So, it turns out that when you’re a country—let’s say Greece, just to pull a name out of a hat—that misses a payment to the International Monetary Fund (IMF), you’re in arrears, not in default.
But it is a distinction without much of a difference. There is only one way the current Greek government can meet its debt obligations, and that is through continued support from the Eurozone institutions that have heretofore kept them afloat. Once those lenders — European finance ministers and Europe’s Central Bank — stop the flow of bailout funds, Greece will be unable to service its debts.
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It will then move from missing a payment and thus being in arrears, as occurred Tuesday night, to full out default. And unless the European finance ministers decide to reopen the spigot, it is hard to envision any other outcome.
The latest out of Athens is that the Greek government may be willing to accept bailout terms they previously rejected as too harsh. But remember, this government was elected to push back hard against such terms, so my sense is that this latest wrinkle doesn’t much alter the highly unstable lay of the land.
How did it come to this?
In an irony that would not be lost on classical Greek tragedians, the word “economics” is derived from the Greek “oikonomia,” meaning “household management, thrift.”
To put it mildly, there hasn’t been a lot of cogent management as the Greek debt crisis has painstakingly unfolded. There’s been some thrift, but it’s been deeply misguided. Let me explain by detailing the evolution of the crisis, giving the current lay of the land, and ending with a few thoughts on how these dynamics might affect us here in the U.S.
To cut to the chase for those who are wondering about that last part, no one knows with certainty how the endgame of the crisis will play out, but it’s not likely to throw our economy off track. And there are potential benefits from a decisive end to this ongoing saga, or at least to this stage of it.
The usual starting place here is to ding the Greek government for becoming unsustainably indebted, with a debt-to-GDP ratio rising above 100% in the mid-2000s, while the Eurozone average was around 50%. But even that part of the puzzle is not that simple. In fact, a key insight we should learn from this debacle is that blaming countries for their debt levels without any analysis of why those levels are where they are is a mistake.
What Greeks clearly were doing wrong was not collecting taxes owed. They were not profligate spenders, as their pre-crisis spending as a share of their economy was just about the Eurozone average.
Their revenues, on the other hand, were well below the averarge. This anecdote gives you a sense of how the government ignored this critical part of their job: When the crisis hit, and the government was scrambling for tax revenues, someone remembered that if you own a pool in Greece, you’re supposed to pay a yearly tax on it, but the revenue office didn’t even bother keeping track of who owned a pool. So when they decided to start collecting the pool tax, they logged onto Google Earth and quickly expanded their tax base.
Still, it wasn’t all their fault, by a long shot. One reason Greek government debt grew so quickly was that Germany, the Eurozone’s powerhouse economy that’s been imposing austerity on the Greeks, used the money from its trade surpluses not to buy imports from weaker peripheral economies, like Greece, thereby helping to foster more balanced growth and less debt in the region. Instead, they bought Greek debt, financing the run-up we’re dealing with today.
The debt diagnosis
As the unsustainability of these debt and trade imbalances became glaringly obvious, the members of the Eurozone had to make the classic diagnosis in a debt crisis: are we looking at insolvency or illiquidity?
When a country (or a city, or commonwealth) can’t realistically service its debt, creditors and policy officials need to decide whether the best way forward is to rip off the Band-Aid and write off the debt – what you’d do if insolvency is the diagnosis – or to provide a temporary bailout to help the country get through a rough patch, with the recognition that on the other side of the patch, the country will be fundamentally strong and flexible enough to grow its way out of its over-leveraged state (what would follow from the illiquidity diagnosis). There are costs to both routes. Charging off debt is a much bigger deal than, say, the loss of value of a stock you own. Debt contracts are legal agreements, and when they get broken, future creditors might not lend so freely and will charge higher interest rates, slowing growth. Still, the bankruptcy option exists for a reason, and in certain conditions, it can be the far better way to resolve a debt. The main condition is this: if a country cannot reasonably generate the income needed to service its debt in the foreseeable future—if it can’t be counted on to get its GDP growing faster than its debt—then default may be the most efficient, humane way forward. There’s no question that path whacks the creditors, but they’re not the only stakeholders of note. When%20the%20crisis%20hit%2C%20someone%20remembered%20that%20if%20you%20own%20a%20pool%20in%20Greece%2C%20you%E2%80%99re%20supposed%20to%20pay%20a%20yearly%20tax%20on%20it%2C%20but%20the%20revenue%20office%20didn%E2%80%99t%20even%20bother%20keeping%20track%20of%20who%20owned%20a%20pool.’ But that’s not what happened. Not only did the Eurozone authorities erroneously choose the bailout route, they did so in the worst possible way, imposing austerity conditions that made it even harder for Greece to grow its way out of the problem. As a result, the Greeks are suffering on at least two painful dimensions. First, the economy is shrinking. Unemployment is through the roof at 25%, youth unemployment is over 50%, and now, even the banks are closed to prevent whatever capital is left in the country from fleeing. The other dimension—more abstract, perhaps, but maybe even more painful—is the loss of political sovereignty and self-determination. That’s partly a function of the ill-founded Eurozone itself. Since it’s only a currency union, and not a banking or fiscal or politically- united union, its member nations are not integrated in the way the United States is, for example. Is the United States at risk? Now that Greece has officially missed a debt payment, it’s effectively in default (a term the IMF has avoided). A default doesn’t automatically imply that the country leaves the Eurozone – back in 2012, creditors took a large write-down on Greek debt, so we’ve been here before – but there are still lots of ways the crisis could drag on. There are two main ways the crisis could hurt the U.S., through trade channels and through financial channels. Our exports to Greece are miniscule—well under 1% of total exports—so there’s not much to lose there. Our exports to the Eurozone amount to about 15%, so if Greece leaves the currency union and that slows other European economies, that could be a drag on our exports. But the shares are too small to make a big difference. The financial contagion is more worrisome, as recent stock market reactions—large selloffs as the situation worsens—suggest. However, the consensus among international finance types suggests that neither markets in Europe nor the U.S. will be broadly affected. (One reason is that 85% of the debt is now in public, versus private, hands, which somewhat insulates financial markets). There’s definitely uncertainty—we’ve never had a country leave the Eurozone, if that’s what we’re looking at. But the thing that messes up markets the most is big surprises, and everyone already knows this situation is a hot mess. In fact, there’s a lesson in that observation, too. It is a mistake—a big one—to solely evaluate the damage of a Greek exit by considering the costs to outsiders, as above. We must also consider the potential benefits to the Greeks—not right away, of course, but after the upheaval resettles—in ending this painful period of their history. They have long suffered, due partially to past mistakes by their government, but far more from their treatment by others. If they decide to put a stop to that, we should not blame them. Jared Bernstein is a Senior fellow at the Center on Budget and Policy Priorities and author of the recently-released book, “The Reconnection Agenda: Reuniting Growth and Prosperity.” From 2009 to 2011, he was the Chief Economist and Economic Adviser to Vice President Joseph Biden.
Jared Bernstein was chair of President Joe Biden's Council of Economic Advisers. Recommended
