America Is the Next Greece! Maybe Maybe Not!

2012 Cambridge Business & Economics ConferenceISBN : 9780974211428

America Is The Next Greece! Maybe…Maybe Not!

By

Wayne Buchanan, PhD

Defiance College

701 N. Clinton St.

Defiance, OH 43512

419 783 2356 (USA)

Abstract

Could the United States become the next Greece in terms of overspending compared to its GDP? With the presidential elections coming up in 2012, much has been written about the US becoming ‘just like Greece’ in terms of spending more that its GDP. This paper discusses this view and gives conclusions concerning this political and fiscal issue.

Keywords: Eurozone, Greece, fiscal crisis, Greek debt crisis, American debt, fiscal collapse, American politics;

Introduction

In early September 2011, the global debt crisis, created by the collapse of the American home markets (Buchanan & Gallagher, 2010), continued to assert its dominating influence over the major markets of the world. For years myriad issues have influenced global markets but currently, one of the leading issues is the European Union’s attempt to keep Greece’s government from completely defaulting on it’s debt. This issue has also been part of the American financial debate as the US tries to create the methodology to take control of it’s current debt load. In this discourse, Americans debated the potential of America following suit of Greece’s economic challenges. The question was, and the debate boiled down to, could America become another Greece?

Greek Situation

It began in Athens but the classic sovereign debt crisis unfolding across the Eurozone’s weaker economies (Greece, Spain, Italy, Portugal, and Ireland) could easily contaminate the larger EU economies of France and Germany, among others. The consequence of Greece’s default is far weightier than most people realize (Ferguson, 2011).

The uniqueness of the European Monetary Union’s (EMU) design does not permit a bailout of Greece by the European Central Bank (ECB), or any country in the European Union (EU), because assistance under the ECB’s articles 123 and 125 is predicated upon natural disasters or exceptional occurrences beyond the control of the country in need. Mother Nature certainly did not cause Greece’s fiscal problem, nor was it beyond Greece’s economic control. Greece cannot print its own money (Drachmas) as it did pre-EMU days, nor can it leave the Eurozone. Only three options are available: Greece defaulting on all or part of its debt; a funding injection into the Greek economy by the ECB; or reducing Greece’s deficit to 3% from 13% of GDP within three years (Ferguson, 2011).

While Greece is not the only western economy to be facing these types of draconian steps to stabilize its economy, how did it get into this predicament?

Timeline of Greek Issues: Why is Greece in trouble?

By moving to the euro in 2002, Greece found that it was easier to borrow money and went on a leveraged-based spending spree. Public spending rocketed, as did the spending on the 2004 Olympics that were massively over budget. Public sector salaries virtually doubled during the past decade. When the global crisis hit, less taxes were collected (due to higher tax evasion and higher employment rates), and the country had to spend more on public benefits. Borrowing to contend with these increased outlays, lenders started charging more interest on the loans (BBC, 2011).

When the global financial downturn hit, Greece was ill-prepared to cope. Between December 2009 and mid-May 2010, the 10-year bond market rates that dictated what Greece would have to pay in interest went from 5% to a peak of over 12%. It was given its original bailout in May 2010 of €110bn of IMF and EU bailout loans. The reason it had to be bailed out in 2010 was that it had become too expensive to borrow commercial money. Rates drop to 8% after the plan is implemented. Yet, within a month, Moody’s downgrades Greek debt to junk. By the end of June 2010, rates move up to over 10% for Greece to borrow money (Cadman & Minto, 2011).

Over the course of the next year, rates rise to 18.4% despite major austerity actions by the Greek government. These measures caused riots and changes in various leadership positions in the Greek government in order to gain support and confidence in the repayment of Greek debt. The 2010 bailout fails to enable Greece to regain control of its debt restructuring and repayment issues, therefore it again turns to the EU and the IMF for assistance (Cadman & Minto, 2011). In July 2011, barely a year later, Greece was granted access to €109bn rescue package from the Eurozone leaders and the IMF. Hopes are to calm financial markets and to stop the spread of defaults spreading throughout Europe (BBC, 2011). Despite this effort, budget deficits increase and the rates on the 10-year bond reaches 18.3% in late August 2011 (WSJ, 2011). By the end of this year, Greek debt will total about 150% of its gross domestic product (Hough, 2011). Greece missed reducing the deficit to 8.4& of its GDP, but it did drop it 5% to a 10.4% level down from 15.4%. Greece is quickly digging a deeper hole now, with deficits expected to total around 10% of GDP this year (Yatrakis, 2011). Yet, short-term Greek bonds recently yielded 30%, a sign that investors only half-expect to be paid (Hough, 2011).

