Friday, 24 June 2011

Origins of the Greek Crisis

Is the Greek debt crisis the fault of predatory banks? It might look that way, given that banks are demanding their money back, Greeks face job cuts and tax rises, and the Greek government now has to pay rates of up to 30% to borrow, if it can borrow any money at all. But an examination of how the crisis began points the finger instead at the euphoria that gripped Greek politicians, businesses and the middle class once the country joined the euro in 2001. Far from euro membership helping the development of Greece’s economy, it has turned into a disaster. Blaming the banks for Greece’s troubles may be popular, but it hides the facts and feeds the delusions of those who think that the only problem with capitalism is finance.

1. Greece’s euro membership

Greece joined the European Union in 1981, and became part of the single European trading market. It began to enjoy strong economic growth, helped by the growing trade relationships with and development aid from the rest of Europe. But there was only limited success in making the poorly developed Greek economy move closer to the European average. The money from European funds – worth several billions of dollars per year - was largely used to plug gaps in the Greek budget that was struggling to meet the costs of pensions and other current expenditures. One study calculates that, up to 1995, 60% of European development funds were not used on infrastructure projects.[1] Although the aid money was better spent after 1995, helping to modernise the transportation network, when Greece joined monetary union in 2001 there was another opportunity to screw things up.

Major European powers decided, just about, that Greece had met the membership rules that focused on economic issues like inflation rates and government spending deficits. These rules were designed to prevent unstable countries from causing trouble for the key players who would have to pick up the bill for the system’s problems, especially Germany.[2]

The benefits to Greece of EMU entry were enormous. Gone was the dodgy Drachma; a tourist currency was now replaced by a big global currency, the euro. This allowed Greece’s borrowing costs to fall sharply, cutting the cost of public sector borrowing and the interest rates paid on business and personal loans.[3] Greece also got a status boost from being a member of the ‘single European currency’, despite its economy still being based mainly on tourism and shipping, with no local industrial output of significance. The Greek sidelines of trade with Balkan countries and being a nice pied-à-terre for some Middle East investment funds could now be presented as some of its advantages for the expanded euro system.

Greece was the ‘far East’ from the point of view of the EMU project, but Greece’s membership appealed to a version of European racism that was delighted to include the ‘home of western civilisation’. More importantly, Greece’s economy was so small that it didn’t seem to matter even if there were to be problems one day. How could a country of 11 million people with an economy that accounted for barely 2% of euro area GDP cause trouble for the big guys? By contrast, at the start of EMU Germany’s economy made up 30% of euro area GDP and France’s was close to 20%.[4]

2. Buying the dream

After EMU entry, Greece thought it had found a cornucopia. From 2001 until 2006-07, it saw progressively lower interest rates, expanding credit and strong economic growth. Greece’s household savings rate fell from 3.2% in 2000, pre-EMU, to minus 3.2% in 2006. People began to spend more than their disposable incomes, and by 2007 the debt-to-income ratio of Greek households had quadrupled to 65%. Regarding external trade, the country’s current account deficit also rose to an astonishing 14-15% of GDP, despite there being only very small inflows of direct investment to finance it.[5] This was one direct result of the big increase of consumer spending. Greece was also making itself uncompetitive, with inflation each year being 1-2% above the euro country average, and there were signs that foreign tourism to Greece was falling back even before the crisis struck.[6]

This was obviously a recipe for trouble, but a worldwide speculative boom after 2001 postponed the day of reckoning. During the boom, borrowers that capital markets had previously thought of as risky ended up paying interest rates on loans not much higher than those paid by the strongest countries. As interest rates fell globally, they fell even more for countries like Greece. In 2000, the year before Greece’s EMU entry, 10-year borrowing rates for the Greek government averaged 6.1% compared to 5.2% for Germany. This was a fairly modest gap by historical standards, because it was already beginning to price in the expected EMU entry. By 2005, the Greek rate was just 3.5% versus the German rate of 3.3%.[7] These lower rates for government debt fed through into cheaper consumer and business loans and borrowing jumped. So, when the speculative bubble finally burst in 2007-08, Greece had huge debts, but then it suddenly found cheap credit impossible to find.

Chart 1: Two-year government yield spread over Germany (basis points) *

Source: IMF World Economic Outlook Update, June 2011
Note: * The vertical axis indicates how many basis points extra the interest rate is for these countries compared to Germany’s government borrowing rate. So 1500 means a rate of 15% on top of Germany’s rate. For example, 18% for Greece compared to 3% for Germany.

After 2008, the gap between the interest rates paid by strong countries and riskier borrowers widened rapidly (see Chart 1 for the picture since 2010, in which Greek yields rose by much more than for Ireland and Portugal, the other EMU countries in trouble). In the face of Greece’s potential default on its debts, two-year yields on government securities rose to as high as 30% last week. Rates only fell back to 27% in the past couple of days – that is 27% per annum - after the latest Greek parliamentary vote that gave creditors some hope of getting repaid.

