Understanding Greek Debt

February 1, 2015

'When the Facts Change, I Change My Mind.
What Do You Do, Sir?'
John Maynard Keynes

By understanding the facts about the real Greek debt situation it is possible to understand the analysis, strategy and tactics of the new Syriza government and to also understand why almost all of the money in the Greek bailout has not actually been spent in Greece but has in reality gone into, and protected, the private sector financial institutions. It was not the people of Greece who benefitted directly from the bailout loans from the IMF, EU and European Central Bank, but the European and Greek banks which had recklessly lent money to the Greek State in the first place. The way this bailout has been structured and delivered has actually made the suffering of the Greek people resulting from national bankruptcy worse and that suffering has been cemented in place as a more or less permanent feature of the Greek nation for years and possibly decades to come. Greece has not been been sent to economic hell, instead it is trapped in economic purgatory.

For several decades Greece has been run by a corrupt elite who mismanaged a woefully incompetent state administrative system sitting on top of an inefficient and uncompetitive oligarchic private sector. This long period of bad government in the years before the financial crash culminated in a massive debt-fuelled spending spree that was so large that it bankrupted the nation. Normally in such circumstances a national default would have taken place and there would have been a wrenching and painful economic adjustment, a devaluation of the currency, losses for the banks that had lent the money, a period of economic contraction and then a period of recovery. None of that took place with the Greek bankruptcy because Greece was part of the Euro currency union.

Because the Greek national bankruptcy occurred within European currency union it meant that the ‘normal’ response to a national default, a devaluation of the currency, was not possible. This made managing the Greek default very difficult because when trying to grow their economy and recover from the default the Greeks are being forced, by the currency union, to use an over valued currency which makes their exports too expensive and their imports too cheap. Under such circumstances it is astonishing that Greece has actually managed to achieve a small current account surplus in the last year, however in reality this was caused by collapsing import demand result from the impoverishment of much of the population. The IMF’s deputy managing director, Nemat Shafik, once memorably compared the process of recovering competitiveness to painting a house

“If you have an exchange rate, you can move the brush back forth. If you don’t have an exchange rate, you have to move the whole house.”

On top of the severe problem of not being able to devalue their currency the Greeks faced other problems because the terms of reference for how the Greek default was going to be managed were set by the institutions of the Eurozone. These institutions were the European Central Bank, the European Commission and the governments of the other member states (above all Germany), and the way the Greek default has been managed has consistently reflected what this group saw as being necessary measures to protect the flawed architecture of the Eurozone rather than the interests of the Greek people. This has meant that the Greek default has not unfolded in the same way it would have done if Greece were not in the Euro zone. Instead of being a short, intense and unpleasant episode of limited duration the Greek default has turned into a quasi-permanent state of deep economic depression with resulting very high human costs.

The priorities of the EU institutions in dealing with the Greek default were focussed on three key issues; transfers, emulation and contagion.

Transfers: Single currency areas, such as the ‘dollar zone’ in the US or the ’sterling zone’ in the UK always also have a single fiscal system whereby the bulk of public spending and taxation occurs through a single integrated system covering the entire currency zone. Through this integrated fiscal system money is constantly collected through the tax system and redistributed from the richer areas to the poor areas in an almost invisible process. Significant public programmes such as social security, pensions, social health, etc are funded by taxation at the level of the entire currency zone. This is not possible in the Eurozone because a fiscal union in the Eurozone would only be practical if it were part of a full political union (i.e. a full blown directly elected European Union government)and this is not possible under current political circumstances. Such a political union would not be supported by either the European political elites or by the mass of ordinary European citizens. Under these circumstances, without a permanent and comprehensive fiscal system across the whole Eurozone, there can only ever be high visibility ‘one off’ emergency transfers of money from richer countries to poorer countries. The richer countries of the Eurozone have actually been making such transfers – to Greece, Portugal and Ireland – during the recent crisis but these transfers are considered to be only emergency measures caused by an unfortunate crisis and not a permanent feature of the Eurozone system. Therefore the transfers come attached with stringent conditions which are intended to preclude the need for any future transfers which means that the conditions are all about cutting spending and reducing deficits. These are are the very things that should not be done at the bottom of a deflationary recession/depression. As a result of these damaging deflationary measures being imposed as part of the financial bailouts the European economy has sunk into stagnation and contraction.

