2009 December 12 Saturday
Will Greece Go Bankrupt?

The European Monetary Union is threatened by the threat of default on growing public debts in Greece, Ireland, Spain, and some other spendthrift European countries. Der Speigel takes notice.

Practically unnoticed by the public, an issue has returned to the forefront in recent weeks -- one that was a cause for great concern at the height of the financial crisis but then, as optimism about the economy began to grow, was eventually forgotten: the fear of a national bankruptcy in the euro zone. And the question as to whether such a bankruptcy, should it come about, could destroy the common European currency.

Greece was always at the very top of the list of countries at risk. But now the danger appears to be more acute than ever.

Greece could conceivably exit the Euro and bring back their drachma if the crisis hits an acute state where the Greek government loses the ability to refinance debt at affordable interest rates. This crisis looks set to get worse before it resolves. The Greek sovereign public debt shows America her future.

Brussels says Greece's public debt will rise from 99pc of GDP in 2008 to 135pc by 2011, without drastic cuts. Athens has been shortening debt maturities to trim costs, storing up a roll-over crisis next year. Some €18bn comes due in the second quarter of 2010 (IMF).

America's fiscal path is more like that of irresponsible southern European countries than like that of the staid solid Germans. We can watch how events play out in other reckless spending countries to get a taste of our future.

There is a risk of financial contagion in southern and eastern Europe.

The European Commission projects Greece's 2009 budget deficit at almost 13% of gross domestic product, versus an EU average of just under 7%. Greek government debt, currently about 112% of GDP, probably will balloon to 130% before stabilizing, Fitch said.

Fitch cut Greece's rating a notch to BBB+, still within investment grade, citing its lack of decisive action to rein in the deficit. High debt and a sluggish economy are shared by Portugal, Ireland and Spain, creating a risk of contagion if investors flee Greek assets.

If you enjoy the chaos of a fiscal crisis then find a way to go live in Greece for a couple of years. Mish Shedlock also sees a possible crisis in eastern Europe.

"This raises question marks over the long-term viability of the euro's current membership," said Simon Tilford, chief economist at the Center for European Reform, a London think tank. "On current trends," he added, "we'll end up with economic stagnation and mounting political tensions in the euro zone, and, at worst, fiscal crises and a loss of political support for continued membership."

The acute crisis might come by the end of 2010.

Dec. 11 (Bloomberg) -- Greece and Ireland are among countries in an “intolerable” economic situation, which may lead to bailouts or even an exit from the euro area by the end of next year, according to Standard Bank Plc.

You can see the market's appraisal of the risks by looking at interest rate premiums over German government debt. Greek leads the way toward default with a premium of 2.5% with Ireland following at 1.8%.

On Thursday, the risk premium that investors demand for holding 10-year Greek government bonds rose again by 0.13 percentage point to 2.50 percentage points over German government bonds, which are seen as safe, according to Barclays Capital. This spread — a key gauge of market fears — has jumped 85% since Nov. 12 and hasn’t been this high since April.

The Spanish and Portuguese interest premiums are substantial but small in comparison.

Thursday, the so-called “spread” between Spanish and German government bonds widened 0.04 percentage point to 0.66 percentage point, while the spread on Portuguese bonds versus German debt is 0.075 percentage point wider to 0.77 percentage point.

...

The spread between Ireland’s government debt yields and the German equivalent widened further by 0.105 percentage point to 1.80 percentage points.

Harvard economist Martin Feldstein says the European Monetary Union allowed the Greek government to be far more irresponsible.

"The current situation in Greece shows the problems created by a single currency," says Martin Feldstein, a Harvard University economist who is perhaps the euro's most prominent skeptic.

...

"The single currency enabled Greece to issue enormous amounts of government debt until it reached the current crisis level," Feldstein said in an e-mail interview.

Will the Germans bail out the Greeks in order to protect the monetary union? I do not see how that can solve the problem without a simultaneous large scaling back of the size of Greek government. How will this crisis resolve itself?

Can Euro zone ejections be limited to only a few smaller reckless countries?

First off, the "oh, it's only Greece, it's only small" argument falls apart. As currencies analysts at Commerzbank said Wednesday, "the euro zone is only as strong as its weakest link."

A high trust high social capital society is a precious vulnerable thing to have (a point that pro-open borders libertarians and liberals do not understand). Greece has low trust and high contempt for government. One in four workers in Greece work for this government that most do not like.

The underground economy, which some estimates place as high as 30 percent of gross domestic product, helps people in countries like Greece that have European prices but salaries below the European average.

As he sat in a cafe with friends in the chic Kolonaki area on a recent afternoon, Antonis, 33, who disclosed only his first name, proudly announced that he refused to pay taxes.