3. So was it the banks?

It is a travesty of the facts to blame the problems that Greece faces on foreign bankers. It is true that banks encouraged consumption spending with easily available credit, that they bought Greek government bonds to fund the public sector deficit and that they now want the money back. But their lending was matched by a ludicrous amount of borrowing and spending from the broad population in Greece: government, businesses and middle class consumers.

Most of the media discussion concentrates on Greek government debt. However, looking at the debt statistics gives you a different view of the problem. Total debt to foreign banks estimated by the BIS at the end of 2010 amounted to $174bn.[8] Yet the breakdown of this huge debt is roughly into 37% owed by the government, 8% by Greek banks and 55% owed by the non-bank private sector.[9] The biggest proportion is the accumulation of debt from businesses and middle class consumers – those with most access to credit. Nevertheless, there are some good reasons why government debt has become the focus.

The first is that Greece has a history of tax avoidance – by the rich, as elsewhere, and also by most of the middle class and self-employed. It has also allowed public spending to run well ahead of the deficient tax revenues. Not that public spending is especially high by European standards. Except for the past couple of years, Greek state spending has been around 45% of GDP, at the same level or a little below the average rate for the EMU countries. However, government tax revenues are much lower than the EMU average, at around 39-40% of GDP compared to the average of 44-45%.[10] This is because of the lower tax take from both wages and from business taxes than in other EMU countries.[11] This is why Greece has had a persistent and large government deficit. This has driven the rise in Greece’s public debt-to-GDP ratio from close to 100% in 2000 to a massive 150% now.

The big Greek debt number did not prevent it from joining EMU back in 2001. Allowances on this criterion had already been made for Belgium and Italy, core members who joined at the start in 1999, and whose debt ratios were also well above the 60% EMU rule. But Greece would only have been able to join if it could show that its annual public sector deficit was close to the maximum 3% level. It was not, but Greek politicians changed the numbers. They took advantage of derivative financial products to make a portion of the government deficit ‘disappear’ from the view of Europe’s accountants. Financial derivatives were all the rage at the time and trading volumes soared alongside the speculative boom. With the help of Goldman Sachs Inc, esteemed provider of plutocrats to the US Treasury and recipient of fawning coverage in London’s Financial Times, creative accounting with derivatives helped the Greek government’s deficit numbers appear small enough for Greece to qualify for EMU membership.[12]

* Correction, added 11 February 2015:  On further investigation, there is little evidence that Greece used derivatives to hide its debt ahead of its EMU entry on 1 January 2001. Greece certainly did afterwards, with the help of Goldmans, etc, but the EMU entry debt criteria were met before 2001 more probably by regular accounting tricks, not with off-market swaps, etc.

Fixing the government deficit numbers continued after Greece’s membership in 2001. However, by 2009, inconsistencies in the data began to show up. The Greek government had to revise its deficit for 2009 up from 6-8% of GDP to 12.7%, and then to 15.4%, as various accounting tricks unravelled.

Most calculations on Greece’s debts show that there is no plausible way that they can be paid in full from the income earned in the economy. Payment of such huge sums of interest to foreign banks from domestic income would depress the economy, as would big increases in taxation or drastic cuts in public spending. That is why foreign creditors also demand that cash is raised to pay the debts by selling Greece’s state assets. On these plans, all kinds of state-owned infrastructure – roads, ports, utilities, etc - would come under the auctioneer’s hammer for sale at bargain prices to foreign capital.

4. Conclusions

Greece is in trouble because of the huge rise in private and public sector debt, which spiralled after the country’s EMU membership in 2001. Though it may be politically expedient – there are few votes lost in knocking the banks - it makes little sense to blame foreign banks for this crisis, with the possible exception of the banks that helped Greece fiddle the figures and lie about its debts. These lies helped Greece gain access to the cheap loans, but the decision to borrow was taken by Greek ministers, businessmen and middle class consumers. Greek government debts were not a problem and were easily funded while the global economy was in a speculative boom. The financial crisis has now exposed the fictitious nature of this prosperity. Greece has debts it cannot pay, and is subject to interest rates at which it cannot borrow. It faces prolonged austerity and the auction sale of the country’s assets so that foreign governments and banks can get their money back. This is not a problem caused by predatory banks. It is a consequence of the failure to develop in the imperial economy.