Why Can't Greece Just Default On Its Debts?

Greece has already defaulted…at least some think so. The reason is that while the expected debt restructuring will not be a complete zeroing-out the debt, it will be in the form of debt buybacks at a discount, longer repayment periods, lower interest rates, and other steps. While not voluntary by the holders of the debt, they will probably be accepted (Yatrakis, 2011).

Banks and institutions already holding Greek bonds are being asked to accept a 21% loss on the debt they hold and swap their holdings for longer-term maturities (BBC, 2011). This debt swap could trigger ratings agencies to declare that Greece has selectively defaulted. If Greece printed the Drachma, it may be tempted to write off some of the debt or print more money to pay down the debt. However, it is in the Eurozone and therefore does not print nor control its currency. Eurozone governments are desperate to avoid a comprehensive default and are willing to give assistance to stop this action by Greece. If this turns out not to be the case, interest rates would rise significantly for smaller EU states when they need to borrow. Ireland and Portugal may have to default as well if this happens. The amount of money that could be lost to the banks of the indebted countries would be untenable. Rescuing still seems to be the preferred action since France would lose upwards of $60B, Germany $44B, and the UK $14B (BBC, 2011). Without a doubt, the irresponsible bankers across Europe who loaned the money to Greece are trying to recoup whatever they can with the help of their governments. The lunacy of these rescues, which are nothing but a patch that does not solve the problems for good, has a positive aspect. The banks that hold the majority of Greece’s debt need time to improve their balance sheets to absorb the fiscal shock of a Greek debt write-off. As this is delayed, the euro continues to be weak and improves these country’s exports. The Greeks also don’t mind the wait because it allows its own banks to build their reserves, and it can borrow to close the gap between tax revenues and government spending. Closing this gap gives leverage to Greece’s bargaining power. With a 10% gap reduction, Greece’s primary deficit will disappear, and it is already half-way there. This will also allow Greece to push back on their creditors because it won’t need them anymore. This will give Greece the chance to balance its books internally even if it is forced to default (Yatrakis, 2011).

Another reason to keep the bailouts coming could be the survival of the 17-nation Eurozone itself. If Greece does not come out the other side of the bailouts, the same actions given to Portugal and Ireland may end up the same way. If that happens, then Spain and Italy could be on the same path as Greece in the near future. These last two economies are far larger than the previous three, and the EU would be hard pressed to give money to Spain and Italy (Alloway, 2011).

A default by Greece or any other EU country could cause a contagion that could require global-scale bailouts. The crash of 1939 started with a default of a small bank in Vienna, when financial globalness wasn’t an issue as it is today (Yatrakis, 2011). This is the battlefield where the fate of the euro will be decided, and whether the Euro survives the crisis, is another question (Alloway, 2011; Yatrakis, 2011).

Greece is a tottering sovereign debt crisis domino that could spell the doom of the European Union. Its fiscal collapse could have EU countries jumping ship to reinstitute their own currencies. Nevertheless, is the US in the same predicament that Greece finds itself and could the circumstances be duplicated in America?

America Is Not Greece

Holland (2011) has five reasons why the Greek situation is similar to what he calls comparing apples to armadillos.

1. Greece Has a Debt Loaded Small Economy

While the debt load is not the largest in the history of the US, the largest economy of the world was in debt equal to 61% of its GDP at the end of 2010. Greece’s debt was 148% of its GDP, nearly two and a half times the relative debt load of America. In addition, Greece’s government spends 40% of its GDP in the public sector, while the US only spends about 25%. No caparison (Holland, 2011).

2. Greece Doesn't Have its Own Currency

The largest difference is Greece’s participation in the Eurozone and does not control its own currency. This is important for two reasons. First, central banks of countries that control their own currency have some tools to manage their debt. For instance, they could increase inflation that would cut the country’s outstanding debt burden. Second, they could just print more money and pay down the debt. Greece cannot do either since it is tied to the euro (Holland, 2011).