“Why should I pay?” he asked with a grin. “I don’t care about my government; I don’t care about my country,” he added. He conceded, however, that he did care about soccer and women.

Update: Mexico's credit rating is as low as Greece's and the market thinks Mexico's default rate is much lower than its credit rating.

Credit-default swaps, contracts investors use to protect against non-payment of debt, show Mexico trading as high-yield, or junk -- placing it three levels below the nation’s BBB+ grade from Standard & Poor’s and Fitch Ratings -- on concern the tax increases will fail to stave off downgrades.

Share |      By Randall Parker at 2009 December 12 10:29 AM  Europe Monetary Union


Comments
stephen said at December 12, 2009 10:51 AM:

Greece does not print the currency that is pays it's liabilities in. The US does. A better comparison would be US state and local governments to individual countries in the EU.

Randall Parker said at December 12, 2009 12:54 PM:

stephen,

But the bond market can get scared of buying more US debt and people can shift out of the dollar. The US government can go further down the fiscally irresponsible road before a reckoning. But the reckoning is not avoidable.

not anon or anonymous said at December 12, 2009 1:33 PM:

Italy's public debt is even larger than Greece, and the country has similar (albeit lesser) institutional problems. So if a debt crisis happens in Greece, the contagion will probably spread to Italy--Spain and Ireland will be hit to a lesser extent. France and Germany have not been immune to excess debt either, so this could definitely threaten the EU as a whole.

Unfortunately, we know very little about how to improve institutional cohesion. What EU subjects can hope for is a mild austerity program to scale back national governments' involvement in the economy.

Wolf-Dog said at December 12, 2009 3:34 PM:

With a few mouse clicks that central banks of all countries can convert the bonds into cash, eliminating all the debt. The only consequence will be that the raw materials will become more expensive. This is being done in the United States already, as the Fed is buying all the bonds in exchange of newly printed cash. Of course there will be inflation, but only at the level of raw materials, because of the following fact: the amount of cash the governments allocate PER impoverished unemployed person is small even though this sum is enormous due to the large number of such individuals.

Trent Telenko said at December 12, 2009 6:04 PM:

Randell.

FYI:

Wednesday, December 9, 2009
New underground economy

Richard W. Rahn

The underground or "black" economy is rapidly rising, and the fault is mainly due to government policies.

Here is the evidence. The Federal Deposit Insurance Corp. (FDIC) released a report last week concluding that 7.7 percent of U.S. households, containing at least 17 million adults, are unbanked (i.e. those who do not have bank accounts), and an "estimated 17.9 percent of U.S. households, roughly 21 million, are underbanked" (i.e., those who rely heavily on nonbank institutions, such as check cashing and money transmitting services). As an economy becomes richer and incomes rise, the normal expectation is that the proportion of the unbanked population falls and does not rise as is now happening in the United States.

Tax revenues are falling far more rapidly at the federal, state and local level than would be expected by the small drop in real gross domestic product (GDP) and changes in tax law that have occurred since the recession began. The currency in circulation outside the U.S. Treasury, Federal Reserve banks and the vaults of depository institutions - that is, the currency held by individuals and businesses - has grown by 13.3 percent in the last two years, while real nominal (not inflation-adjusted) GDP has not grown at all, and real (inflation-adjusted) GDP incomes have fallen by more than 3 percent. With the growth of electronic means of payment and financial service providers, it would be expected that the currency component of GDP would fall, not rise.

The underground economy refers to both legal activities, such as often found in construction and services industries where taxes are not withheld and paid, and illegal activities, such as drug dealing and prostitution.

jimmy said at December 12, 2009 6:08 PM:

"The underground or "black" economy is rapidly rising"

What's wrong with that? Are you racist or something?

Trent Telenko said at December 12, 2009 6:11 PM:

Also note that there a lot of other reasons for the "unofficial economy" to grow that are structural in nature.

First, divorce and a loss of a steady job often put men with alimony in the position of going "unbanked" in order to pay rent and buy food, given court judgments against them.

When I mentioned the above as a part of a conversation on that Wash Times article, an acquaintance sent me the following:

"If you're doing day labor, or low-level commission-only sales, as some of my younger friends are, you have to be crazy to keep a bank account; there's no really free checking anymore, and the bank will make off with your last ten bucks in fees right when you need new work gloves or a couple boxes of mac and cheese, and then hit you with late fees that can be a sizable fraction of your next check . Check cashing services take a much lower fraction of your money, if your income is sputtery/unreliable and sometimes goes to zero.

When I got driven into day labor, many years ago, I had a no-fees-at-all savings account at an S&L; I could deposit checks there at no cost, get $25 (a weeks groceries if I was careful) back on any check over that amount, and the check would clear in a week; then I just had to get there between 9 and 4, M-F, sometimes a hassle. But it cost no money.

