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Greek Debt Crisis


When the 2008 economic recession in the U.S. began to spread globally, the Greek economy disproportionately declined. News media quickly and inextricably linked the terms “Greek government” and “debt crisis,” and later created the portmanteau “Grexit” to describe a Greek exit from the European Union. Coupled with a fourfold food poverty increase, an unemployment rate that rose to and now remains above 25% and youth unemployment above 60%, the Greek government does not have the funds to pay its creditors.

The Greek government may not have money, but it has options:

raise taxes, or
cut spending on domestic investments and pensions.

Analysts refer to these two options as austerity. However, austerity, the attempts by governments to match spending with revenue, inevitably encounters a feedback-loop problem: since the Greek economy is largely centered around public spending and around the market liquidity of retirees spending their public pensions, cuts to public spending essentially are direct cuts to the economy. Cuts to the economy yield lower tax income, which negates any progress made by austerity to eliminate debt. Therefore, where austerity attempts succeed at shrinking Greek government spending, they fail to retain tax revenues, and just delay the solution. (See this explanation from the 3:57 to the 4:30 mark).

So perhaps the Greek government does not have money or options. Continuing to ignore the problem certainly seems ineffective. Facing increasing interest rates on payments and the social unrest caused by low market liquidity (which means that banks have little cash to dispense, see 1:00 to 1:50 mark), the Greek government cannot afford to progressively nibble the edges of its budget, as it has through eleven separate austerity bills over five years. A debt haircut threatens to unsettle the entire global financial order, first toppling the eurozone, then Germany, then much of the West’s neo-liberal economic dream. Implications abound for citizens and global financial markets alike.


The eurozone experiment began in 1999 to unify European states under a common currency, regulated by the European Central Bank (ECB). From then until 2001 when Greece joined, consultants from Goldman Sachs labored intensely to falsify official financial reports for the Greek government. Greece likely did not meet key macroeconomic targets required for entry, most importantly the less than 3% debt-to-GDP ratio.

The “creative accounting” techniques of Goldman Sachs allowed Greece to “cheat on its euro-entry exam” in claiming less than 1% debt-to-GDP, a figure well below the 3% requirement and even farther below its actual 3.7% figure. When the Greek government revealed this news several years after joining the eurozone, ECB officials responded with little more than a request to hire better bookkeepers. From an entirely macroeconomic standpoint, Greece therefore did not belong in the eurozone.

Typically, states facing high unemployment
will devalue their currency to attract low interest rates from investors and decrease the cost of exports, stimulating the economy and fixing the unemployment problem.

Conversely, states with low unemployment
want an expensive currency to increase their citizens’ purchasing power in international goods and keep prices down at home.

Countries tied into the euro face a dilemma; states create financial policy, but the ECB creates monetary policy. The above Keynesian assumptions about unemployment become meaningless when states cannot control their own fiat currency.

See this video for more information on the divorce between fiscal and monetary policy in the eurozone.

Many investors thought that, given this divorce of power, Greece would accept its fate and tame its government expenditures. This thought – a recognition of the value of increased economic stability – pushed investors to offer loans to Greece substantially, and at below-market interest rates. This self-fulfilling prophecy worked: the investments themselves stabilized the Greek economy more than any government policies did. The public sector then expanded accordingly.

The eurozone depends on at least modest homogeneity among member states. In an attempt to only allow member states with similar economies, the ECB set very specific, calculated values for some important macroeconomic targets. When Greece entered with a mathematically untenable debt-to-GDP level, its fate was already sealed: it would disproportionately benefit from eurozone membership and disproportionately suffer from financial decline. Greece’s main industries- tourism and shipping- fared poorly in the 2008 recession; foreign capital flows dried up, and with government spending constant, the economy collapsed.

Greeks evade taxes equally as much as they pay taxes. The self-employed most commonly evade. In 2009, self-employed Greeks “dodged taxes on at least €28 billion of unreported income” amounting to almost a third of the annual deficit. Excessively wealthy business executives aside, standard mid-to-upper-class white collar professionals owe the most in taxes.

These also have the most political connections: with the exception of lawyers, who have an “already nasty habit of becoming politicians,” the three most tax-dodging professions account for “about half the votes among Greek M.P.s.” Unsurprisingly then, the parliament lacks motivation to fully prosecute tax evasion among its colleagues. Nor will the government collect these taxes retroactively; Prime Minister Tspiras vowed during his campaign to forgive most unpaid taxes.