3. The United States Can't Default (Unless it Chooses To)

Because America owns its own currency, it cannot default unless is chooses to do so. America can always print more money to pay off the loans and with the current recession causing high unemployment and excess capacity, the threat of high inflation is remote. Greece cannot print money, therefore, cannot pay off its loan from within (Holland, 2011).

4. Nobody's Foolish Enough to Buy Greek Debt

Greece’s current massive debt load prevents it from selling its own government bonds in the private market. In addition, it is being forced to adopt severe austerity measures to receive continued bailout money from the EU (Holland, 2011).

America, on the other hand, can sell its debt, at a cheap price, and almost at will. As long as the Eurozone is having it current issues, America is the best place to put long-term investments. America has it’s own issues, but other countries are worse off (Holland, 2011).

5. Greece Doesn't Do a Good Job Collecting Taxes

Greece could reduce most of its deficit if it collected a higher rate of taxes owed by its citizens. While Greece loses about a third of this amount, the US only loses 15% (Holland, 2011).

Greece is insolvent, has a small economy, tied to a common currency it does not control, and is in debt past its eyeballs. America is solvent (so far), has the largest economy of all, controls its own currency, and is not in debt past its eyeballs (Holland, 2011).

America Does Look Like Greece

There are economic similarities between America and Greece that would make people believe that America is Greece. Both countries are bleeding red ink at about the same rate relative to their GDP. Greece is bleeding at a 10.5% rate compared to 9.3% for the US (FactCheck.org, 2011). The US is now where Greece was a decade ago; if it does not mend its ways, it will certainly start looking like Greece in this respect (Papagianis, 2010). This comparison between the two countries make sense because without making debt reduction actions, the US is poised to go down the same path Greece has traveled in the last decade.

Could America Become Greece?

Does the US have the political fortitude to stop the bleeding and does this action need to be accomplished by tomorrow? Currently, the US will kick the can down the street as the solution to this debt-spending binge as the Europeans have done already. The reason is the deeply divided ideological differences between the two parties in Congress. However, there may be an unseen benefit in this debt morass. With the next governmental elections coming up in November 2012, both Democrats and Republicans are offering different proposals for resolving the ‘looking like Greece’ debt explosion. As usual with politics, both solutions will work, but differently. Republicans would reduce entitlement programs (Medicare and possibly Social Security) and keep taxes low. Democrats would raise taxes on the wealthy and corporations and cut spending on defense. Past compromising would have implemented a mix of these two solutions, but that is almost impossible in the vitriolic political atmosphere in Washington. Therefore, the electorate will make the decision in November 2012 by choosing between the two options (Yatrakis, 2011).

Conclusion

Does America look like Greece and could find itself in the same predicament? Yes and no. Yes, the two countries are deficit spending at about the same rate and the potential of America following Greece’s example laid down over the last ten years is certainly possible. American can create the environment that will stifle job creation and economic growth if it is not careful. No, the sovereign currency crisis in Greece is very different from America. The US controls its fiscal system and can take steps to pay off its debts by just printing more money. While the repercussions are not nice, it may do this on its own accord.

Yet, economic ruin is not just about specific debt-to-income ratios, but also what the voting public thinks about a particular set of solutions that will ensure future financial stability. For both Greece and America, if they do not get serious about deficit reduction, the conditions for crisis will remain. This is something that neither country can sustain.

References

Alloway, T. (2011). The US’s Greece-y new debt dynamics. Retrieved 8/30/11 from

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Buchanan, W.D. & Gallagher, M. (June, 2010). Taming of the Celtic tiger: America’s

homeownership collapses Irish Economy. 2010 Oxford Business & Economics

Conference Proceedings. St. Hugh’s College, Oxford University, Oxford, UK.

Cadman, E. & Minto, R. (2011). Interactive timeline: Greek debt crisis. Retrieved 8/30/11 from

FactCheck.org. (2011). FACT CHECK: Does the United States “look a lot like Greece?”

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Ferguson, N. (2011). A Greek crisis is coming to America. Retrieved 9/2/11 from

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totally wrong: Right-wing media and lawmakers are spinning utterly wrong comparisons

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June 27-28, 2012

Cambridge, UK1