What Do We Do About Greece?

On June 30th, 2015, posted in: Economic News, Newsletter by

In a foreseen yet dramatic move, Greece defaulted on a $1.7 billion payment to the International Monetary Fund (IMF) Wednesday, making it the first ever developed country to default to the IMF. The Greek debt crisis began in 2010, the same year Greece accepted a bailout of billions of euros from the IMF and European Union (EU). The bailout came with strict austerity terms, including increasing taxes and reducing spending. However, in January 2015 the voters elected an anti-austerity far left government that believed they could renegotiate the austerity terms of the bailout. The leaders said they would not cut retirement benefits and decided to raise taxes on the wealthy. This failed and caused the economic and financial situation to worsen; the new government did not contribute to the country’s growth and failed to pay any of its debts.

Since Greece is in the EU, it no longer has its own currency. Greece could devalue its currency to make the debt go away, or reduce pension benefits so its supporters won’t see it. Instead, the new government is in a tough position. Having run out of OPM (other peoples’ money) they are forced to rely on the market. However, private investors are unwilling to buy Greek bonds, so they are hoping other governments will step in and save them.

Fortunately, thus far, the IMF, the EU, and the European Central Bank (ECB) are refusing to support the status quo. With the Greek government’s back to the wall, a national vote on their options has been scheduled for July 5th. This referendum will decide whether the people want to accept the lenders’ latest offer and continue with austerity (higher taxes, pension cuts, and some market reforms) or not. If the vote is a no, it is unclear what will happen. One potential outcome is Greece exiting the Eurozone and abandoning the euro.

The government is urging citizens to vote no, believing if the lender’s offer is rejected it would put more pressure on other governments to step in and bail them out. At the same time, the Greek banks are facing liquidity problems as citizens are withdrawing funds to protect what little they have. The Greek banks are receiving Euros from the Bank of Greece (their central bank), which is being provided through ECB. The ECB has stopped the Bank of Greece from printing more Euros to fund the outflows. Having no choice, the Greek government declared a “bank holiday” until July 6. This makes it so customers can only withdraw 60 euros per day.

Greece, at the same time, is preventing capital from fleeing the country. The result is likely to be a double-dip recession. Fortunately, Greece cannot go bankrupt. Though many have compared the situation to Lehman Brothers, the Greek debt crisis is more like Detroit. When Detroit defaulted, the U.S. (equivalent to the EU) survived just fine. Greece, like Detroit, has already wasted the money it borrowed. The only thing left for Greece to do is recognize the loss. This loss doesn’t damage the Greek economy; instead, the loss will be absorbed by the IMF, EU, and ECB.

Economists are urging the EU to not cave to this leftist Greek government. Greece must implement the reforms it has steadfastly refused to utilize. If they do, it will result in Greece eventually repaying its obligations (albeit the pains of austerity–increased poverty and unemployment rates–will indeed continue to be felt). Without reforms, the outcome is likely more of the same. This will lead to more stagnation and default in the future, especially with more payments due at the end of this month.

Regardless of how this turns out, most commentators say it is getting more press than it deserves. Europe has had years to insulate itself against the potential bankruptcy of Greece. Foreign banks are no longer holding much Greek debt and the countries most susceptible to the effects of Greece’s bankruptcy are being backed by European lenders. Therefore, Greek’s bankruptcy will most likely just affect Greece. There is not a world liquidity crisis like 2008. With the US equities going down, it is really a buying opportunity. In any event, investors should stay the course and wait for the correction.

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