Public Opinion

The general public in Greece remains divided, but mostly confused. Many (according to a firsthand reporter conducting street interviews here, at the 2:55 mark) do not understand the complex economic concepts involved in making decisions about financial policy, but P.M. Tsipras nonetheless deferred the choice to a voter referendum. Voters had to accept or reject a loan package from the ECB, where rejection also partially indicated leaving the eurozone.

The ECB withdrew its end of the referendum bill for renegotiation, so the vote was essentially meaningless, but the 39%-61% yes to no vote still clearly demonstrated Greek frustration with European “discipline” and a desire to further Spriza’s anti-austerity measures. The radical leftist party Spriza originally won the January 2015 election on a heavy anti-austerity platform. Ironically, the subsequent proposals accepted by Tspiras “were harsher than those the citizens had just rejected.” To the Greek people, “it all felt like a farce.”


If Greece defaults on its debt, European creditors will have to take a haircut. In a 50% financial haircut, for example, the Greek government would pay back 50% of their loans, forever ignoring the rest. Politicians have a tendency to use benign-sounding words and phrases to describe policies, when regular people would use “theft.”

Most European banks are leveraged between twenty and thirty to one, meaning they operate 3% to 5% away from their long-run shutdown point. To insure shareholders and customers against insolvency, regulators require banks to hold assets worth 6% of their exposures.

In other words, banks do not lend without the solid ground of at least some assets beneath them, specifically 6%.

In the haircut situation, the value of Greek holdings and bonds would fall dramatically, so the affected banks lose assets. When they lose assets, they must unwind frozen holdings to recoup the cost. Usually these holdings come from the derivative market. Selling a derivative out of panic inevitably lowers the value of the yet-unsold derivatives, even further lowering the bank’s total asset base. For every $1 million lost in a haircut, banks must unwind $18 or $19 million in holdings; this whiplash effect destabilizes the market, lowers overall liquidity and the raises the risk of instantaneous collapse.

That Germany pushes for harsh bailout terms comes primarily not from its citizens, though they feel little sympathy for Greece, but from this volatility in the derivative market. The term derivative generally denotes financial tools that have no value in themselves, their value must be derived from something else. A person can never walk into a forest and accidentally stub their toe on a derivative, trip over a derivative while running from a bear, or gather sticks for fire wood and accidentally splinter their finger with a derivative. They exist only as a mathematical and financial abstraction based upon other, more tangible measurements.

The Deutsche Bank derivative exposure (or, the total derivative amount) reaches $75 trillion, more than twenty times the entire German GDP. Under normal circumstances, the market fulfills derivative contracts and the $75 trillion falls to its true market value of $522 billion in deposits. Germany can easily manage this level.

However, in a whiplash situation the high exposure level threatens to quickly burst, before the derivatives contracts can be fulfilled; in other words, the system could entirely collapse. In describing this effect in 2002, Warren Buffet succinctly called derivatives “financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal.” Greek failure to repay debt therefore threatens the entire neo-liberal market structure.

Less dramatically, Greece could leave the eurozone and print its own money, somehow exchanging its citizens euros for a new, post-drachma currency. Low market liquidity- the primary effect of the debt crisis for citizens- threatens main-street Greek economics and baseline food purchasing power; local banks had just 50 euros per citizen on stock at the time of the referendum. If Greece altogether left the euro, countries with similar debt-to-GDP ratios may also leave, particularly Portugal and Spain.

Solutions and Conclusion

The Greek debt crisis, though political in origin, threatens millions of citizens who have no control over financial markets and international monetary policy. At risk of sounding melodramatic, the economy impacts daily living at even the desire to live daily. The country also faces the problem of refugee population flows, and if Greece cannot maintain its own finances, can humanitarian watchdogs condemn the failure to provide them with adequate food and shelter?

Greece has long artificially sustained an economy centered around public sector growth. This makes austerity painful, even unproductive in the short-term. But in the long-term, no state can spend more than it has.

Tsipras must achieve what previous government have not: cut public spending while somehow maintaining tax revenue; his failure to match revenue with spending, alongside a failure to actually negotiate a substantial loan assistance package with the ECB will sink the country into a permanent and likely irrevocable economic wasteland.

The ancient Greeks (see Molyneux’s ending remarks), no less ironically, professed a simple but profound truth that perhaps more politicians today ought to consider:

“Take what you want- 
but pay for it.”

One Comment Post a comment
  1. Christoff #

    Very nice analysis of the possible “Grexit” and the implications for the private sector as well. Macro is going to be fun.


    November 24, 2015

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