Greek debt threatens to choke Europe

Greece has become the "epicenter" of a possible global financial storm. Greece has had a growing debt crisis and is struggling to find ways to solve this crisis before it becomes an even bigger issue.

Paul Syvret
November 04, 2011 12:00AM
Courier Mail

GREECE - that picturesque little Mediterranean nation at the epicentre of what could become a global financial storm - should perhaps be viewed as the economic equivalent of the canary in the coal mine.

The Greek insolvency is not the cause of the rapidly mounting debt crisis in Europe but rather a symptom of a wider malaise and a monetary union that simply cannot continue in its present form.

Early yesterday Australian time, Greek Prime Minister George Papandreou appeared to back away from calling a referendum to approve the latest $130 billion rescue package for his stricken country.

This flirtation with democracy ahead of the interests of financiers and central bankers was as brief as it was chaotic.

The about-face came as his Government (which was due to face a knife-edge confidence vote last night) teeters on the brink of collapse, with Papandreou's finance minister in open rebellion over the referendum - a vote which if it failed would trigger a disorderly debt default.

This in turn would crystallise massive losses for Europe's big banks and financiers, many of which would need billions of dollars of fresh capital to survive, which is why France's Nicolas Sarkozy and Germany's Angela Merkel are so keen not to see Greece collapse.

In that sense their desire to "rescue" their southern neighbour stems as much from self-interest as any sense of altruism.

In return for the bailout largesse, Greece must implement yet another round of harsh austerity measures, guaranteeing years of economic hardship for the nation's already battered populace.

This is where we get to the crux of the problem.

Two years of grinding budget cuts have not only failed to stem Greece's ballooning deficit, they have served to shrink the Greek economy by about 14 per cent. In short, the money "saved" by savage spending cuts has been eclipsed by the plunge in tax revenues stemming from negative economic growth. All pain, no gain.

Never before has a nation suffering a solvency crisis had to endure austerity on these terms. Past events of sovereign default - and the ensuing fiscal restraints imposed by the International Monetary Fund - have been accompanied by compensating measures.

First, the impecunious nation will devalue its currency sharply, which makes its export sector (in Greece's case mainly agricultural products, manufactured goods, textiles and tourism) more competitive.

Second, the central bank will move to slash interest rates in an attempt to stimulate growth or, in some cases, apply other more unorthodox monetary policy measures such as quantitative easing (in effect printing more money).

But Greece, which is a currency user (the euro) rather than an issuer, has none of these tools at its disposal.

And interest rates are set for the entire eurozone by the European Central Bank.

This one-size-fits-all approach to currency and monetary policy across a series of economies as diverse as Europe is a recipe for disaster.

Monetary union without accompanying fiscal union (a central government in charge of things like taxation and welfare) - as is the case in federations of states such as Australia, the US and Canada - is doomed.

In Europe's case, Greece is just the first domino, with Italy now showing very real and frightening signs of distress.

Italy's economy has tanked, with GDP growth flatlining in absolute terms, and shrinking markedly on a per capita basis. Prime Minister Silvio Berlusconi is pushing for even harsher austerity measures as Italy's bond yields rise to distressed levels.

Italy, with total borrowings of $2.5 trillion is the world's third largest debtor nation after the US and Japan.

At 6.2 per cent, the pricing of 10-year government debt is more than three times that accorded to Germany and makes the task of refinancing the $350 billion of Italian debt that matures next year all the more difficult and expensive.

And those prices are soaring, despite the European Central Bank actively buying Italian bonds over the past three months in an effort to depress the yield. (And remember here that when Greek, Portuguese and Irish yields pushed through 7 per cent and stayed there, all three countries required bailouts as the task of refinancing their own budgets became impossible.)

In Italy's case, things are starting to look scary, with the higher cost of borrowing likely to wipe out any gains that government spending cuts might realistically achieve.

That means Italy's deficit will continue to rise and the country already runs a primary deficit (the shortfall before allowing for interest payments).

Add in what is likely to be further economic contraction as a result of austerity measures (and, like Greece, Italy has no currency or monetary policy stabilisers) and that debt profile looks even worse.

So while all eyes right now are on the circus being played out in Athens, don't forget that Europe's problems are both systemic and structural and not confined to a handful of smaller peripheral nations.

Certainly in Italy's case the country is too big to fail. Likewise it is also probably too big to bail.

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