Economic Forecasts

Surviving the Greek Financial Crisis

Despite the recent friction, I believe the eurozone is stronger after putting down the Greek rebellion.

The Greek crisis may have disappeared from the headlines, but the bitter taste of the recent confrontation between Greece and the rest of Europe will last for some time.

In taking a hard line against Greek demands that more debt be forgiven, the European Union noted that Portugal, Spain and Ireland met the reform and payment deadlines set forth in their earlier debt crisis agreements. In response, the Greeks stated that they had already suffered a 25% drop in gross domestic product over the past five years, far greater than the decline experienced by any other European economy. Furthermore, the Greeks reminded the Germans that despite Germany’s brutal occupation of their homeland during World War II, the Allies forgave 50% of Germany’s debt in 1953—implying that Greece should be granted similar debt forgiveness.

But a closer look reveals the weaknesses in Greece’s arguments. After Greece adopted the euro in 2001, a flood of cheap capital sparked a huge economic boom. Land and housing prices increased, profits rose smartly, and the labor market tightened. Workers were able to demand sharply higher wages, and businesses flush with funds granted those demands. At the same time, the government increased the benefits in an already overly generous pension system. From 2000 to 2007, Greek GDP expanded by nearly 58%, far more than that of any other European country.

When the financial crisis struck, lenders pulled back and the good times quickly ended. As Warren Buffett has observed, when the tide goes out, you find out who has been swimming naked. By 2009, Greece was exposed without even a fig leaf. Wages were far too high to be competitive, and the country’s debt, barely serviceable in good times, could not be refinanced at the higher interest rates lenders demanded.

Greece’s economy contracted much more than that of any other European country. But Greece’s claim that it suffered more must be viewed in comparison with the preceding boom. Despite the huge economic contraction, Greek GDP is more than 25% higher than in 2001, a better performance than Spain, Portugal or Italy.

Why couldn’t the Europeans forgive some of Greece’s debt, as the Allies did for Germany after World War II? They already have! The agreements negotiated over the past several years to extend loan maturity and sharply lower the interest rates that the Greeks had originally agreed to pay are equivalent to writing off about half of the Greek debt.

Fatal mistake. Prime Minister Alexis Tsipras made the fatal mistake of thinking he could bully Greece’s creditors into accepting his demands and still stay in the eurozone. But without extensive cash advances from the European Central Bank, Greece was forced to close its banks. Those hastily arranged closures have caused severe economic hardships and will hamper any economic recovery. Who will put money in Greek banks knowing that they could close again? The Greeks cannot rebuild trust in their financial institutions without extensive guarantees by the ECB, which will be granted only after a painful restructuring of Greece’s financial system.

Despite the recent friction, I believe the eurozone is stronger after putting down the Greek rebellion. Even with the ECB’s massive program of buying bonds to bring down interest rates, the euro has emerged from the Greek crisis with considerable strength.

Sound finance and fiscal responsibility do pay off in the long run. It’s not a coincidence that Germany is the richest country in the European Union. Greece will eventually pull out of its slump. But its current hardships are of its own making, not those of European hard-liners.

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