This is what Mario Draghi the President of the European Central Bank said about transfers in January 2015.

“In other political unions, cohesion is maintained through a strong common identity, but often also through permanent fiscal transfers between richer and poorer regions that even out incomes ex post. In the euro area, such one-way transfers between countries are not foreseen”

Emulation: The richer countries of the Eurozone want the transfers that have taken place (to Greece, Ireland, Portugal) to not become the norm. They desperately do not want a situation where Eurozone members states can run up large debts and expect to be bailed out. Transfers from richer to poorer countries in the Eurozone are not going to be a permanent feature of the Eurozone system and so any such emergency transfers must come with very tough conditions attached. These tough conditions are not merely intended to force healthier fiscal policy in the recipient nations but also to be so harsh and demanding that other nations will think twice about getting themselves in a position where they too might need to be bailed out. Tim Geithner, the former US Treasury Secretary, has gone on record in both his book and in interviews with FT about his dealings with the EU at the time the crisis first erupted and makes it plain that there was a strong and explicit desire to punish Greece. In February 2010 Geithner was at a G7 gathering in the Canada and by then it had already come out that Greece’s budget deficit was 12% of GDP – not 6% as previously claimed – and the wheels were coming off the Greek bond market. Geithner says that “the Europeans came into that meeting basically saying: ‘We’re going to teach the Greeks a lesson. They are really terrible. They lied to us. They suck and they were profligate and took advantage of the whole basic thing and we’re going to crush them.’ That was their basic attitude, all of them.”

Contagion: All the governments of the Eurozone have to raise funds by selling government bonds and if the market thinks that any government is riskier than others then the interest the banks demand in order to buy those bonds will increase and thus servicing government debt (rolling over – repaying – expiring bonds by selling new ones) will become very much more expensive very quickly. A very large government debt is perfectly manageable as long as the financial markets have confidence in the government and country concerned thus making servicing that debt by new bond sales affordable. Conversely a large debt can become unmanageable very quickly, as happened to Italy recently, if the markets decide that because of the risks involved it will only buy new bonds with cripplingly high interest rates. The Eurozone leaders believed, probably rightly, that if financial institutions were made to take big losses on the Greek debt, causing perhaps a string of bank collapses, lending to other Eurozone countries with big debts would become very expensive and possibly dry up altogether, fuelling a spreading debt crisis in the Eurozone. Italy is particularly vulnerable because it has high debts and a lot of short term bonds that have to be rolled over very frequently. This vulnerability of the Eurozone governments’ bond market is a design fault of the flawed Eurozone system (possibly a topic for a future post). It is not the responsibility or fault of the Greek people who are the ones paying a tremendous price in suffering in order to prop up the badly designed Eurozone.

So the bailout package for Greece was assembled, painfully slowly because the management of the Eurozone is a Byzantine labyrinthian mess, and the package had the following core components:

It was impossible to officially knowledge that Greece was bankrupt. A problem of insolvency had to always be presented, and be dealt with, as a problem of illiquidity. Greece had not gone bust it had just temporally run short of money and needed a bridging loan during a difficult period. All its debts would be paid.

Protecting banks from losses was seen as being the paramount concern. This was to to prevent contagion and a resulting spread of the crisis across the weaker Eurozone periphery, and so the funding from the Troika would go primarily to rescuing Greek’s creditors, the banks.

