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
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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 ?