May 17, 2010
Formula for Grecian Debt
On the way to school this week I was tuned to NPR so my daughter could listen to a current event story for class. Unfortunately, Greece was in the news, with a problem that seemed just a bit too complicated for a fifth grader.
Greece is a small and faraway place. It has a population and economy about the size of Michigan. It is a small part of the European Union, which about a decade ago introduced a single currency for all member states. A single currency works fine in a place like the US where individual states do not engage in deficit spending. It is a real challenge in Europe where, if a single nation decides to engage in large deficit spending it can do so by selling treasury bonds. This is the equivalent of having a low interest credit card debt. This boosts the amount of money floating around the country and, just like personal credit card debt, lets the country live large – for a short while.
In years past, few would care if Greece decided to default on its bonds. But, in years past, no one would lend Greece money. Joining the single European currency provided some security on the Greek debt. It is a lot like having a rich uncle co-sign your credit card; it lowers your rate and increases your card limit. In this case, Greece’s rich uncle is Germany. So, Greece could only borrow the money at a low interest rate because everyone knew that the rest of Europe, especially Germany, would bail them out.
The security of an expected bail-out combined with a socialist government meant that Greece piled on the debt. They currently owe somewhere between 125 percent and 149 percent of their GDP. This is so high that Greek cannot conceivably pay it off. By contrast, the US debt is under 70 percent of GDP.
Without help, Greece will, in effect, declare bankruptcy. This will lead to the collapse of banks throughout Europe, and a second recession. The rest of Europe won’t let this happen, and so will instead bail Greece out.
As a condition of the bail-out, and a concession to a reality that seems in short supply in Socialist governments, Greece will have to live within its means. Greece will have to cut public sector employment, wages and benefits, reduce payments to the unemployed, cut public sector pensions, drastically reduce public spending on health care, suspend public works projects, extend the retirement age, cut subsidies to universities. They will enter a generation of austerity in which their best and brightest young people will leave for Europe or America. As it has been with every socialist government everywhere, since the beginning of time – the ill effects will last more than a generation.
We in the US are a very, very long way from Greece, geographically, economically and politically. All we have to do is live within our means. But then, maybe this is something a fifth grader can understand.
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