Greece's Problems

Greece’s fiscal problems have been much in the news recently. Essentially, the country is bankrupt. They have bond payments coming due this month, and they don’t have enough euros in the treasury to pay back the bond holders.

There is nothing unusual about that. Most governments don’t actually pay off their bond holders when the note comes due. What they do is issue new bonds, and just keep rolling the debt over. Greece’s problem is that they have hit their credit limit. The international financial markets are so nervous about how much debt has already been issued that they don’t want to allow Greece to continue digging the hole deeper.

This is not the first time a sovereign nation has run into this problem. Nations can’t handle their credit cards any better than the average American. The nation state playbook says that in a circumstance like this, you devalue your currency. Devaluation makes your exports cheaper, imports more expensive, and pays back the bond investors with a cheaper currency than they loaned you. The inflationary effects make everyone poorer, including the bondholders, who have to take a haircut on the value of their investment.

This isn’t an available option for Greece, because the Greeks don’t have their own currency anymore. They use the common European currency, the euro. If Greece defaults on its bonds, all of the countries in the Euro zone are in the splash zone. Hence the incentive for the other European Union countries to bail Greece out.

The other European nations, notably France and Germany, along with the International Monetary Fund, have agreed to be the lender of last resort to the Greek government. But there are conditions. They are requiring Greece’s government to reduce the government budget deficit from 13.9% of GDP to 3.9% over the next three years.

With their back against the wall, the Greeks are agreeing to the plan. They are cutting pensions, cutting salaries of government employees, and raising the retirement age. On the revenue side, consumption taxes are being increased one tenth, from 20% to 22%.

How big a cut is this going to be? Government spending makes up about 43% of the total Greek economy. The proposed austerity package of tax increases and budget cuts aims to get that down to about 35%. The government in Greece is going to have to shrink by about 20%. Overall, the average man on the street is going to get 10% poorer over the next couple of years, but the effect will be concentrated for government employees and retirees.

No wonder they’re protesting.