Comment on the Greek Situation

Greece Has Had a Terrible Time

The economic situation in Greece over the past few years has been, quite simply, appalling. Since 2007, Greek GDP has fallen over 25% [1]. To put that decline in perspective, UK GDP fell by less than 5% in total during the recession years of 2008 and 2009 [2]; the fall in Greek GDP is almost exactly the same as the fall, from peak to trough, in the United States’ GDP during 1929-1933 [3], the worst years of the Great Depression. But as the chart below shows, while the USA effectively suffered a three-year disaster followed by a sharp recovery, Greece has seen years of grinding decline. The country’s suffering has gone on for so long – without any real solution being offered – that its people have turned to radical politics for a way out.

Why have these awful events happened to Greece? They were started, of course, by the global financial crisis of 2008-09. But while other countries were able to put together some kind of crisis response, Greece was a prisoner of history and economic circumstance.

  • First, the Greek government had extremely limited room for manoeuvre. Its ratio of government debt to GDP was 120% at the end of 2007, before the global financial crisis even began. For comparison, UK debt to GDP was a mere 45% [4]. Greek governments had spent beyond their means for many years. Greece’s debts amounted to 177% of GDP at the end of 2014, far worse than any other member of the Eurozone [5], but the other European countries appear dead set against the possibility of further debt forgiveness.
  • Second, Greece has resisted reform and has become a poster-child for economic mismanagement. Ireland, which required a large-scale bail-out for its banks, played by the EU’s rules, exited its programme at the end of 2013 and can once again borrow money on the public markets. The market remains extremely wary of both Greek banks and of the Greek government.
  • Third, Europe’s monetary union was not mature enough for Greece’s budget to be supported by its European partners in a smooth way. Not until 2012 did the first European bailout institution, the European Stability Mechanism (ESM), come into existence; and, throughout the crisis, other EU members have offered Greece only further debt, rather than true, no-ties support. Compare this situation to that in the United States, in which federal-government money can simply flow to depressed states, for example through federal unemployment benefits, block grants to the states, and so on. American states can and do become relatively depressed – real GDP in the state of Michigan in 2014 was below its level in 1999, for example [6] – but the US has mechanisms to mitigate the effects of such problems.
  • Fourth, while a non-EU country facing problems of the severity that Greece faced after 2008 might have allowed its currency to depreciate, Greece was locked into the euro. A somewhat similar case is that of Argentina, which broke its currency peg to the US dollar in 2002 and, after the initial economic shock, saw its growth rebound sharply, to almost 9% in 2003 [7].
  • Fifth, Greece, like all the Eurozone countries, did not have an independent monetary policy, since policy for the euro is set by the European Central Bank (ECB). Incredible as it seems now, the European Central Bank raised interest rates twice in 2011, so Greece actually faced tightening monetary policy as its depression intensified. The US Federal Reserve also tightened policy during the Great Depression [8] and, although that mistake is now well-understood by economists, the fact that the ECB makes its decisions for the Eurozone as a whole effectively meant that the same error occurred in Greece.

These considerations are the reason why Greek politics have taken a turn for the radical: radical change, in the EU’s attitude or in the circumstances of Greece, would be the only way to break out of the constraints that the country faces. The people of Greece have elected a government that is at least prepared to try to escape from the prison in which they have found themselves. Whether they will now reject the EU’s latest offer is impossible to say, but the possibility is certainly real.

European Implications

Since Greece may be heading for a general default, or even out of the euro, it is as well to consider what the implications of those things would be for the rest of Europe. Here, the picture is rather brighter. Since the start of the Eurozone crisis, European institutions have come a long way. A whole system of bailout institutions has been created, and the European Central Bank, having pledged in 2012 to do ‘whatever it takes’ to save the euro, has decided to buy government bonds if necessary to keep them from selling off; embarked on programmes of unlimited lending to European banks; and, now, started a programme of quantitative easing. Government bond markets in Italy and Spain, major countries that could cause real trouble for the Eurozone, have largely stabilised thanks to these actions.

Moreover, other previously vulnerable European countries are in better shape than they were before. Italy’s GDP fell only 0.4% in 2014, and Spain returned to growth [9]. Whereas both countries previously imported significantly more than they exported, that situation has turned around, with both running current-account surpluses in 2014 [10]. Moreover, their banks, like those across the Eurozone, have improved their capital positions and been through rounds of stress-testing – the European banking system is in much better shape today than it was in 2011.

When Greece first hit the headlines, Italy and Spain were running significant current-account deficits, banks were extremely fragile, bailouts did not exist and the European central bank seemed determined to do nothing but focus on controlling inflation. Now, times have changed, and the Eurozone looks considerably less vulnerable to contagion from a country that is, after all, less than 2% of the Eurozone economy [11]. Three or four years ago, the Greek situation was important for what it said about the Eurozone as a whole. The less the situation of the major European economies resembles that of Greece, the less important the Greek crisis becomes to the EU as a whole.

Conclusion

We do not know what is going to happen in Greece. Considering the economic disaster that has befallen the country, it is possible that Greek voters or the Greek government could take the country to a major default, or euro exit, and nobody really knows whether those events would be catharsis or nemesis for the Greek economy in the long run. They would likely cause short-term turbulence in financial markets; however, Greece looks today much less like the canary in the European coal mine and much more like a special case. It is far from clear that even a worst case outcome for Greece would be a disaster for the wider Eurozone. As so often, the likely outcome is murky and it is far from clear that the doomsayers have it right. With good financial plans in place and portfolios of an appropriate level of risk, our clients should be able to ride out any period of volatility and continue to focus on their long-term goals.

 

John Butters CFA, Chartered MCSI

Head of Investment

                                                 

[1] Eurostat, using annual real GDP growth figures.
[2] Ibid.
[3] Federal Reserve Bank of St Louise, using annual real GDP data.
[4] World Bank, via Federal Reserve Bank of St Louis.
[5] Eurostat.
[6] Federal Reserve Bank of St Louis.
[7] Ibid.
[8] As famously criticised by Milton Friedman and Anna Schwartz in A Monetary History of the United States.
[9] Eurostat.
[10] Tradingeconomics.com.
[11] Eurostat, Aspinalls’ calculations.
2017-07-20T12:51:24+00:00