Tony Norfield, 24 June 2011

[1] See A Antonios, ‘EU’s Structural Funds and the Public Investment Programme in Greece: 1985-2005’, p15.
[2] This stress on the economic rules for joining EMU was because the political treaties deliberately did not include any provision to leave the single currency, in order to make the new system appear to be more solid. Flying in the face of historical examples of broken monetary unions, European officials always declared that EMU membership was ‘irrevocable’.
[3] See David Marsh, The euro – the politics of the new global currency, Yale University Press, 2009. He notes (p228) that Italy, Spain, Ireland and Greece enjoyed much lower government borrowing costs on entering EMU.
[4] Data are for the year 2002, and taken from ‘European Economic Statistics’, 2010 edition, on the Eurostat website.
[5] Developing economies often have large current account deficits, but these can be the result of imports of capital goods paid for by inflows of foreign direct investment. In such cases, the deficits are a sign of economic development, not weakness. This was not true for Greece.
[6] These data are taken from the ‘EU economic data pocketbook, 3-2010’ and ‘European economic statistics 2010 edition’, published by Eurostat in 2011.
[7] Data taken from Eurostat’s ‘European Economic Statistics 2010 edition’, Table 4.33, p174.
[8] See the BIS Quarterly Review, June 2011, Table 6A, pA28.
[9] This breakdown is for 24 countries only, shown in the BIS Quarterly Review, June 2011, Table 9C, pA84.
[10] See ‘European economic data pocketbook, 3-2010’, Tables 32 and 33.
[11] See ‘European economic statistics 2010 edition’, Table 4.25 and 4.26.
[12] It has been widely reported that major US investment bank, Goldman Sachs, was instrumental in managing a derivatives-focused programme for the Greek government to hide the real state of its public finances from the EU authorities ahead of its membership of the euro in 2001. See for example ‘Goldman Sachs faces Fed inquiry over Greek crisis’, The Guardian, 26 February 2010.


  1. Excellent article.

    However , Tony, do you not consider the Greeks' lack of relative competitiveness as a contribution to the country's fall? Of course, I refer to 'competitiveness' in the neo-classical sense, yet arguably, it contributed to Greece's deficit and indeed, national and private-sector debt. For an illustration, take the graph on 'page 9' of the following report - - depicting what could only be described as a 'boom' in the average relative unit labour costs of Greek firms, relative to Germany. The country's output costs have also been relatively high.

    In essence, Greece has not progressed through the so-called 'supply side' reforms which the likes of Germany and Austria have undertaken, which among many other things, perpetrate an atomisation of the labour market and indeed, the abolition of collective bargaining power, in order to drive down domestic wages for the benefit of profit. The PIIGS economies, including Greece of course, having not passed through such reforms and generally holding much greater average output prices than many of their 'Eurozone' counterparts found it tough going; without an independent exchange rate that could work to restore a degree of competitiveness in the short-run at least, domestic markets were overwhelmed through a 'substitution' of trade, in which the exports of more neo-classically 'efficient' countries flooded in, rendering domestic producers to the long-line of the 'invisible hand's' devastation and attrition, due of course, to the associated unemployment effects. Spain for example, ran a current account deficit in every year from 1999 till 2010.

    A lack of ability to exploit the Eurozone's lax barriers to trade may have affected the Greek economy in two ways; as net exports fell, due chiefly to imports substituting domestic production at a relentless rate, the government saw need to stimulate growth through an almost constant, fiscal expansionary policy - Greece has failed to run a surplus since, and indeed well before joining the Euro - which of course, will have contributed the country's ever-increasing national-debt. In addition perhaps, obstacle of 'relatively' high wages that simply refused to budge, forced an increasing number of private-sector firms to turn towards banking liquidity, which may have contributed to the high levels of private-sector debt Greece experienced.

    Yet does this not all suggest Greece should not have been allowed to enter the Euro-area in the first place? The notion that the Eurozone resembles anything near an optimal currency zone has surely been exposed as utterly laughable during the last two years, and furthermore, does this represent a form of 'economic imperialism', in 'efficient' countries utilising the lack of trade barriers provided by the defining principles of monetary union, to expand business, increase exports and thus, ceteris paribus, domestic growth, yet all at the expense of ultimately less developed, and less financially 'efficient' nations?

    PS. I'm a recently finished a-level student, studied the 'PIIGS' and the effect of the 'Euro' upon them just this year, final exam just last week was based upon it - so my understanding my not be as sophisticated as yours!

  2. Banks (with international connections) lent heavily to Greeks after it joined the EMU in 2001, encouraging people and businesses to take loans, buying up Greek bonds etc. You know how fractional reserve banking works so this was good for the greedy bankers, they were actively chaining the Greek people to massive debt. Then when the “bubble burst” in 2008, after the banks had taken more from the global economy than was actually in it, they decided to call in their loans, when it became clear (duh) that the Greeks could not pay. So they downgrade Greek bonds, generally trash the Greek economy and prevent the government from getting decent loans. Now the EU, on behalf of the banks is attempting to destroy Greek society by demanding a halt to meaningful government spending, selling off of state assets, and thereby absolutely impoverishing the Greek people, so that they can be “paid back”.

    This is predatory capitalism, and your article is an apology for it.