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What's the Matter with Greece?


What's the Matter with Greece?

June 30, 2015

Greece has been on life support for the past five years, receiving financial assistance from Eurozone member states, the International Monetary Fund and the European Central Bank in exchange for economic reforms to stabilize its finances.

Last week, Greek Prime Minister Alexis Tsipras said "no" to creditors' demands - tax increases and pension cuts - for releasing additional funds, without which Greece can't make a $1.7 billion loan payment to the IMF on June 30. Tsipras called a July 5 referendum on the Eurozone's offer, which is moot at this point, and is encouraging Greeks to vote "no." 

For Tsipras, "no" means "yes" (hopefully) to a better deal from Greece's creditors. For German Chancellor Angela Merkel and other European leaders, "no" means "no" to the terms for additional bailout funds and "no" to remaining in the Eurozone. The showdown with Greece, which The Guardian called a "Sarajevo moment" for the Eurozone, continues as the clock ticks down toward the midnight deadline. As we went to press, Tsipras became the first to blink, asking for a new bailout to replace the expiring one.

So what exactly is the matter with Greece? Simply put, it was in the wrong place (Europe) at the wrong time (1999) when 11 countries with 11 different languages, governments, cultures and customs abandoned their domestic currencies and tied their collective fate to the euro.

The Eurozone lacked many of the essential ingredients for a successful monetary union, including labor mobility and a mechanism for fiscal transfers in the event of a crisis. The only question was, would the benefits - greater integration of capital markets, reduced transaction costs, enhanced trade and elimination of exchange-rate risk - outweigh the costs associated with asymmetric shocks and the loss of central bank sovereignty over interest rates and exchange rates?

Don't get me wrong. Greece has long-standing problems that make integration with highly developed economies difficult. It fudged its deficit numbers in order to gain entry to the Eurozone. Its debt stands at 177 percent of GDP. The Greek economy has contracted by almost 25 percent since the end of 2006. The unemployment rate exceeds 25 percent. Productivity growth is low. Political corruption is rampant. Tax evasion is something of a national sport. And bailout money keeps going to repay prior loans

Greece is certainly no stranger to financial crises, having spent half of the time since its independence in 1829 either in default or rescheduling its debt, according to Carmen Reinhart and Kenneth Rogoff, authors of "This Time is Different."

A better question might be, what's the matter with the Eurozone's designers? Unlike the Founding Fathers in the United States, Europe's leaders tried to do the impossible: to synchronize the economies of diverse nations with a single currency, a single central bank and individual fiscal authorities. 

"It was an accident waiting to happen," says Michael Bordo, professor of economics at Rutgers University, who co-authored a book on the history of monetary unions. "What went wrong, aside from the basic structure, was that the world economy was growing in 1999-2006," hiding many of the inherent problems. Capital flowed from the core countries to the periphery, creating a boom in the prices of non-traded goods, imbalances and ultimately a bust, which laid bare the structural problems. "It was a mistake from the beginning," he says.

Europe lacked many of the prerequisites for an optimum currency area as described by Robert Mundell, the economist and Nobel laureate considered to be the father of the euro. Those criteria included labor and capital mobility, wage and price flexibility, and an automatic fiscal transfer mechanism in case of crises - something that is a challenge without a fiscal union.

Europe's economies would seem to represent the antithesis of optimal for monetary integration. Germans are still Germans; Greeks are still Greeks. The citizens of European lack a common identity, common language and, in some cases, common goals.  

Greece requires a different monetary policy than Germany in order to escape its cycle of debt-deflation. It can't depreciate its currency to make its exports more competitive. Nor can it lower its benchmark interest rate, set by the ECB. The yield on the 10-year government bond spiked to 15 percent this week, reflecting the perceived risk of owning Greek debt - even for a day.

So what is the solution to the accident that finally happened? A successful resolution would have to include a write-down of Greece's debt, according to Bordo. "There's no way Greece can grow its way out of this," he says. In addition to debt relief, the Eurozone needs increased integration among its members, starting with baby steps. With so much bad blood between Greece and what it sees as its austerity taskmasters, it is hard to imagine Germany sharing responsibility for what it sees as Greece's spendthrift ways.

And yes, Greece needs structural reforms - badly, Bordo says. "It's a crony-capitalist emerging country." 

The week ahead will be crucial in determining Greece's near-term fate. July 4 may be a national holiday in the U.S., but the real fireworks will take place across the Atlantic on July 5.


Caroline Baum is a contributor to e21. You can follow her on Twitter here.

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