Spring, 2010

From the Editor

Greece's Bailout Will Affect All Europe

We may think of ham or bacon when we read about PIGS, but in the aftermath of the financial crisis and in the midst of the Herculean efforts being undertaken to help Greece avoid default, PIGS is typically used as an acronym referring to the troubled eurozone economies of Portugal, Italy, Greece and Spain.

Although it looks like Europe will bail out Greece to avoid a messy sovereign default, with a reluctant Germany putting up a big share of the coin, the announcement of a $146 billion bailout package, which was promoted to stop a crisis of the Euro, seems to have done nothing to solve the problem.

Mostly this is because the bailout doesn’t, in fact, solve the problem. The problem is that Greece borrowed too much money. The bailout plan? Well it allows Greece to borrow more money! Yes, of course, there is a stern package of austerity measures set by the International Monetary Fund that Greece has agreed to implement, but there is little public support for austerity in Greece. In fact the streets of Athens have been filled with protests and marches, sometimes violent, as students, pensioners, workers in both the public and private sectors, Communists and others have objected to any measures that would require sacrifice. On May Day this year, young people wearing gas masks and hoods lit vehicles on fire, broke the windows in store fronts, and directed Molotov Cocktails and rocks at the police all while shouting: “No to the IMF’s Junta.”

The subtle term for what is likely to happen is to acknowledge that the austerity plan faces “implementation risk,” which means that there is a risk local politicians will lose all interest in implementing unpopular austerity measures once they get their hands on the money.

What we are observing now is really the reason the Euro was a bad idea. Normally, a country such as Greece, with its own currency — the Drachma before Greece adopted the Euro — would deal with such a crisis by devaluing its own currency. This is exactly the same thing as having workers accept lower wages, pensioners accept smaller pensions, welfare recipients accept less welfare, etc. The difference is that since all arrangements remain the same in nominal terms, a country is spared the social unrest Greece is experiencing in trying to get everyone to agree to take less.

Indeed one of the long-term negative consequences for Europe of bailing out Greece is that cultures that have been more financially successful, such as the Germans, may draw the lesson that profligate living pays off — and they will, consequently, work less, pay less taxes and save less.

If the Drachma was still around, trade could help spark a Greek revival. A collapse in the value of the Drachma would make Greece more competitive. It would instantly find its exports more appealing to customers around the world, while local consumers would find imports prohibitively expensive so they would buy more domestically produced product.

Foreign companies would find Greece more desirable for factories and offices as the cost of operating would be low and the currency favorable for export. Tourists would find their money brings more value in Greece and would start visiting more frequently and support local hotels, restaurants, shops and attractions.

These are the “automatic stabilizers” that help countries bounce back from bad economic problems. Without an independent currency though, none of these things happen.

In the United States, we can tolerate this type of thing because if Detroit collapses and Dallas booms, although it may hurt the local boosters, and certainly, localities will fight to rise again, it really is not a matter of national importance. It is impossible to imagine Greeks being as sanguine about the decline of Athens as the population moves to Frankfurt.

There is a world out there hungry for Greek figs, Kalamata olives and a universe of other wonderful Greek items, but the currency alignment is wrong and, until that is rectified, Greece will have a difficult time either painstakingly negotiating its way through a massive economic reconstruction with each domestic interest group or remaining less competitive than it could be.  EXP