Greece is in the midst of economic catastrophe, with both political and economic repercussions on the horizon.
The Greek debt crisis is many years in the making. In 2009 the budget deficit hit 12% of GDP and all the big rating agencies such as Fitch, Moody’s and S&P, downgraded Greek debt to junk status, so named for the higher risk of the borrower, i.e. the Greek government, being unable to repay their creditors.
This only stoked fears that Greece would not be able to pay back debt and investors started to get nervous. The Greek GDP had stalled and debt levels were at crazy highs. Debt was 127% of total Greek Gross National Product in 2009!
As bond investors became nervous, yields on Greek government bonds rose sharply. That means that bonds currently being sold in the market were essentially losing value.
For example, say the Greek government issued a bond. You buy this bond for 100 Euros and the government promises to pay you 110 Euros one year from today. All of a sudden people became panicky and bond yields soar. Now that bond you paid 100 Euros for is selling for just 60 Euros on the market.
So Why Are Greek Bonds Losing Value?
Everyone is starting to believe that there is a good chance Greece is bankrupt. So whoever bought your bond would have no confidence that they would get the money promised to them. That’s why they are asking for such a steep discount to take on the risk.
Once panic sets in, it can be hard to bring the markets back. Once bond yields reach record highs no one wants to risk any money. The economic system stalls and that’s never a good thing. In Greece high bond yields essentially shut down sources of private lending. Economies depend on investment to keep growing and the tap was now closed.
Desperate Times Call for Desperate Measures
With no source of income other than taxation, Greece would find it increasingly difficult to finance their public spending. They would soon go bankrupt.
In May of 2010, the IMF along with the European Central Bank and other Eurozone countries approved a €110 billion bailout so that Greece would not default on its sovereign debt.
The condition: Greece had to impose strict austerity measures, and severely slash their spending.
When a country is already in trouble, austerity seems like the common sense solution, but in economies it can have a restrictive effect at first. Economies in this situation tend to contract first, shedding its inefficiencies and experiencing pain along the way, before finding room to grow again.
Greece was plunged back into recession and now needed a second bailout worth €130 billion. Investors holding Greek bonds would have to accept extended maturities (instead of getting paid in 2020 they would get paid in 2030) and a 50% face value loss. This second bailout was approved in February 2012.
The Calm Before the Storm
It looked like everything was back on track. The economic outlook was promising, and Greece experienced three straight quarters of growth in 2014. Greece’s private lending market restarted; but then recession hit again in the last quarter of 2014. This happened just after a parliamentary election that resulted in the Syriza (Coalition of the Radical Left) party gaining control of the government. The Syriza would go on to refuse the terms of the bailout.
Because of all the political uncertainty – all aid was suspended until Greece either accepted the conditions once more or until a compromise could be reached.
That’s where we are now.
Greece is living pay check to pay check. No one is quite sure how much money they have left but the troubled economy had to dip into an emergency reserve account in order to make a 750 million euro payment to the IMF. Apparently 650 million euros were drained from the reserve account and supplemented with 100 million euro from the country’s cash reserves.
What is striking is that the emergency reserve account is actually funded by the IMF.
Every IMF member is allocated a portion of the IMF’s currency, known as Special Drawing Rights (SDRs). Generally countries use SDRs to bolster their currency. In nations where the currency is vulnerable to large swings and capital flight, SDRs act as a sort of buttress but it is extremely unusual for SDRs to be used to make payments.
Essentially Greece paid the IMF with the IMF’s money. Money the IMF had given Greece to use only as a last resort.
It’s a pretty desperate move.
Greece and the Eurozone are dancing dangerously around each other. Greece has been accepting bailout money since 2010 and using it to pay its bills, both at home and abroad.
Responsibility and Recession
The Eurozone is willing to lend money to Greece but only in exchange for severe austerity measures. The Greeks want the money but are unwilling to implement the changes. A proposed change to Greek pensions has been a particularly sore point of discussions.
Neither party wants a Greek default. The Euro area is already balanced precipitously economically speaking, and a Greek default could send the entire region into recession. The Greeks themselves don’t want further hardship after a nearly 6 year long recession but both parties are reluctant to be the first one to blink in this economic game of chicken.
Bond yields are rising again, and the stock market is hurting. Talks of Greece exiting the Eurozone are intensifying. It may just be rhetoric but at the same time Greece is running out of money to pay wages to government workers, keep pensions going and finance public spending.
Greek Finance Minister Yanis Varoufakis is on record saying that the liquidity situation in the country was dire and that Greece could run out of money in two weeks.
The clock is ticking.