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Greek Fiscal Crisis: Is a First World Debt Crisis in the Making?

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Title: Greek Fiscal Crisis: Is a First World Debt Crisis in the Making?


1
Greek Fiscal Crisis Is a First World Debt
Crisis in the Making?
  • Dr. Kenneth Matziorinis
  • Dept of History, Classics, Economics
  • and Political Science
  • John Abbott College

Montreal, QC, April 16, 2010
2
Is a First World Debt Crisis in the Making?
This time is No Different
  • In their recent book Carmen M. Reinhart Kenneth
    S. Rogoff (2009), This Time is Different Eight
    Centuries of Financial Folly, Princeton
    University Press, report the findings of their
    recent studies based on 66 countries, across 5
    continents and 8 centuries of economic history.
  • They find that sovereign debt and default crises
    have actually been more common than we realize,
    that
  • during major episodes more than a third (33) of
    countries are undergoing default or in the
    process of a serious debt restructuring
  • they have exhibited a continuing serial pattern
    of recurrence throughout history
  • they have involved countries from both the
    developing as well as the developed world.
  • every time there is a lull experts pronounce that
    this time is different and yet the cycle of
    defaults keeps on repeating itself

3
Is a First World Debt Crisis in the Making?
Sovereign Defaults have been a normal feature of
all periods and all countries
  • Reinhart Rogoff report the following findings
  • 1) There have been long periods where a high
    percentage ( gt 40) of countries have been in a
    state of default or restructuring
  • 2) Since 1800, there have been 5 major default
    cycles. with one ot two decade lulls in between
  • 3) Serial default is the norm throughout every
    region in the world, including Asia and Europe
  • 4) Global economic factors such as commodity
    prices and center country interest rates have
    played a major role in precipitating these crises
  • 5) Periods of high international capital mobility
    have produced international banking crises, not
    only as in the Asian, South American, Russian and
    more recently global financial crisis, but
    historically

4
Is a First World Debt Crisis in the Making?
Sovereign Defaults have been a normal feature of
all periods and all countries
  • 6) Contrary to contemporary opinion, domestic
    debt constituted an important part of government
    debt in most countries
  • 7) A significant share of domestic debt was of a
    long-term maturity
  • 8) The government?s gain to unexpected inflation
    often derives at least as much from capital
    losses inflicted on holders of long-term
    government bonds
  • 9) The median duration of default spells in the
    post WWII period is half (3 years) the length of
    what it was during the 1800-1945 period

5
Sovereign External Debt 1800-2006Percent of
Countries in Default or Restructuring
From Reinhart RogoffSovereign Defaults have
been happening in the past and will happen in our
future!
6
You Should not be Surprised, This is what History
Teaches us
Canadians have been fortunate enough to have
escaped the ravages of major financial defaults
  • Since its creation in 1867 Canada has never
    experienced a sovereign default or debt
    restructuring although we came danerously close
    to ones in the 1930s and again in the 1990s
  • Unlike most countries, Canada has experienced few
    episodes of excessive inflation, the highest
    inflation rate ever recorded in Canada was in
    1917 when inflation reached a maximum of 23.8
  • Our history of relative monetary and fiscal
    stability have ill prepared us to understand what
    other countries have gone through or what we may
    go through in the future, but it is never too
    late to learn

7
What are the Major Types of Sovereign Debt
Defaults?
External and Internal Debt Defaults
  • External debt default Here a country defaults on
    its payments to foreign debt holders. When a
    country runs into a sovereign debt crisis
    interest rates rise, capital flows stop and the
    country is thrown into a severe period of
    economic contraction and fall in living
    standards.
  • When this happens, the country has a choice of
    debt repudiation which means it renegs on its
    debt to foreign debt holders entirely as
    Argentina did recently, as the Soviet Union did
    with Czarist bonds and Mexico in the 19th century
    or
  • debt restructuring and debt rescheduling which
    means that it sits down with its foreign
    creditors and negotiates a settlement. Usually,
    the creditors are forced to take a loss on some
    portion of the debt, known as a haircut,
    interest rates are renegotiated towards more
    favourable terms and external lending resumes
  • The IMF was created in 1945 to assist countries
    when they run into this type of crisis by
    extending emergency lending at concessionary
    rates based on conditionality, that the
    government undertakes a specific set of reforms
    to balance its budget and return the country to
    financial solvency

8
What are the Major Types of Sovereign Debt
Defaults?
External and Internal Debt Defaults
  • Internal debt default Here a country runs into
    an inability to service its debts to its citizens
    but is not forced to default, because the
    government has the power to print money to
    service its debts. This results in a rise in
    unexpected inflation and results in economic
    stagnation -stagflation
  • The inflation unleashed by the printing of money
    reduces the real value of the bonds held by debt
    holders who are its own citizens and thus the
    government lessens the burden of its debts.
    Inflation shifts the burden of debt from the
    state to its citizens and represents the ultimate
    form of taxation.
  • The process of unwinding the sovereign debt
    burden results in a period of moderate inflation
    (10 - 20) and moderate contraction. The
    Developed world went through such an episode
    during the 1970s. Today, with central bank
    independence, it is questionable to what extent
    central banks will allow this to happen without
    breaching their inflation control mandates. If
    they resist, interest rates will rise.