The bail out terms had to be harsh and were focussed on achieving a Greek budgetary surplus which could be used to repay the debt. In order to deter other Eurozone countries from thinking they could use the richer countries as lenders of last resort a harsh, punitive in fact, reform package would be imposed on the Greeks. This reform package would not actually directly attack the oligarchic and corrupt elite that had caused most of the problems but would, following the narrative of ‘this is not a bankruptcy’, be all about balancing the books and achieving a budget surplus. So spending was to be slashed, assets sold off, taxes raised. This reform package was imposed even though it has been understood since the Great Depression of the 1930s and since the work of Keynes that cutting spending, raising taxes and reducing a budget deficit is exactly the wrong thing to do at the bottom of a depression and will only lead to the deepening and perpetuation of the depression.

When the IMF, European and ECB bailouts began in 2010 €310 billion had already been lent to the Greek government by reckless banks and the wider European financial sector. During the decade before the financial crash of 2007-8 the global financial system was awash with cheap capital looking for investment opportunities no matter how speculative or risky. The vast amounts of cheap capital flowing through the financial system were the recycled surpluses from the countries running them, and the two biggest by far were China and Germany. Most Chinese capital ended up in the USA fuelling the sub-prime property bubble. Most of the German capital found it’s way into European financial system fuelling property bubbles in Ireland and Spain and a government spending spree in Greece by the centre right government of 2004-9.

Since the bailout began, the ‘Troika’ of the IMF, EU and European Central Bank have lent €252 billion to the Greek government. Of this, €34.5 billion of the bailout money was used to pay for various ‘sweeteners’ to get the private sector to accept the 2012 debt restructuring. €48.2 billion was used to bail out Greek banks following the restructuring, which did not discriminate between Greek and foreign private lenders. €149.2 billion has been spent on paying the original debts and interest from reckless lenders. This means less than 10% of the money has reached the people of Greece.

Today the Greek government debt is €317 billion. The debt has not gone down because the Troika bailed out the banks and not the Greek state. Now 78% of the debt, a total of €247.8 ,is owed to the ‘Troika’ of the IMF, European Union and European Central Bank. Debt recently held by private financial institutions is now a debt held public institutions primarily in the EU but also across the world.

The bail out has not been of Greece but of the the European financial sector, passing the Greek debt that was owed to the private sector to the public sector.

Who the Greek debt is owed to at the end-2014

CreditorAmount Owed
IMF€27 billion
EU€194.8 billion
ECB€26 billion
Other€69.2 billion
Total€317 billion

Bailing out European banks rather than making them cancel debts ensured the private investors would get repaid, whilst the public would pay the costs of having to cancel debts in the future. Meanwhile the austerity program that was imposed as a condition for the injection of public funding has crashed the Greek economy, increased poverty and pushed unemployment to a politically unsustainable 25%. Take note that an openly Nazi party came third in the recent Greek election.

The really terrible thing is that after all the suffering caused by the massive government cuts and the economic collapse, the contraction of the Greek economy means the Greek debt has actually grown in relation to Greek GDP. Greek debt was 133% of GDP in 2010 and is 174% today. Greece is in a deep hole and the stern instructions from Brussels and Berlin to the people of Greece are to keep digging as hard as they can.

In 2012, two years after the bailouts began, it was finally accepted that Greece needed some debts cancelling. An agreement was reached with many private creditors to cancel 50% of the debt owed to them. However by this stage the public institutions of IMF, EU and ECB had been bailing out these reckless lenders for the previous two years, so many had already been repaid. None of the debts being taken on by the public institutions were included in the debt reduction.

Moreover, whilst the IMF, EU and ECB debts were excluded, debts owed to Greek banks and financial institutions, including pension funds, were not. The 50% debt reduction bankrupted these banks, so the Greek government borrowed more money from the IMF, EU and ECB to bail out the banks. The pension funds which lost large amounts were not refunded.

If Greece were to adhere totally to the Troika terms, over the next five years it would make resource transfers of about 20 percent of one year’s GDP. From the point of view of the creditors, that’s a trivial sum. From the point of the Greeks however, stuck as they are at the bottom of a very deep depression, it’s crucial. The difference between a primary surplus of 4.5 percent of GDP and, say, 1.5 percent of GDP for the Greek economy and the welfare of its citizens is huge.

