4 minThe economic situation in Greece
Guy Wagner The inconsistencies that were predicted by many economists when the euro was introduced, but were masked by the favourable economic situation between 2000 and 2008, have now come to light with the problems in Greece.
As the European Central Bank's monetary policy is essentially based on the economic situation of the "large countries", and more specifically, Germany and France, the Southern European countries' membership of the euro has enabled them to enjoy much lower interest rates than those to which they were accustomed when they had their own currencies. The authorities in Southern Europe have not taken advantage of these rates to reduce their debt – Greece, for example, continues to record an annual budget deficit of more than 5% despite growth rates well above the average for the eurozone (on this note, one could also speculate about the reliability of Greece's economic data as the government has just revised the deficit for the 2009 fiscal year upwards from 6% to 13%).
The low level of interest rates has also given rise to excessive consumption and favoured the appearance of speculative bubbles (credit, housing, etc). Between 2000 and 2007, unit labour costs (output per worker per hour worked) rose by around 20% in Italy, Spain, Greece and Portugal, while in Germany, there was no change. The resulting excessive consumption and negative trends in labour costs led to the appearance of increasingly high external deficits. In 2008, Greece's current account deficit was around 15% of gross domestic product. In terms of competitiveness, Greece has fallen to 71st place in the World Economic Forum index, below countries like Botswana. The fact that labour costs and the current account balance are not part of the convergence criteria set out in the Maastricht Treaty is one of the euro's major weaknesses. This weakness is further accentuated by the lack of automatic transfer mechanism between countries in the eurozone, which contrasts with the situation between the various States in America.
The Southern European countries are now in a very precarious situation. As significant external deficits build up, their foreign debt levels are also rising (1). If their external debt to gross domestic product ratio continues to increase, there will come a day where foreign investors will expect a higher return for continuing to finance these countries, resulting in an increased debt service cost and the appearance of a vicious circle. This is what is happening in Greece.
In the past, Greece could have applied an easy remedy: devalue its currency and print money. This option is no longer possible since the country joined the eurozone. On the contrary, the strength of the euro is weighing on the country's main industry, tourism. Since the start of 2006 the euro has gained 40% against the Turkish lire. In 2008 Turkey's revenue from tourism rose, while Greece saw its tourism-based revenue slump.
The situation in Greece is not without hope however. In principle, the country may rely on the support of the other eurozone members. The government could undertake privatisation to lower debt. In a country where the black market is estimated at some 25% of Gross Domestic Product, increasing taxes would make a major contribution to reducing the budget deficit. However, the fact remains that finding sustainable solutions to Greece's problems would require drastic austerity measures and result in falling living standards. In practical terms, neither the government nor the population seems willing to undertake such measures.
The imbalances described above are not new and have not prevented the euro from becoming the main alternative to the dollar on the currency markets. However, the fact remains that since the single currency was introduced, the imbalances have worsened and, unless there is a significant improvement in the economic situation, are likely to undermine eurozone cohesion. It is not for nothing that history shows that few monetary unions have survived.
What impact could Greece's problems have on the financial markets? First of all, in an environment where everyone seems convinced that the only way for the dollar to go is down, the situation reminds investors that when it comes to currencies, everything is relative and that the euro also has its problems. Given the inverse correlation between the dollar and the stock markets (the dollar falls when the stock markets rise and vice versa), a recovery in the greenback could see equities correct. The more so since, for many investors, the dollar seems to have replaced the yen as the preferred carry trade currency. Furthermore, risk aversion, which, after soaring to heady heights in 2008, has been falling since March, could rise again. Finally, the example of Greece shows that bond markets are not willing to tolerate a never-ending increase in governments' capital requirements.
(1) A country's current account deficit results from the shortfall of national savings compared to total investments. It is important to note that economists often make the distinction between a situation in which this inadequacy is due to particularly high levels of investments and a situation in which it results from falling savings.
In the first case, foreign capital finances the expansion of production capacity which, in the longer term, should enable the country to increase output and reduce foreign debt without having to lower living standards. In the second case (the Southern European countries), foreign capital is only used to finance excessive consumption. Here the increase in the foreign debt to gross domestic product ratio becomes particularly worrying (although it is difficult to know in advance from when this ratio is no longer sustainable) and forces the countries concerned to reduce consumption and sacrifice some of their living standards.