9
Alternatives Methods for Reducing Sovereign Debt
Burdens
Currency Debasement and Currency Depreciation
  • Currency debasement When a sovereign debtor is
    unable to pay its bills it may resort to debasing
    its currency. In the past when metalic money was
    used, it came in the form of dilution in the
    amount of gold or silver contained in the metalic
    money and this ofcourse, produced inflation and
    resulted in a devaluation of the country?s
    currency
  • Currency devaluation or depreciation When a
    sovereign debtor is unable to meet its
    obligations it can resort to currency
    depreciation. This works when a country is
    utilizing a flexible currency regime whereby it
    allows the value of its currency to be determined
    by demand and supply in the foreign exchange
    market.
  • Devaluation and depreciation help a country boost
    its exports and reduce its imports thereby
    stimulating domestic economic activity and
    moderating the contractionary effects on
    production and employment arising from the debt
    pressures.

10
What are the Major Precipitating Causes of
Defaults
Commodity Cycles, Large Uncontrolled
International Movements of Capital, Wars and now
Banking Crises
  • World Commodity Price Cycles When commodity
    prices fall many countries exposed to the
    exportation of commodities succumb to external
    defaults
  • Large Movements of Capital Flows When large
    amounts of capital flow into a country they
    increase its indebtedness and when the cycle ends
    and interest rates rise, they are unable to
    repay, forcing them to default
  • Wars Wars -both external and civil- have always
    disrupted the monetary and fiscal stability of
    nations leading to sovereign debt defaults
  • and due to a relatively recent and perhaps
    biggest financial innovation in the history of
    banking the introduction of bank safety net i.e.
    liquidity insurance, deposit insurance and
    capital insurance that can cause a sovereign debt
    default when the losses are transferred to the
    state
  • Financial Leverage and Banking Crises

11
Banking on the State to a Degree of Biblical
Proportions
Following the global financial crisis the banking
system of the developed world has come to rely
on the state to a degree of BIBLICAL proportions
  • In a recent study for the Bank of England, titled
    ?Banking on the State? Alessandri and Haldane
    (November, 2009) have tabulated the total support
    provided by the US, UK and Eurozone governments
    to the financial sector of the economy
  • It totals over 14 trillion or almost 25 of
    global GDP!!!
  • This figure tallies the support given only to the
    financial sector and does not include the fiscal
    stimulus packages introduced by these governments
    nor the sizeable cumulative fiscal deficits that
    have resulted from the global economic downturn.
  • The liabilities and losses from the banking
    crisis have been transferred to the sovereign to
    a degree never seen before in economic history!

12
A Role Reversal Between the State and the Banks
Whereas before the banks were the victims of
sovereign debt defaults today the sovereign state
is the victim of bank defaults
  • Alessandri Haldane (2009) in their insightful
    paper state the following
  • Historically, the link between the state and the
    banking system has been umbilical. Through the
    ages sovereign default has been the single
    biggest cause of banking collapse
  • For the past two centuries, the tables have
    progressively turned. The state has instead
    become the last-resort financier of the banks. As
    with the state, banks? needs have typically been
    greatest at times of financial crisis. The Great
    Depression marked a regime-shift in state support
    to the banking system. The credit crisis of the
    past two years may well mark another
  • Then, the biggest risk to the banks was from the
    sovereign. Today, perhaps the biggest risk comes
    from the banks. Causality has reversed.

