The financial crisis of Greece is caused by big debts. It is the debt crisis of Greece that has ruined the economy of the country and the Europe zone. To understand the debt problem, it is important to know how debts work in the economy.
The economy is built on debt-based growth where the concept is that debt will facilitate growth (Reade, 2011). The central bank circulates money in the economy through government and creditors. Also, the money given out by the central bank, the principle amount, has to be given back with interest. The problem is there is only principle amount circulating the economy. There is no money available, after paying back the principle, to pay the interest (Reade, 2011). The only way to pay the interest is to borrow more money. For example, once the money is borrowed, the user will leverage it to make more wealth and this will fuel growth and encourage MORE borrowing. As it turns out, it’s does not really fuel growth, it just increases debt. However, since the economy is built on credit borrowing, the economy has to constantly out grow its debt to sustain itself (Reade, 2011). Greece has borrowed a lot of money and they have continued to borrow money to repay the previous loans. This has kept increasing the debt the country holds. They have trapped themselves into a debt loop.
The economy of Greece fell into financial crisis for couple of major reason. The reasons include domestic problems, excessive government expenditures, pension system, tax evasion and easy access to capital. They got into bigger and bigger debt. The total public and private debt of the country is 350 billion euros (“Greece’s crisis”, 2012).
Greece had become a part of the European Union in 2001(BBC News, 2012). There are some requirements that a country must meet to be part of the EU. It turned out that Greece had hidden the actual government budget and deficits and other financial information to become part of the EU. They had shown the balance and numbers that meet the criteria of joining EU. Once Greece was part of EU, the new government of Greece discovered high national debt and budget deficit in 2009. The debt was very large. It was 113% of its GDP that is close to twice the amount allowed to EU members of 60%(BBC News, 2012). The government had bonds worth billions due to investors from abroad. When the real debt was revealed in 2009, all credit agencies heavily down graded the Greek bonds.
Initially, the investors and banks abroad bought the Greek bonds because they were considered very safe since it’s the government who will pay back. The reason for them being very safe is because the government can either raise taxes or print new money to repay the bonds. The problem is Greek government cannot print it’s own money anymore since it’s part of the EU now (Akram, Sajjad, Fatima, Mukhtar, & Hassan, 2011). They don’t control their currency. The EU would not consider printing more money because it would devalue the Euro for other countries using it as well. It would cause inflation for everyone.
The government has high expenditures. They have been running on budget deficit for many years. Moreover, they are borrowing money to pay off previous debts. They do not have saved money or large tax revenues to pay off their debt (Wallop, 2010). Extremely generous wages and pension plans for public sector was a contributor to the expenditures. After joining EU, Greece saw an increase in wages of 5% annually. The age of retirement in Greece was 58(Akram et al. 2011). The pension plan was designed such that after retirement, the person would earn 92% of pre-retirement salary (Wallop, 2010). In addition, there was a growing population of retirees. The tax revenues declined and expenditures increased. The government continued borrowing money to fund the expenditures and salaries instead of managing and cutting down expenditures. Wallop (2010) states that many individual and business evade paying taxes to the government. It has contributed to low tax revenues for the government.
Greece debt became worse after joining EU. Initially, Greece had to borrow at an interest of 10% or over (Wallop, 2010). As a member of the EU, the interest rates dramatically fell for Greece to borrow. It went down to 2%-3% interest (Wallop, 2010). Since Euro was considered a very stable currency, investors lent money at low interests. Greece was able to fund its budgets at low interest (Akram et al. 2011). This was beneficial in the short-run, however, it put Greece in even more debt. At the end of the day, it’s still a debt and it must be repaid with interest.
The core problem for Greece is huge debt. It has debt bigger than the entire value of its GDP put together and huge deficits. The problem wouldn’t be as severe if Greece had its own currency and not use Euros. Greece debt is most dangerous to everyone in European Union. The reason it’s so dangerous is because “the government was borrowing billions and those debts, like subprime mortgages in the United States, were often repackaged as complex commodities and sold off around the continent.”(Krieg, 2011). Everyone around the continent wanted a piece of it, especially banks in France and Germany. The banks of the two countries would suffer a big loss if Greece doesn’t repay the debt. It is apparent that Greece cannot pay back its debts of billions of Euros. Everyone around the continent would suffer a huge loss if Greece were to default.
Banks of many countries have a hold in the Greek debt. Japanese banks hold 432 million in Greek debt; Spanish banks hold $540 million, American hold $1.5 billion, Italian $2.35 billion, UK $3.4 billion, French $14.96 billion, German $22.65 billion, Greek banks hold $62.8 billion of the debt (Badkar & White, 2011). If Greece defaults all these banks lose their money in billions. Moreover, the whole banking system would collapse. The banks would stop lending money. There would be intense pressure on Portugal, Ireland, Iceland and Spain to meet its obligation and not default (Sanati, 2011). No banks would also lend them money at all since there are next in line for debt crisis and high chances of default. If they did, the conditions will be extremely tight if any country failed to pay the debts(Pryce, 2012). A default on debt would leave the Eurozone open to other shocks in economy. If Greece defaults, it will no longer be part of the EU and would have to start a new currency for the country. Greece would be in a very bad situation because it doesn’t have natural resources or an economic boom to support the country (Stewart, 2012). Strong EU countries already want Greece out of the EU. They believe they can manage without Greece as part of EU (Stewart, 2012). A Greek default will cause liquidity crisis around the world.
