Greek Debt Crisis, Social Democracy, Welfare State, Keynesians, Inflation, Tax Evasion, Common Currency and the Eurozone

Posted by PITHOCRATES - June 19th, 2012

History 101

Higher Debt Balances accrue Higher Interest Costs that Reduce Income

The Greek debt crisis has been in the news for a long time.  Which has contributed to the Eurozone sovereign debt crisis.  Most people understand that it’s bad.  But they may not understand how bad.  Or understand what exactly happened.  What caused it.  And why they can’t fix it.  For it’s been a crisis since 2009.  And all we hear is that it’ll be apocalyptic if we don’t bail out Greece and save the Euro.  Which would be bad.  As most apocalypses tend to be.

To get a general understanding we’ll use an analogy.  Let’s say you just got a new job and are now earning $80,000 annually.  Your future is bright.  And you’re very happy.  You buy a big house.  And you run up your credit cards furnishing it with lots of nice stuff.  Because you’re earning $80,000 a year and can easily afford it.  Well, perhaps not easily.  But you can still put food on the table.  And take a nice vacation with your better half.  But then a recession sets in.  They cut your bonus.  And some of your benefits (taking a large health care deduction out of your check).  But that house payment remains the same.  As do your credit card bills.  So you cut out the vacation.  And eat more hamburger and less steak.  To adjust to the lost income.  Then worse comes. 

You lose your job.  Go on unemployment.  Which doesn’t pay your bills.  So you desperately look for a new job.  In the bad economy the best job you can get pays only $50,000.  Which is a lot more than unemployment.  But a far cry from $80,000.  You can keep making your house payment.  But you have to slash nonessential spending.  And cut up your credit cards.  Because those high credit card balances require a payment that’s almost as big as your house payment.  Almost your entire paycheck goes to your creditors.  All because you started spending money you didn’t have because you thought that $80,000 job would never go away.  In fact you spent based on what your income would grow to.  Beyond that $80,000.  This is the Greek debt crisis.  Only without the spending cuts.

A Policy of Constant Inflation Monetizes Old Debt and Bumps People up into Higher Tax Brackets

Like the rest of Europe Greece became a social democracy.  Which is socialism-light.  The people learned they had the keys to the treasury.  All they had to do was to vote for people who liked using that key.  And they did.  Government spending soared beginning in the Seventies.  The public sector grew.  Creating a lot of government jobs.  With some generous pay and benefits.  But the country was also a welfare state.  Which meant everyone got a state pension.  State health care.  And other state social benefits.  You didn’t have to work for the government to enjoy the generosity of the state.  And the state was generous.

And the generous government spending just grew more generous.  Strong economic growth allowed more spending.  And more borrowing.  (From 2000 to 2007 Greece led the Eurozone in economic growth.  Which probably sealed their fate.  Because the increased spending during boom times they could never sustain during bad economic times.  And bad economic times were coming.)  Budget deficits became a part of the Greek government.  For they were also Keynesians.  Who believed in the value of running deficits.  And accruing debt.  They devalued their currency.  Which helped make their exports cheaper.  And it monetized their debt.  A policy of constant ‘but manageable’ inflation made old debt worth less.  And easier to pay off.  Just as inflation made people’s savings accounts worth less over time.  But running budget deficits year after year increased their outstanding debt.  Starting slowly at first.  Then growing greater.   Prior to 1984 Greek debt as a percentage of GDP was below 40%.  By 1998 it was above 60%.  By 1990 it was above 80%.  By 1994 it was above 100%.  By 2010 it was above 140%.  By 2011 it was above 160%. 

The Keynesians don’t see a problem with this.  Because they believe if you keep depreciating the currency the older debt just goes away.  It’s like redeeming a $100 savings bond from 1875.  Back then $100 was a lot of money to the government.  Today it’s the loose change they drop from their pockets that isn’t worth bending down to pick up.  Metaphorically, of course.  In time with steady inflation those old debts simply become chump change.  And there’s something else Keynesians love about inflation.  It’s a hidden tax.  Sometime it’s not possible politically to raise taxes.  So they can use inflation to bump people into higher tax brackets.  Making them pay a higher percentage of their income to the government.  Which brings us to another Greek problem.

At the Heart of the Greek Debt Crisis is the Welfare State

Greece is a welfare state.  Like other welfare states they have to fund that welfare with taxes.  So they have high tax rates.  Because it’s what the people want.  That welfare state.  Which requires those high tax rates.  But they have a problem.  People don’t like paying taxes.  Especially the Greeks.  Who have taken avoiding paying taxes to an art.  Which plays a big problem in the Greek debt crisis.  People demanding all of that government spending.  Yet refusing to pay the taxes to pay for it.  Causing great problems.  Especially when they joined the common currency.  The Euro.

The common currency changed things.  They could no longer depreciate their currency.  Because it wasn’t their currency anymore.  It was the Eurozone’s currency.  Joining the Euro was like giving a bunch of people credit cards and telling them they had to restrict their purchases so that their annual deficit and total debt fell below certain percentages of their income.  And those numbers to join the Euro were as follows.  Their deficit had to be below 3% of GDP.  And their debt had to be below 60% of GDP.  If all the members kept within these limits they would maintain their good credit rating.  And be able to use their ‘credit cards’ responsibly.  And not shock the European Central Bank when they opened the credit card statement at the end of the accounting period.

It appears that Greece massaged their numbers with some creative bookkeeping to meet the requirements to join the Euro.  And to stay within the currency union they may have misreported their economic numbers.  (When the crisis began the Greeks officially reported that their deficit was 5% of GDP.  Which exceeded the allowable 3% but was salvageable.  After some outside audits they revised their 2009 deficit up to 15.6% of GDP.  Making the crisis more of an apocalypse).  Why did they do this?  Because they wanted to keep spending.  But they couldn’t depreciate their currency anymore.  The economy was in recession which higher tax rates wouldn’t help.  Not to mention all of the tax evasion.  So that left borrowing as their only avenue to sustain that excessive government spending.  Sort of like trying to solve the problem of having your credit cards cancelled for nonpayment by getting new credit cards to use to accumulate even more debt that you can’t repay.  They’ve gotten one bailout package already.  And a second one is theirs if they commit to some austerity.  Which the people have rejected.  At least those rioting in the streets.  And considering how generous those benefits had been it’s hard to blame these people.  For life as they knew it is over for them.  Thanks to irresponsible government spending that made them dependent on the government.

So there are a lot of factors that caused the Greek debt crisis.  But at its heart is one thing.  The welfare state.  For if there was no excessive government spending they wouldn’t have had those large deficits.  Debt.  Or debt crisis.

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