A GREECY AFFAIR

We live in a world which is continuously growing 

smaller. Countries are bound together by trade, security and economic links in an intricate manner. The happenings of one part of the globe has a distinct impact on other parts. In this scenario, it becomes increasingly necessary for us to have an idea about what is happening around the world. I am going to try and explain a news heading which everyone has been seeing for a long time. The Greek/Euro-zone debt crisis.

Greece is historically known to us all for being the birth place of democracy, for its imposing architecture and for having Footballers with names longer than their national anthem (Sokratis Papastathopoulos, Panagiotis Tsalouchidis etc. When they enter the field the opposite team and the commentators shake with fear). But in recent times, Greece has been catching our eyes for being at the centre of the Euro zone financial crisis. I thought of taking up this issue because once you take out all the hard economic terms and the math terminologies (which is why people usually skip this particular news heading), the Greek debt crisis is rather simple and interesting.

I should take a disclaimer that the information which I am about to share is all second-hand. I've spend some time reading up about this issue from different sources and I am going to make an attempt to share what I've understood along with a few of my opinions. In no way is this an in-depth analysis or a comprehensive picture. Please do let me know in the comments if I've made a mistake or if I have left out any crucial details. Moreover I am not going to use any complex economic terms (mainly because I don't know them either) or get into a number crunching exercise to present the issue. I shall try and explain it in such a manner that a middle-schooler can understand the topic. On the off-chance that you are younger than that, u probably should not be on the internet anyway.

To completely understand the crisis, we have to take a brief look into how Europe was. For almost all of its history, European countries have been at war with one another. There have been periods of relative peace and relative turmoil, but except for the last 30-40 years, a feeling of mistrust and dislike have been widespread among all European countries regarding their neighbors. In addition to this, each country had it's own currency and economic policies. Traditionally, these two factors have manifested in huge trade barriers and the geographic advantage of being nearby was never really of much use to anyone.

After the two world wars, the world economy in general and the European economy in particular were in shambles and a greater need for corporation was felt for. In Europe, this lead to a series of talks and discussions which finally resulted in the formation of the European Union (EU) after the signing of the Maastricht Treaty in 1993. This opened up the internal borders of Europe and was a promising step towards increased regional corporation in trade and commerce.

However the issue of different currencies remained unresolved. A sizeable portion of the capital was being spent in currency conversion when countries traded with each other. This was to be rectified by the adoption of a new currency, Euro, all across the EU nations. Euro was adopted by the EU members on January 1st, 1999. The individual currencies of member countries were phased out and after a short transition period, Euro became the common currency of transaction. Individual national banks were diluted of their power and a new central entity, European Central Bank (ECB) was established in Frankfurt.

It is necessary for us to understand here, the difference between what is called the  fiscal policy and the monetary policy of a country. Fiscal policy refers to the policy followed by the government related to its expenditure. Things like taxation, public spending, pension policies etc would come under the fiscal policy. On the other hand Monetary policy refers to the policy which takes care of the flow of money in an economy. Things like interest rates, money to be kept as cash in banks (known by the fancy term Statutory Liquidity Ratio) etc comes under the purview of Monetary policy. Within the EU, the Fiscal policy was under the control of individual governments while the Monetary policy was controlled by the ECB.

This separation of fiscal and monetary policies, in retrospect, was an in built weakness of the Union and would eventually lead to the debt crisis. If we look at India, we have RBI looking after the monetary policy and the Ministry of Finance looking after the fiscal policy. However both these agencies work in close contact with each other and play a complimentary role to keep India's economy healthy. However in Europe, it was almost impossible for the ECB to follow a monetary policy which would be in the best interest of all its member countries. This scenario was considered during the adoption of Euro but the increased wealth which the members would accrue by the removal of trade hurdles was seen as a positive which would far outweigh any other losses.

Before the formation of EU, countries like Greece had access to only a limited capital from outside investors. The interest rates on loans were also high. This was due to the comparatively low credit-worthiness( i.e. the ability of a country to pay back its debt) of these countries which were in tune with their economic capabilities. However after adopting Euro, countries like Greece had sudden access to large sums of money at low interest rates. This was due to the juggernaut German economy which also had adopted the Euro. Investors felt that incase of any economic troubles in Greece, Germany would definitely back it up as they shared a common currency. Essentially, this is analogical to Greece getting a credit card with Germany written on it. To give you a perspective, the interest rates for Greece in pre- EU days was around 18%. Later it dropped to almost 3%, i.e. the rate at which Germany paid it's interest.

