There has been a lot of news over the last year about the situation in Greece and how Greece’s economy could possibly take down the Euro. The ripples from such an event could set off a global slow down. But, what is the problem with Greece’s economy, and why has this never been an issue before?<\/p>\n
To understand what is going on with the Euro and Greece, it is helpful to understand just where things stand today, and where they stood a couple of decades ago.<\/p>\n
Before the implementation of the Euro as a single currency for countries across Europe, each country had its own money. Greece had its own currency called the drachma, and other countries had their own currency such as the German mark, the French frank, and so on. Each country gave up its own currency to make one currency to be used through out Western Europe, with the notable exception of England, which refused to give up the English pound.<\/p>\n
Typically, when a country takes on too much debt there are various market forces that “fix” the problem. For one, the bond markets begin to demand a higher interest rate in order to invest in the country’s bonds. This is simple supply and demand. More debt means more bonds (in dollars). Once investors have their fill of 10-year bonds paying 5 percent, the only way to get them to buy more is to pay more interest.<\/p>\n
Countries who let their deficits get out of control can either raise taxes or cut spending. Neither is politically popular, and often neither one actually happens. The result is that the country simply prints more money to make its debt payments. This results in inflation.<\/p>\n
Inflation is the effect of supply and demand on money. When there is more money, it is easier to get and less scarce. That makes people want more of it in exchange for other goods or services that have not gotten easier or harder to acquire.<\/p>\n
When a country like Greece has its own money, inflation slowly makes its currency worth less, both at home and abroad. That means that the cost of goods and services increases. This is not popular either, but it happens slowly over time and without any actual government action, so it isn’t until later that the population is really affected. Theoretically, a government could continue with inaction for decades or longer, all because the results don’t affect any other countries directly. It is simply a case of reaping what you sow.<\/p>\n
The problem that exists now is unprecedented, because the Euro itself was unprecedented, at least at this level and size. The Greek deficit cannot drive inflation in just Greece because the same currency is used throughout Europe. Furthermore, the Euro is controlled by a European bank, not a Greek one, so Greece can’t just print its way out. The result is that the only force acting on Greece is bond yields and those recently got so high that the country couldn’t repay them.<\/p>\n
Before creating the Euro, the countries agreed to a bunch of rules about how they would behave with their economies since the actions of one country would end up affecting the others. These conditions included limits on spending and deficit levels. Unfortunately, the previous Greek administration copied a page out of the financial fraud playbook and lied about the Greek deficit for years. When it was found out, the levels that existed were too high to comply with Euro rules.<\/p>\n
The result of all this is that various European countries agreed to provide some of their money to Greece on the condition that Greece get its act together and stopped its deficit spending. This led to some very unpopular political decisions by the Greek government in the form of spending cuts, which may or may not harm the economy so much that tax collection slow down, making the whole thing moot. At least Europe has bought some time.<\/p>\n
The real difficulty comes from a fundamental flaw in the construction of the Euro and European Monetary Union. While everyone liked the idea of a unified currency, no one was interested in a unified government. This leads to a disconnect between policy decisions and their natural effect on an economy’s currency. In other words, Greece’s bad economic policy decisions are divorced from their usual effect on Greece’s money. So, Greece’s currency can’t be worth less due to bad policy, and Germany’s worth more due to good policy.<\/p>\n
It seems that England may have been right to not join the Euro. While Europe worries about its currency and the interlinking it requires among countries, no one is worried about the Pound which continues to reflect only the policies and financial restraint or lack thereof of the British Government.<\/p>\n
Even if Europe is able to weather this particular economic storm, it won’t be the last unless the country’s policy decisions are as unified as its currency. Look for the problem to clear up when the inevitable economic expansion helps fix everyone’s balance sheets. But, also look for it to return during the next economic cycle when a recession exposes the same problems again.<\/p>\n","protected":false},"excerpt":{"rendered":"
There has been a lot of news over the last year about the situation in Greece and how Greece’s economy could possibly take down the Euro. The ripples from such an event could set off a global slow down. But, what is the problem with Greece’s economy, and why has this never been an issue before? Greece and the Euro To understand what is going on with the Euro and Greece, it is helpful to understand just where things stand today, and where they stood a couple of decades ago. Before the implementation of the Euro as a single currency for countries across Europe, each country had its own money. Greece had its own currency called the drachma, and other countries had their own currency such as the German mark, the French frank, and so on. Each country gave up its own currency to make one currency to be used through out Western Europe, with the notable exception of England, which refused to give up the English pound. Greek Deficits and Inflation Typically, when a country takes on too much debt there are various market forces that “fix” the problem. For one, the bond markets begin to demand a higher … <\/p>\n