Beware of Greeks Bearing Credit

While the economy in United States has been slowly crawling out of recession, things are getting nastier in parts of Europe. The Euro-zone is facing its biggest crisis since its founding as currency for accounts in 1999. The problem is based in the debt and deficit problems for several of the EU member states that use the Euro as their currency. Greece, Portugal, Spain, Ireland (and Italy but they always seem allowed to get away with this stuff) are all facing the prospect of far outstripping the maximum debt and deficit levels. Greece is particularly bad off at the moment.

Reuters has a timeline of how Greece got to this point here. Essentially what happened was that in 2009, the social-democratic PASOK party won an election and upon taking office found that the right wing government they defeated had been cooking the books. PASOK had to revise upward their expected debt and deficit levels (they about doubled). At that point, the shitstorm began. Greek debt will exceed 120% of Greek GDP this year. This is about double the maximum permitted in the Eurozone. Greece is also about to be forced to refinance about 50 Billion Euros in debt (a chunk of debt about 14% of Greece's total GDP - see the Greek entry in the CIA world factbook here). Their credit rating has already been downgraded.

The debate now is centered on whether and how the EU as a whole should help Greece get through the crisis. So far there is an "agreement in principle" to help Greece refinance their debt but there is no enthusiasm for a full fledged bail out. The Greek government is blaming the EU for not doing enough. Greek public opinion is not being kind to the EU (even though the problem was caused by decades of Greek governments' over spending and outright fraud by the previous government). The Greek government is being forced to enact dramatic auterity programs, slashing spending and hiking taxes.

OK, so that's the problem now. The future problem is just starting to take shape and has to do with how the EU responds to this. In effect the EU is a federal system with the member states acting the role of states/provinces. What Greece wants is for the EU to implement a full fledged bail out - effectively taking over responsibility for Greek debts. This would be a no-brainer good thing for Greek politicians. The problem is that we know what happens when a federal government rescues constituent state governments like that. This is exactly what happens in Argentina. In that country, the individual provinces' debts are effectively backed by the Federal government. So if one or more of the provinces gets into a situation where they can't pay their debts, the Argentine feds are required to pay. The result is that the provincial governments have little incentive to restrain their spending (and a lot of incentive to spend like drunken sailors on favored programs for constituents). This moral hazard problem in turn leads to Argentina having a nasty chronic/recurring problem with debt and deficit crises.

The danger for the EU is that if they engage in a full fledged bailout, they risk establishing a precendent that risks transforming the EU into an Argentina-like moral hazard basket case. On the other hand, if they don't do anything, they risk the legitimacy of EU membership and institutions among Greeks and other countries in similar situations. They also risk the consquences of a Euro government defaulting on billions of Euros of debt denominated in their currency.

This is interesting in light of the fact just a year or two ago, many were predicting that the dollar would be replaced as the world's primary currency of accounts by a basket of currencies including the Euro. Now we see the Euro zone countries struggling to keep their act together. Their difused financial and budgetary decision making structures are proving problematic.