This lead to a spending spree in Greece and other EU countries. Large debts were incurred as the governments spent money in furthering their political image within their respective countries. Huge pension funds, increased government jobs, salary hikes etc were given out by different parties to keep their voters happy. In some countries like Ireland and Spain, large scale housing and property booms were the order of the day. 

Due to the easing of borders and euro, all of Europe was a close knit economy now. Banks in Spain were lending to companies in Portugal. Investors in Germany were buying up bonds in Greece. French banks were funding public works in Ireland. Weak economies like Greece were basically borrowing more money to pay off the existing debtors. The situation was sustainable as long as the credit kept coming in.

However in 2008, the American housing markets collapsed (this was due to the Sub-Prime mortgage crisis which is too big to explain in a foot-note) and its aftershock shook the global economy. Funds were drying up and this lead to a sudden end to the easy credit availability around the globe. Countries like Greece had run up huge debts and as the money flow stopped, they found themselves in a position where they could barely meet the internal expenses let alone pay of the external debts. The Greek economy was in the brink of a disastrous collapse. It was a sharp wake up call for Greece and it was time to face the music for years of financial indiscipline.

We have to understand that the mentality of countries like Greece towards finance is radically opposite to Germany. While Germany followed a highly conservative and disciplined economic system, Greece's was rather complacent and lacked planning and long term vision. The taxation was inefficient and only 20-30% of the taxes really reached the Greek treasury in a good year. The public sector was filled with non-essential workers who were overpaid. Nepotism and political over-spending was a common affair. However due to the previously mentioned economic linkages, a crisis in Greece was a crisis in all of EU.

The only economy strong enough to help Greece was Germany. Countries like Portugal, Spain, Italy were already teetering on the edges of an economic collapse themselves. Reluctantly, Germany agreed to pick up the tab on the huge debts Greece had amassed. However, the German Chancellor Angela Merkel and her Finance Minister Wolfgang 

Schäuble imposed strict austerity measures on the Greeks as a pre-condition to their help. The austerity measures called for ramping up the entire Greek system by cutting out non essential workers, reducing salaries, increased and efficient taxation schemes, structural reforms to improve competitiveness, sales of government assets, pension fund reductions etc.

It is interesting to observe why the Germans bothered to help the Greeks as opposed to letting them leave Euro. Firstly, if Greece defaults, this would start a domino effect leading to the collapse of other weak EU countries. This would be very bad for the German economy. Secondly, a Greek exit (a 'Grexit', as some call it) would lead to a weaker Euro which would cause substantial loss to the Germans. As they say, if one of the PIIGS leave the group, the others would soon follow. PIIGS stands for Portugal-Ireland-Italy-Greece-Spain. This would, in effect, ruin the Euro. Thirdly, a lot of German investors had also invested in Greek bonds. The sum paid to bail out Greece was considered lower than the combined losses the German investors would incur if Greece defaulted, left the Euro and rolled back to drachma, it's pre-euro currency.

As of now the third bail-out package is active for Greece. The austerity principles which Germany imposed on Greece was a cause of social unrest and lead to political instability in Greece. Greek civilians viewed the austerity principles as an insult imposed on them by the bossy Germans. The current party in power, Syriza, rode into Athens on a promise of cutting the austerity principles short and restoring the Greek pride. The young new Prime minister Alexis Tsipras and his Finance minister Yanis Varoufakis have their jobs cut out for them in balancing the German demands and the interests of their Greek compatriots. I am not going into the technicalities of the bail-out deals which involves the EU, IMF and ECB (called The Troika). 

The last point we need to look at is how do we ensure something similar to this modern Greek tragedy doesn't play out again in the future. Sadly it is almost impossible to ensure this with the existing setup. Unless the fiscal policy of member countries are also controlled by a central body (similar to how ECB controls the monitory policy) there is no check in place to prevent unbalanced expenditures in EU. But such a central system is almost impossible to be set up as it is equivalent to individual countries giving up their sovereignty (similar to forming a United States of Europe). We can only hope that the other European economies learn from Greece and trust that they learn to live within their means. However, considering the European penchant for grandeur and extravagance, in all probability, our trust is grossly misplaced!