The CFA Society Chicago Book Club met on March 17 to discuss Greece and how the debt crisis came to be and the outlook going forward. Matthew Lynn’s 2011 book, Bust; Greece, the Euro, and the Sovereign Debt Crisis was a fantastic read and encouraged a very in depth discussion.
Just two short years after the collapse of Lehman Brothers, Greece faced mounting debts resulting from easy borrowing driven by cheaper rates after arguably fiddling its way into the Euro in 2001. The Euro was created in 1999 to promote three key components. 1) Promote open trade across European borders minimizing FX risk, 2) Initiate a more dynamic, prosperous, and innovative Europe, and 3) Provide price stability with the intention of competing with the USD as a global safe haven currency. Interestingly, countries like Portugal and Greece with much poorer credit quality were able to borrow Euros as easy as Europe’s strongest country, or Germany. By becoming part of the Euro, countries resulted in a loss of national sovereignty and could no longer devalue their way out of debt as they did in the past. Nor could they target a lower currency to export their way to growth.
Understanding Greece involves taking a look at the country’s history. There have been predominantly two Greek families in power post WWII. Post WWII, Greece never modernized while the North became industrial powerhouses. Greece has had to rely on shipping, tourism, and agriculture. They never heavily targeted investing in manufacturing like the North. Greece has defaulted on numerous occasions including 1826, 1843, 1860, and 1893. In 1997, the Greek Central Bank had to raise rates from 10% to 150% to stop the currency from going into freefall. When evaluating whether Greece was suitable for the Euro, Greece was initially denied in 1999 but by July 2000, supposedly inflation was down to 5% and the budget deficit was only 1% of GDP gaining Greece entrance into the Euro effective 1/1/2001. Once Greece switched to the Euro, we saw the Greek economy create strong growth but rising trade and budget deficits. With low rates and the ability to borrow, Greece was riding an illusion of prosperity. The 2004 Olympics held in Athens was a giant cost to the country. Millions were spent on new stadiums that unfortunately tend to collect dust once the games are over. In September 2004, it was reported by the Greek government that the accounting was incorrect and the country should never have been in the Euro. The EU did nothing about it. Greece continued to not play by the rules running up a higher and higher budget deficit to GDP. Tax evasion and bribery has been common corruption we have seen in the country. The Greek Pension system certainly doesn’t help the deficit as the retirement age is significantly lower than that of countries in the North. Unmarried woman for example receive their parents pension if they are unmarried which discourages employment. The Euro was not meant to be a currency you joined to become a stronger country, it was meant to only include the strongest countries to ensure price stability.
It was not only Greece that was incentivized to borrow at the ultra low rates once joining the Euro. We saw very similar issues in Portugal. Spain’s borrowing fueled a real estate boom that resulted in high growth but with relatively low productive growth making Spain less competitive. Ireland cut its corporate tax rate luring corporations from all over driving the per capita income to one of the highest in the world. The lower ECB rates resulted in Ireland’s excessive borrowing and an artificial property boom.
Germany on the other hand was running a surplus while the Club Med countries were running deficits. Postwar Germany is said to be an economic miracle. West Germany had strong growth driven by a stable currency, low inflation, hard work, brilliant engineering, and a frugal mindset. Germany was not in favor of the Euro given their strong stable currency. Germans tend to live within their means and avoid borrowing and credit cards. The culture of Germany includes saving, living within their means, manufacturing, and frugality. This all seems to diverge from the cultures of the Club Med countries which has led to where we are today.
After just under a decade, once 2009 hit following the credit crisis, we began to see the negative impacts of the excessive borrowing of peripheral Europe. We saw downgrades from S&P and Fitch in late 2009. Stocks in Greece began to fall, yields spiked, and bailout discussions began. Germany did not want to bailout Greece. The No Bailout Treaty of the EU also stated that each member state was responsible for its own public finances which was a precondition for long term growth in Europe. From the end of 09 through May 2010, much debate and meetings took place to resolve the European sovereign debt crisis. To protect the Euro, Merkel ended up compromising breaking the No Bailout Treaty and coming together with the IMF to bailout Greece, Portugal, and Spain among others in the trillion Euro bailout. This resulted in the ECB for the first time buying government bonds helping to lower rates and increase prices to stabilize the Club Med countries. Austerity programs across the Club Med countries were initiated and confidence was restored in the Euro. Government salaries were frozen and social programs were cut. Italy was forced to cut wages or suffer stagnation. The question remaining was, did the EU and IMF provide a cure, a short term fix, or poison to the region?
It seems as though Greece has tended to follow the script of new government and new spending program, then falling GDP, austerity, and another EU bailout. Excessive borrowing without investing in manufacturing led Greece to where it is today. The author believes that once the moral hazard of providing bailout funds was initiated, the Euro was destined to fail. He believes it was a major policy mistake to put politics in front of economics by creating a single European state. He argues that bringing together the very strong economies of Germany and France with that of Greece, Ireland, and Portugal was a major mistake. He argues that the markets should decide the outcome and it would have been better long term to let Greece go bust rather than provide a bail out.
Upcoming Book Club Schedule:
April 21, 2015: The Forgotten Depression: 1921: The Crash That Cured Itself by James Grant
May 19, 2015: How Latin America Weathered the Global Financial Crisis by Jose De Gregorio
June 16, 2015: TBD
July 2015: TBD
Aug. 2015: TBD (NOTE: Those who attend the Aug Book Club meeting will receive a free copy of Superpower: Three Choices for America’s Role in the World by Ian Bremmer. This is his new book and was released May 2015.)
Sept. 2015: Superpower: Three Choices for America’s Role in the World by Ian Bremmer