It is in this context that the significance of recent comments from Yanis Varoufakis about Greece being insolvent becomes clear. Openly acknowledging that Greece is bankrupt is very important because everyone knows that bankrupt entities do not pay their debts, that the creditors of bankrupt entities always take a loss.

In his “open letter” to German citizens published on January 13th 2015 Alexis Tsipras the new Greek Prime Minister took a similar position on the consequences of trying to deny that Greek has gone bankrupt. This is what he said:

“In 2010, the Greek state ceased to be able to service its debt. Unfortunately, European officials decided to pretend that this problem could be overcome by means of the largest loan in history on condition of fiscal austerity that would, with mathematical precision, shrink the national income from which both new and old loans must be paid. An insolvency problem was thus dealt with as if it were a case of illiquidity.

In other words, Europe adopted the tactics of the least reputable bankers who refuse to acknowledge bad loans, preferring to grant new ones to the insolvent entity so as to pretend that the original loan is performing while extending the bankruptcy into the future. Nothing more than common sense was required to see that the application of the ‘extend and pretend’ tactic would lead my country to a tragic state. That instead of Greece’s stabilization, Europe was creating the circumstances for a self-reinforcing crisis that undermines the foundations of Europe itself.”

Syriza is proposing a debt conference based on the ‘London conference’ which agreed debt cancellation for Germany in 1953. The 1953 conference agreed to cancel 50% of Germany’s debt to governments, people and institutions outside the country, and the payments on the remainder were made conditional on Germany earning the revenue from the rest of the world to pay the debt. The German debt deal in 1953 was very successful. It supported German economic recovery, and gave an incentive for creditors to trade so that they would be repaid. Greece was one of the countries which agreed to cancel the German debt it was owed.

Syriza is proposing debt cancellation through a similar conference (some have suggested of around 50%, though there is no policy officially stated), with the remainder of the debt to be paid over several decades to ensure that Greece can continue to repay. At the same time it wants to stop the fire sale of valuable Greek state assets at rock bottom prices and wants to reflate the economy. Greece is not in budget deficit at the moment, both the government budget and the trading current account is in surplus. Syriza thinks it would be better to use that surplus to reflate and grow the economy instead of tossing it uselessly into the vastness of a mythical debt repayment.

Syriza is not trying to deliver a ‘leftist’ program, it is a government that wants to deliver a fairly run-of-the-mill social democratic program within a Keynesian economic policy framework. Only in the bonkers world of the Eurozone would this be seen as radical or dangerous.

The entire framework in which the causes and cures for the problems of the weaker periphery in the Eurozone has been thought about has been wrong. The results are clear. Depression, stagnation and impoverishment. It’s time for a change.

Postscript: The view that the current Greek debt and repayment package is unsustainable is widely accepted and understood. In October 2013 the minutes were leaked from the 2010 IMF Board meeting which approved the Greek bailout contribution. The minutes show that many countries on the IMF board were opposed to the terms of the proposed Greek bailout and thought debts should be cancelled instead. Most strikingly, drawing on their own experience of failed bailouts in the late 1990s and early 2000s, Argentina argued that a “debt restructuring should have been on the table”.

Brazil said the IMF loans:

“may be seen not as a rescue of Greece, which will have to undergo a wrenching adjustment, but as a bailout of Greece’s private debt holders, mainly European financial institutions”.

Iran said it would have expected a debt restructure to be discussed, as did Egypt, which said the IMF’s growth projections were “optimistic”, a word repeated by China. The growth projections were extremely optimistic; Greece’s economy is now 19% smaller than the IMF said it would be, having shrunk by more than 20% since the start of 2010.

India warned that the scale of cuts would start a spiral of falling employment which would reduce government revenue, causing the debt to increase, and making a future debt restructuring inevitable. This is exactly what happened; unemployment in Greece is over 25%, with almost two-in-three young people out of work.

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