All that's gone now, as is that marvelous archaism, the pay envelope. Younger marginal workers just get beaten up, one way or another, and losing a few percent off every check isn't nearly as bad as the things banks do to people whose accounts sometimes veer low. Some credit unions still offer semi-decent services, but they are few, far between, and not always easy to get to (because of the first two factors).

We could conceivably rebuild the old low-profit or not-for-profit services-for-the-working-poor financial institutions, or create new ones, but I haven't even heard a peep about that idea from either party. Yeah, it would require a fair bit of engineering and regulating, the people who would benefit most don't vote, and all that. Still, it could be done, it would make the country a better place to live, and it's not as complicated as a lot of things we do routinely. It's just lack of will and unwillingness to tell the financial industry that they are only entitled to 98% of the pie ..."


Randall Parker said at December 12, 2009 8:11 PM:

Trent,

I try not to violate copyright law and so I trimmed back your quote and also indented it.

Interesting point about the growth of the black market. But since taxes haven't really gone up much yet I wonder how much of the increase in the shadow economy is really driven by taxes. Maybe some people feel so poor they feel they can't pay much in taxes. I do know struggling people who are just getting by. I can imagine them avoiding taxes for that reason.

I also wonder if the black market has gotten bigger due to more trading of used goods. Too poor to buy new stuff? Buy and sell at yard sales. Make deals of services for goods with people you know.

But the economic downturn hit especially hard in construction which I would expect has a substantial amount of off-the-books deals. A customer pays cash for repairs? Do not report it. Then pay workers with cash.

I am curious to know which kinds of economic activity are most off the books. I would expect home and car repair to have a lot of tax evasion. Lots of cash in those services.

Randall Parker said at December 12, 2009 8:13 PM:

Trent,

I bet the desire to avoid financial creditors make people avoid checking accounts. They do not want to appear like they have any money.

James Bowery said at December 12, 2009 9:01 PM:

Stephen writes: Greece does not print the currency that is pays it's liabilities in.

The compromise reached in the US Constitution was to make this a moot point by allowing only gold and silver to be used as legal tender by the States. But there clearly is a question of what happens to a sovereignty that cannot pay its debts. Does it turn over its territory to the likes of Bernie Madoff? Stanley Kubrick once asked one of his screen writers if it would be possible to film the Holocaust -- not like Schindler's List, which is about a few Jews surviving -- the movie where you show the mechanics of 6 million Jews being systematically put to death. With modern video cams and internet distribution, Kubrick's challenge might be met without a dime for special effects.

Trent Telenko said at December 13, 2009 8:12 AM:

>>I bet the desire to avoid financial creditors make people avoid checking accounts. They do not want to
>>appear like they have any money.

Exactly.

I have both a family friend and an in-law in exactly that situation.

This is a unintended consequence of the 2005 credit reform act.

Note as well that, as my acquaintance mentioned, that banks hit everyone with small accounts charges and fees that kill the last $10-50 in a low end, less than $500 average per day balance checking accounts, which is what these people need to eat.

See:

"If you're doing day labor, or low-level commission-only sales, as some of my younger friends are, you have to be crazy to keep a bank account; there's no really free checking anymore, and the bank will make off with your last ten bucks in fees right when you need new work gloves or a couple boxes of mac and cheese, and then hit you with late fees that can be a sizable fraction of your next check . Check cashing services take a much lower fraction of your money, if your income is sputtery/unreliable and sometimes goes to zero.

Between the drug laws, credit laws, court orders from the divorce industry, and predatory banks using bounced checks as a profit center, low end, cash only self employment drives people into the pure black economy to avoid the hassle associated with "white economy" AKA banks.

Randall Parker said at December 13, 2009 9:21 AM:

Trent,

I know people who stopped paying their credit cards without declaring bankruptcy. I also come across people on forums who claim to have done the same. Years have since gone by. They have debts but are hard to reach. No listed phone and phone not under their name. If you have room mates you can put all the utilities in their names. Still need mail for car registration and a few other things though. But some use a different address for that.

Advocatus Diaboli said at December 13, 2009 9:50 AM:

Does it matter? credit based monetary systems require periodic resets.

And yes, I am also promoting my new blog (http://dissention.wordpress.com) which also talks about this issue , but in a much broader context.

Trent Telenko said at December 14, 2009 7:34 AM:

Randall,

The long and short of it is that credit card companies and banks have poisoned the well of lower to lower middle class good will and they are acting accordingly -- AKA they are ripping off banks & credit card companies and "going off the grid."

Given how the banks are using the political system with TARP et al, the American middle class is following that lead.


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