Transcript | 5. lecture: Genesis of the euro crisis - Greece - University for modern Slovakia

In the previous UPMS lectures we have inter alia explained that the world economy underwent a period of abundance and growth in the first decade the new millennium. This period was characterized by a significant degree of fiscal and monetary expansion, which together with the enormous increase in financial globalization, new financial products has created the illusion of risk-free growth and prosperity.

In the years 2008 - 2009 it was fully revealed, that it was just a bubble that burst with a great noise exposing all the problems, which it had previously created and concealed.

Let's look at what happened in Europe. As we said a week ago, the euro was introduced as a virtual unit of account in 1999 and as a real fully fledged currency in 2002; i.e. at the time of the greatest abundance and the greatest global boom. As we have also said they were carefree times and the euro has strengthened this carefreedom significantly. There was a belief on the market that the riskiness of euro area member countries was significantly reduced and that in fact there were no differences in the risk of loans to Greece and Germany. This was clearly demonstrated by the evolution of spreads, i.e. the interest differentials between loans of individual countries. Prior to joining the euro zone, Greece used to borrow significantly more costly than Germany, after entry, these differences became minimal. Even in October 2009, Greece borrowed only about 1.3% more costly than Germany. In March 2010 it was 2.5%, 7.5% in April, and 10.4% in May. After the rescue action of the EU, it had temporarily dropped although, but in September again Greece borrowed almost 10% more costly than Germany.

Among the problematic countries nowadays belong especially the so called peripheral European countries PIGS, Portugal, Ireland, Greece, Spain, or PIIGS (also including Italy). The causes of the problems of these countries are not identical. We will look at the example of Greece on the one hand and Ireland on the other. The fundamental difference is that while in Greece, mainly the government has failed, in Ireland it was mainly (though not only) the failure of the private sector. And an important role is played in everything, as always, in addition to politicians the banks and bankers. And, of course, the euro.

First, Greece. Greece traditionally had not a very responsible economic policy. High level of bureaucracy, corruption, state intervention, fiscal irresponsibility, inflation was more the norm than the exception. Devaluation of the Greek drachma was the mechanism through which the Greeks paid contribution for such a policy and through which the marked used to be re-balanced. This matched also the conditions under which Greece was borrowing before joining the eurozone.

Source: Reuters

Table: Greek bond spreads against German bonds (10Y bonds) were over 1000 bps (basis points, 100bps = 1 percentage point) at the beginning of 1995 and gradually diminished with the expected entry into the euro area. At the beginning of 2001 they were at about 50bps and in the next years the Greek bond yields were almost identical to the German. Spread was less than 0.5 p. b. until 2008, when under the influence of the growing crisis fiscal problems of the country began to manifest. Spreads thus continuously increased until the current level of 8 p. b. (March 2011).

Then joining the euro area came, and Greece was accepted only because of the very generous way of assessing compliance with the Maastricht criteria (public debt was already 100% of GDP while the Maastricht limit is 60%). And they began to feast. The enormous debt burden, the living conditions above affordable level, lack of reforms, and if it was not enough even falsification of statistics, mainly in terms of deficit and debt. All crashed after elections in October 2009 when the new government announced that instead of the expected deficit of 3.7%, a catastrophic 12.5% ​​of GDP in 2009 was awaited. The reality was ultimately even worse as the deficit reached 15.4% of GDP.

Life above affordability is the best shown by comparison of real wages development in the years 1999 to 2009 in Greece and Germany. While in Germany, real wages for this period decreased by 6% in Greece they were raised by 44.6%. The fact that the problem was mainly due to the government activity in the public sector is best illustrated by comparison of real wages in the two countries in the public sector. While in Germany they had decreased by 1.5%, in the Greek public sector real wages had increased by an incredible 76.7%.

Thus the most important cause of the crisis in Greece was a major disparity between salaries and evolution of productivity. When it all broke, Greece ended in a situation when no one was willing to lend them under acceptable conditions. And then the help came from the euro area. At the end of April 2010, Greece asked the European Union for help. European Commission, European Central Bank and the IMF prepared a three-year stabilization program and the euro area countries together with the IMF collected 110 billion euros for loans for Greece. It was argued that it will help Greece and solve their problem. Today it is clear that neither first nor the second is true.

The Greek government has adopted consolidation program which is very ambitious and difficult for Greece. According to it, after the public deficit of 15.4% in 2009 and 9.6% in 2010, it will gradually reduce to below three percent in 2014. It is very doubtful whether this goal will be achieved, as it also requires many unpopular measures, and also means a reduction in domestic demand, which significantly reduces economic growth and especially on the grounds that (unlike Ireland) the failure of domestic demand is not replaced by increased export performance. And that is just the biggest problem of Greece - low competitiveness. In other words, the problem is not a lack of liquidity but a lack of solvency. This is later reflected in the low economic growth and also growth of debt. Even provided that the consolidation program and reducing the deficit below three percent in 2014 will be achieved, public debt of Greece in 2012 will get to around 150% of GDP. Thus the burden that is difficult to sustain without additional assistance from the euro area. The only chance to reduce this debt is a massive privatization program and the sale of assets owned by the Greek state. A more realistic possibility which is, however, denied by politicians and bankers is to restructure the Greek debt. Why they deny it, and why the Greek loan was a mistake we will discuss in the following lectures.