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CRISIS/ Why this Greek tragedy matters to the world

February Thu 18, 2010

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Last week, the EU emergency summit on debt-stricken Greece and the risks it poses to the euro ended with a show of unity. But Germany’s refusal to join a swift bailout has since led to bitter recriminations, with the Greek prime minister George Papandreou blaming Europe’s lack of united support for reinforcing anxieties in the market. These fears could also threaten other heavily indebted countries in the Euro zone, triggering a wave of defaults across Europe and North America which could endanger a global recovery. What happens in Athens could yet decide the economic fate of the West and the rest.

 

The Euro zone is not about to implode but its members are stuck. If Greece implements its ambitious austerity programme, the country faces a vicious cycle of debt-deflation whereby savage cuts in public spending lead to economic contraction and falling prices, increasing the real value of their national debt. Greece already owes about $412 billion and might need to borrow another $79 billion in 2010 alone. Its fellow Euro zone members and international markets were shocked to hear that successive Greek governments had cooked the books and underreported their debts for years.

 

But if Germany and others do provide a bailout, European credibility will be damaged, which would increase the cost of borrowing in Europe, pushing countries like Greece ever closer to bankruptcy and default. Greece’s budget deficit is approaching 13 per cent of its national output and public debt is fast approaching 125 per cent of its national output.

 

Athens is on the brink but it is not alone. Its fate could be shared by Portugal, Italy, Ireland and Spain, which are similarly indebted. If Greece’s crisis becomes collective, it may indeed test the Euro zone. The US economy would not be immune with a federal deficit in 2010, like in 2009, that will reach 10 per cent of gross domestic product which will become far more troublesome if other dominoes begin to fall.

 

The voices arguing for swingeing cuts to public spending as a remedy are increasingly shrill, from the Republicans in the US to the Tory Party in the UK. Academic historians such as Niall Ferguson have joined them. Armed with data from the IMF (a bastion of the neoliberal orthodoxy that got us into the current mess), many claim that fiscal reductions of up to 13 per cent of GDP are needed over the next few years. Without them, the economies in the western world and Japan would collapse, they argue.

 

Soaring public deficits and debt levels push up real interest rates and increase the costs of borrowing for the private sector, which would reduce investment and choke growth. Moreover, the spectre of runaway inflation – caused by fiscal profligacy and weaker currencies – will induce central banks to abandon monetary expansion and raise base rates. All of these actions would increase the costs of servicing public debt. Some estimates suggest that the US may have to devote as much as one-quarter of the federal budget to pay the interest on its debt. With the prospect of either stagflation (economic stagnation and inflation) or debt-deflation (falling incomes/prices and higher real debt), the days of western hegemony seem numbered.

 

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