The EU is working on bail out for Greece debt. However, it is apparent that Greece will not be able to repay the loans. Therefore, the EU is doing its best for bail out and delaying the default. They are working a systematic default to reduce the consequences of the default because no one knows the exact results of default. It has never happened before in history where a country has such massive debt that needs bailout.
In May 2010, the EU and IMF had put together an emergency loan package of 110 billion euros (European Commission, 2012). 30 billion was of the 110 billion euros was given out in May, the rest will be disbursed through-out a three-years plan. The loan was given on the condition that they make significant changes to public finances and economic policies. It requires harsh austerity measure on Greece’s part. The reforms for Greek austerity measures have made the condition worse in the country. The country is entering into its fifth of continuous recession. The situation is so bad that unemployment rate has gone as high as 25%. A quarter of the country is jobless. This has declined the revenues from taxes. It’s more like depression in the economy. The austerity measures have caused lot of protests and riots in the country (“Greece’s crisis”, 2012). They are also working on getting private creditors to take 50% loss on the bonds (Schneider, 2012). They plan to write off 50 cents for every dollar borrowed. Overall, the steps taken to support Greece are pushing the country further into recession for the short-term at least.
The EU and IMF is working with Greece to reduce the debt to 60% of the GDP by 2020(Hoffman, 2012). To achieve this target by 2020, there has to be lot of write offs on the loan. Countries and creditors are not willing to do that(Hoffman, 2012). Moreover, the economy of Greece is going into further recession that has made EU and IMF to reconsider and modify the target of reducing debt by 2020. They are thinking of providing 2 more years to Greece to meet its obligations (Hoffman, 2012). The Greece has taught some important lesson for rest of the world. The government should be careful about how they fund themselves and the overall budget. Debt levels must be managed at a sustainable level. As it is stated by John Adams, “There are two ways to conquer and enslave a country. One is by the sword. The other is by debt.” Greece has become an enslaved nation to the European Union. It must do what is required and demanded by the EU. Greece cannot even control the money supply of the currency it uses. There is nothing left for them but to listen to EU and hope that it can recover and meet its debt obligations. The nation is conquered with no jobs or money available for many people to make a living.
The large debt, initially enjoyed by the public, must be repaid with harsh measures and sufferings for the whole country and it’s people. Greece is an example of a result of reliance on pure borrowing to support itself. The country has spent money freely for wages and other expenditures without big tax revenues. Soon, the debt caught them and left them in slavery condition. It is surprising that a government would continue borrowing knowing that it does not have the ability to pay it back. It is a very dangerous government to rely on for the citizens. Greece teaches two main lessons. One is to make sure there is enough revenue coming to support the country and there are no massive tax evasions. Second is to always control spending based on the revenue it produces and do best to avoid large debt. A country should avoid debt and follow the rules it bind itself with. For instance, Greece let its debt go double the limit set by the EU as a member. Based on Greece government’s actions, it is not a trustworthy government to work with for people.
Reade, J. (2011). The global debt crisis – perfectly explained [Web]. Retrieved from http://www.youtube.com/watch?v=Kz6xG2YtyyE&feature=related
Krieg, G. (2011, Nov 4). An idiot’s guide to the greek debt crisis. ABC News. Retrieved from http://abcnews.go.com/blogs/headlines/2011/11/an-idiots-guide-to-the-greek-debt-crisis/
BBC News. (2012, June 13). Timeline: The unfolding eurozone crisis. BBC News. Retrieved from http://www.bbc.co.uk/news/business-13856580
Akram, M., Sajjad, H., Fatima, T., Mukhtar, S., & Hassan, M. A. (2011). Contagious effects of greece crisis on euro-zone states. International Journal of Business and Social Science, 2(12) Retrieved from http://search.proquest.com/docview/904510973?accountid=11233
Wallop, H. (2010, April 28). Greece: why did its economy fall so hard?. The Telegraph. Retrieved from http://www.telegraph.co.uk/news/worldnews/europe/greece/7646320/Greece-why-did-its-economy-fall-so-hard.html
Badkar, M., & White, G. (2011, Sept 12). Reminder: Here. Business Insider. Retrieved from http://www.businessinsider.com/greece-default-contagion-2011-09?op=1
Stewart, H. (2012, Feb 12). There’s talk of an exit – but default would have catastrophic consequences. The Guardian. Retrieved from http://www.guardian.co.uk/commentisfree/2012/feb/12/grexit-greek-default-catastrophic-consequences
Sanati, C. (2011, June 17). End of the line: What a greek default means. CNN. Retrieved from http://finance.fortune.cnn.com/2011/06/17/end-of-the-line-what-a-greek-default-means/
Pryce, V. (2012, May 13). Greece would face dire consequences from a euro exit – as its people know . The Guardian. Retrieved from http://www.guardian.co.uk/business/2012/may/13/greece-must-stay-eurozone
European Commission. (2012, March 19). Support for greece. Retrieved from http://ec.europa.eu/news/economy/120319_en.htm
Schneider, H. (2012, Feb 21). Greek bailout plan now moves to the imf. The Washington Post. Retrieved from http://www.washingtonpost.com/business/economy/greek-bailout-plan-now-moves-to-the-imf/2012/02/21/gIQArxuNRR_story.html