).

Taking a few steps back, from the European Community perspective, Greece represents everything the group was trying to avoid when it established its common currency, the Euro. Unfortunately, in the optimism that accompanies many new ventures, the Union neglected to have any support (bailout) features or exit strategies built into its constructs when the Euro was created a decade ago. The plan was to rely on self policing regarding member’s fiscal deficits and total debt outstanding relative to a country’s economic output. What is now coming to light is that in order to participate in the Union, and thereby benefit from much lower borrowing costs, numerous countries fudged the numbers, surprise.

This sub-group of the EU has been dubbed the PIIGS, for Portugal, Italy, Irelands, Greece and Spain, and is too large a part of the organization to just ignore and hope the problems go away. So the more well heeled of the group, Germany, France and others are scrambling to rescue the reprobates in order to prevent an uncontrolled failure of the region’s financial infrastructure. But the only solution appears to be for the more conservative governments and citizens to subsidize the fudgers and spendthrifts; Germans sending their tax dollars to Greeks. In my opinion, the most likely outcome will be a very messy process over the next couple of weeks to establish support for Greece, and by extension the PIIGS, to buy time for a more orderly default or devaluation of Greek debt. Of course, there is always the possibility of a policy mistake that leads to an economic contagion in the European region and a substantial decline in the Euro; however I think this will be avoided by putting lipstick on the PIIGS.

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