What is the problem with Greece?

I am becoming increasingly infuriated by the low quality of reporting on the BBC and Sky News about the various issues facing Greece today. In this essay I shall attempt to give a brief overview of what Greece’s situation is, how it got there, and what might happen next.

Greece is a eurozone country. This simply means that the Greek Government allows Greek citizens to pay taxes in euros, denominates its national debt in euros, and that Greek businessmen by and large do business in euros. Greece cannot be ejected from the eurozone; it must decide to leave of its own accord.

What has happened then is that the country has run up too much debt. Normally a country in Greece’s situation would print money – ‘quantitative easing’ – which devalues the currency held by its citizens, but also the currency owed to its creditors. There is no reason after all to renege on a deal where you provide someone else with something you can make infinite amounts of at very low cost. However, because Greece borrowed euros, and not drachma, it cannot make more. Only the European Central Bank can print euros.

It is in the same situation Britain was in at the end of the First World War, when it had a massive amount of debt, denominated in pounds, but theoretically convertible to gold. After trying to muddle along for a few years, it eventually came off the gold standard in 1931 and inflated away its debt.

Graphic “When Greece falls” presented by Dutch government on 21 June 2011, speaking of European sovereign debt crisis (Photo credit: Wikipedia)

Greece then, has three alternatives:

1. It can leave the euro, reissue its euro-debt in drachma, and inflate it away; or

2. It can remain in the euro and simply default on the debt, leaving its creditors to suck up the losses or

3. It can implement massive cuts in public spending until its debts are paid.

Either of the first two options, despite being preferred by many Greek voters, would trigger a ‘credit event,’ meaning that the insurance which European banks are required to hold on sovereign debt by the Basel III regulations (called Credit Default Swaps or CDS’s) would pay out. The exposure of European financial institutions to this risk is difficult to estimate. To give the Greeks an incentive to take the latter option and avoid a default (and subsequently triggering massive CDS payouts), a consortium of other European countries offered Greece hundreds of billions of euros to accept an austerity plan.

These Greek elections are important, then, because almost all parties have pledged to attempt to renegotiate some or all of the cash-for-austerity agreement. The far-left Syriza party originally pledged to ‘tear it up’. This is against a backdrop of a country where – despite the European cash injection – law and civil society are breaking down. In Germany, public opinion is becoming increasingly frustrated with Greece, with one open letter, published in a major German newspaper, saying that the only reason Greeks could still withdraw Euros from ATMs was because ‘a German taxpayer put them there.’

Sadly, I predict that the bailout will not work. ND and PASOK will form a government and make a half-hearted attempt to renegotiate the terms of the austerity agreement, maybe changing something superficial as a sop to the Greek people, but it will not be enough. Where 250bn euros failed, 130bn euros almost certainly will too.

Jonathan Jones

Related articles

• Greek Election: Either Way, Greece Will Eventually Default – GeoStrat (blogs.wsj.com)
• Citi’s Buiter: Greece will be forced out of the euro regardless of who wins the Sunday elections (zerohedge.com)