By André Cartapanis
Translation: Davina Durgana
Passage au crible n°47
The crisis of the sovereign Greek debt is far from being resolved. These uncertainties remain based on the magnitude of the drop in ratings, which now inevitably must be assumed by the holders of this debt. The recent agreement by the Bundestag of a new support plan for Greece, with the promise of a loan of 109 billion Euros, which allows the pursuit of the adjustment of public accounts without the default of the Greek State. However, the magnitude of the budgetary adjustments under consideration – to the order of 10% of Greek GDP in two years – and the brutality of wage deflation have provoked a recession without precedent since post-World War II: with a drop of GDP of 4.4% in 2010 and of 5% in 2011.
> Historical background
> Theoretical framework
Shortly after the victory of PASOK (the Panhellenic Socialist Movement) in the elections of October 2009, the new Greek Minister of Finance announced a revision of the figures of the budgetary deficit. Contrary to the 3.7% predicted in the beginning of the year, he anticipates a deficit of 12.5% of GDP. This is the starting point of the crisis of the sovereign indebtedness of Greece. Since this occurred, international investors were fearful of not being reimbursed for the debt they own. Financial markets require thus prohibitive risk premiums in order to continue to buy the Greek debt, while rating agencies have contributed for their part to the maintenance of the panic in degrading the Greek note in the markets, but also those of Spain and Italy. Since Fall 2009, the phases of intense crises that followed have left a fear of default on payment, notably in the Spring of 2010 and in August-September 2011. They have been interrupted by periods of remission, determined by the procrastination of diverse European countries. Simultaneously, towards the end of 2009, the return of global growth – truly to a moderate rate – drove the countries of the Euro Zone to privilege the reduction of public deficits, in order to not expose themselves to the defiance of rating agencies and financial markets. This has resulted today in a slowdown, which has left the fear of a second recession and new crises among the European banks, particularly for those which hold the important portfolios of the Greek, Spanish and Italian public debts. This is to say that the Greek crisis reveals the macroeconomic dynamic that has followed the financial crisis in Europe. However, this also equally sanctions the effects of the creation of the Euro where the Monetary Union has reinforced the heterogeneity of the Euro Zone and where the countries of the South have accumulated commercial unbalances or budgetary deficits throughout the 2000’s. Such has been made apparent before the crisis, Greece represented the archetype of this type of trend, budgetary incompetence and statistical lies.
1. The Consequences of Banking Crises. The history of financial crises teaches us in the aftermath of banking crises that there is a contraction of economic activity, which appears almost inevitable. Additionally, this weighs considerably on public finances through various channels: 1) a strong decrease in fiscal receipts; 2) a mechanic growth of social expenditures which add to the cost of bank bailouts; 3) a discretionary increase of the budgetary deficit in order to exert a countercyclical effect on economic activity; 4) an increase in interest rates.
2. The Propagation of Banking Crises to Crises of Sovereign Indebtedness. In their last work dedicated to the history of financial crises over eight centuries, Carmen Reinhart and Kenneth Rogoff clearly emphasize these mechanics. On average, since the post-War era, the public debt increased by 86% in three years and then created a serious banking crisis. However, certain countries induced more important effects. From this point of view, the growth of the Greek debt between 2007 and 2010, to the order of 105% of GDP to 142% corresponds to a much weaker degradation, only around 35%. As a case in point, the banking crisis that hit Finland in 1991 resulted in an increase of the public debt by nearly 280%. The budget balancing fluctuated thus from +1% in 1990 to -10.8% in 1994. One observes the same phenomenon for the banking crisis of Sweden in 1991: from a budgetary surplus of 3.8% the year preceding the crisis to a deficit of 11.6% in 1993. This systemic inheritance of the banking crisis is naturally all the more painful than the public indebtedness which was elevated before the crisis, and which was exactly the case in Greece with a budgetary deficit of 10% in 2008 and of 15% in 2009. It has contributed to the disastrous management of the crisis by the member countries of the Euro Zone.
Since the onset of the Greek crisis, the specificity of a crisis of sovereign debt for a country belonging to a monetary union appears clearly through several markers: 1) the impossibility, in theory, to appeal monetary refinancing of the ECB (European Central Bank); 2) the difficulty of considering a recourse through the IMF, imposing loan-conditionality in macroeconomic policy on one of the members of the Euro Zone; 3) the profound resistance of other member countries to consider a sovereign default, due to the risk of contagion among them; 4) the absolute impossibility of using the weapon of the exchange rate and of the depreciation to alleviate the cost of the budgetary rigor in giving a boost to exports. From this point on, it falls to the leading organs of the European monetary union to confront this issue. This is what the ECB did – under the decisive impulse of Jean-Claude Trichet – in adapting in a pragmatic way his doctrine and by massively buying the Greek debt. This polity was taken not only to avoid a default, but also to prevent the collapse of its price, which was susceptible due to international speculation to trigger an unsustainable increase on the interest rate on the Greek public debt. In return, on the side of governments, one is stuck in the hesitations and analytical errors. Principally determined by considerations of internal policy or by doctrinal options, certain countries – Germany primarily – refused, in the first place, to grant the urgent loans to Greece, in overestimating the capacity of their economy to rapidly adjust its public accounts, even if massively degraded, through a rigorous budgetary policy. Similarly, they have reclaimed a restructuring of the Greek debt, implicating private investors: they have also overestimated the effects induced by the liquidity, or even the solvability, of European banks or financial institutions, which hold Greek titles. Yet they have resolved to engage in the support plans and have endorsed the creation of European Funds of Financial Stability. This turning point came, however, after interminable equivocation which accounted for the defiance of market, not only to the respect of the Greek or Spanish debts, but towards the Euro and the strength of banks in Europe. Additionally, the budgetary policies have privileged, since the end of 2009, the reduction of deficits. They have contributed thus to the weakness of growth, as much in the heart of Europe as in the periphery of the Euro Zone, in Spain, Italy, and above all in Greece. The crisis of the sovereign Greek debt was aggravated, so the recession reduced even further their capacity to repay and the road to Athens rumbled.
Aglietta Michel, “La longue crise de l’Europe”, Le Monde, 18 mai 2010.
Cartapanis André, “June 13, 2010, The Unachieved Integration of the Economic and Monetary Union, The Crisis of the Euro Zone”, Chaos International, PAC (Passage au Crible), (25), 12 juin 2010.
Cohen Daniel, “La crise grecque. Leçons pour l’Europe”, Revue économique, 62 (3), mai 2011.
Reinhart Carmen et Kenneth Rogoff, Cette fois, c’est différent. Huit siècles de folies financières, Paris, Pearson, 2010.