13
Government Support to Financial Industry
The support given to financial industry since the
inception of the Anglo-American financial crisis
has been of biblical proportions
Source Alessandri Haldane, Table 1, Banking on
the State, Bank of England, November, 2009
14
Implications Arising From Extension of Banking
Safety Net
When banks win they keep the profits, when banks
lose, the state takes the losses!
  • Alessandri Haldane state that there is an
    unwriten social contract between the state and
    the banks state support for the banks is one
    side of the contract, state regulation is the
    other.
  • While the state expanded its support for the
    banks it has not expanded its regulation of the
    banks
  • When banks know that the state will run to their
    support in times of crisis they can afford to
    take bigger risks. Without more regulation they
    are driven to increase their returns by taking
    bigger risks. When they win they keep the
    profits, when they lose, it is the state that
    pays
  • We all know who is behind the state you the
    taxpayer and the recipient of public services.
    Something has gone terribly wrong with this
    picture

15
World Economic Growth, 2001-2009 and Projections
for 2010 2011
The global economic downturn that followed the
global financial crisis impacted the world?s
developed economies far more than it did the
developing economies
10
8
6
4
2
0
-2
-4
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
Advanced Economies
Emerging Economies
World Average
Source IMF WEO Update, January 26, 2010
16
Government Budget Deficits, Percent of GDP, 2009
Budget deficits have exploded all over with the
worst affected being in the advanced industrial
world
Iceland
Greece
UK
Spain
Ireland
USA
Portugal
France
Japan
Czeck
Belgium
Russia
Turkey
Italy
Netherlands
Canada
0
2
4
6
8
10
12
14
16
18
17
Advanced Economies Gross Debt-to-GDP Ratios,
2010 IMF Projections
Debt-GDP ratios have been rumped up dramatically
in many countries
Percent () of GDP
250
225
Japan
Iceland
200
Greece
Italy
175
Belgium
USA
150
France
Canada
125
Portugal
Israel
100
UK
Germany
75
Ireland
Austria
50
Netherl
Spain
25
0
Strategies for Fiscal Consolidation in the
Post-Crisis World, IMF, February 4, 2010
18
Debt-to-GDP Ratios Advanced vs. Emerging G-20
Nations, 2010
Debt-GDP ratios for advanced countries are bearly
triple those of developing countries. Clearly it
is the developed world that is facing a sovereign
debt crisis
120
100
80
60
40
20
0
Advanced G-20
Emerging G-20
Source IMF
19
Fiscal Consolidation Required to Achieve Debt
Target Between2010 and 2020
IMF study has calculated that many advanced
industrial countries will have to undertake a
high degree of fiscal consolidation over the next
10 years to achive debt targets
Percent () of GDP
16
14
12
10
8
6
4
2
0
GRC
IRE
JAP
USA
UK
SPA
POR
FRA
BEL
AUS
ITA
GER
CAN
Degree of Fiscal Consolidation
Source IMF, Strategies for Fiscal Consolidation
in the Post-Crisis World, February 4, 2010
20
The Economics of Debt-GDP Ratios
Countries with higher growth rates and inflation
can reduce debt-GDP ratios faster
  • Government Debt
  • Debt-GDP Ratio ------------------------- x
    100 Nominal GDP
  • Government (or public) debt grows when the
    government has a budget deficit and it stops
    growing when it balances its budget
  • To reduce the debt-GDP ratio, nominal GDP must
    grow faster than the government debt. For this
    to happen, the economy must experience economic
    growth in output (real GDP), rise in prices
    (inflation) or both.
  • Low interest rates also help in that they contain
    the interest cost of servicing the countrys debt
    and help balance the budget sooner
  • In the long-run demographic factors also play a
    role, in that a country with stagnant or
    declining population experiences much slower
    growth in its nominal GDP and makes it harder to
    bring down the debt burden

21
What are the Prospects for Economic Growth and
Debt Reduction?
Growth prospects are poor, entitlements are large
and the European countries have placed themselves
into a deflationary straightjacket
  • In light of the large debt loads advanced
    economies will have to undertake a series of
    fiscal consolidation measures to reduce
    government spending and increase taxes which will
    lower the growth rate of these economies for a
    number of years to come
  • Most of these countries have high and rising age
    dependency ratios and low or falling population
    growth rates which put additional pressures on
    the state and reduce the growth potential of the
    economies
  • All of these countries have expensive social and
    entitlement programs which add to the burden of
    the state and reduce room for manuevre
  • The Eurozone countries are especially vulnerable
    because they are tied into a monetary framework
    that places priority on monetary control and low
    inflation

22
Why has Greece Garnered so much Attention lately?
Greece has the worst combination of high debt
level, large budget deficit and large external
debt
  • A country of 11.2 million and GDP of US 360
    billion, representing 2.8 of Eurozone and 27th
    biggest economy in the world
  • Has one of the highest debt-GDP ratios in the
    world 113 of GDP
  • Has one of the highest budget deficits in the
    world 12.9 of GDP
  • Has a large current account deficit 11.0 of GDP
  • Has a high degree of net foreign debt 70 of GDP
  • Has not had a credible financial reporting of its
    fiscal position
  • Is viewed as the first domino in a potential
    first world sovereign debt crisis
  • Greeces total outstanding public debt amounts to
    290 billion euro
  • If Greece were to default on its debt payments it
    would amount to the biggest sovereign default in
    history, bigger than that of Russia and Argentina
    combined
  • If Greece were to default, it would raise fears
    that the crisis will spread to other Eurozone
    members and this could cause the collapse of the
    euro currency

23
Why has Greece Garnered so much Attention lately?
But because it part of the Eurozone, has given up
control pf monetary policy and the printing press
  • Since it joined the Eurozone, it has ceeded
    control of monetary policy to the ECB and can no
    longer print money
  • Wages have risen faster than in Germany and has
    not adapted its economy rapidly enough to global
    competition, especially from Asia
  • Two of its largest industries, maritime shipping
    and tourism were hit strongly from the global
    economic downturn
  • The Eurozone has not injected the same degree of
    monetary liquidity as did the UK and the USA
    while the ECB has maintained a more
    contractionary monetary stance than the other two
    central banks
  • The euro has appreciated by about 65 since 2001
    against the US Dollar and by 47 against the
    Chinese Yuan

24
10-Yr and 1-Yr Greek Government Bond (GGB)
Yields 1998-2010
Greeces entry into the Eurozone has allowed
long-term interest rates to be cut in half and
short-term rates to be cut 5 -fold which
stimulated borrowing
12
10
8
6
4
2
0
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
1-yr GGB
10-yr GGB
25
USD/EUR Exchange Rate Since Greeces Entry Into
the Eurozone 2001-2010
Between January 2001 and January 2010 Euro has
appeciated by 65 against the US Dollar,
undermining the competitiveness of Greek exports
USD/EUR Exchange Rate
1.6
1.5
1.4
1.3
1.2
1.1
1
0.9
0.8
0.7
0.6
2001
2001
2001
2002
2002
2003
2003
2004
2004
2005
2005
2006
2006
2007
2007
2008
2008
2009
2009
2010
2010-12
USD/EUR Exchange Rate
26
Greece/euro vs UK /euro Exchange Rates March
2008 - March 2010
Being part of the Euro Area Greece?s exchange
rate remains fixed compared to Euro Area member
countries while UK has allowed the Pound to
depreciate against Euro Area countries
1.1
1
0.9
0.8
0.7
Greece/Euro
UK/Euro
27
Value of US Dollar Relative to Price of Gold
1900-2009
The USA has been able to sustain its economy by
debasing its currency at the cost of product and
asset inflation which in recent years has
produced serial asset bubbles, financial crises
and international trade imbalances. At some point
this game will come to an end with devastating
consequencesIndex (1900 20.67) Formula ( 1 /
USD Price of Gold ) x 20.67 x 100
1000
100
10
1
1900
1910
1920
1930
1940
1950
1960
1970
1980
1990
2000
2010
Series 1
28
US GDP IN NOMINAL US DOLLARS VS. US GDP MEASURED
IN GOLD, 1929 - 2009
When measured in gold terms, this chart clearly
shows the peaks and valeys in US economic history
since 1929 and shows that since 2000, the US
economy has entered a period of decline
Trillions of US Dollars
Billions of oz of Gold
100000
100
10000
1000
10
100
10
1
30
32
34
36
38
40
42
44
46
48
50
52
54
56
58
60
62
64
66
68
70
72
74
76
78
80
82
84
86
88
90
92
94
96
98
0
2
4
6
8
10
USA GDP Current
US GDP in Gold
29
US Federal Gross, Net and Foreign Debt as Percent
of GDP , 1939-2009 and Projections to 2011
US Federal debt levels have risen dramatically
since the global financial crisis. Gross debt
will reach 100 of GDP in 2011 and foreign debt
35
Percent of GDP
140
120
100
80
60
40
20
0
39
44
49
54
59
64
69
74
79
84
89
94
99
04
09
11
Gross Debt
Net Debt
Foreign Debt
30
US Foreign debt as percent of publicly held debt,
1969-2009
The US has been relying increasingly on foreign
savings to finance its debt. In 2008, foreign
borrowing accounted for over 50 of money raised
to finance its debt
Foreign debt as of Publicly held debt
60
50
40
30
20
10
0
39
44
49
54
59
64
69
74
79
84
89
94
99
04
09
Series 1
31
Total US Debt Outstanding Household, Business
Government, 1974-2009
Total private and public debt in the US is now
370 of GDP
Percent of GDP
Trillions of Dollars
400
60
50
300
40
200
30
20
100
10
0
0
1974
1979
1984
1989
1994
1999
2004
2009
Total Debt to GDP
Total Debt
Source Federal Reserve Board, Flow of Funds
Accounts Z1 d3 Canbek Economics
32
Is the Greek Crisis Coming to America ?
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