Let's start simply, with budgets. Countries, like households, have income and expenses. Countries get income through taxes. Taxes tend to be related to a countries gross domestic product (GDP), so the more stuff a country makes, the more its government makes in taxes. If a government spends more than they earn in a given year, it is called a deficit. Do this enough, and that will lead to debt.
Debt isn't a bad thing, as long as it is a reasonable percentage of income. Most of us are comfortable going into debt to buy a house or a car. In Canada, household debt as a percentage of yearly disposable income has steadily increased from 90% in 1990 to about 140% today. The same idea can be applied to countries. For example, Canada's debt to GDP ratio is about 34%, which is reasonable. However, this is only the debt owed to Canadians, called "internal debt". We also have debt we owe to foreigners, which is about 75% of GDP. This is called "external debt".
You may be asking, how can countries have debt? Where does the money come from? Let's go back to our household. Say you buy a house and get a loan from the bank. This is "external" debt, because you borrowed from someone else. But say you want to buy a car but the bank won't lend you money. You could raid your kids college fund, or you borrow from your rich aunt. These could be thought of as "internal" debt.
How do these translate into a countries debt? Well, most countries issue bonds, which are basically I.O.U.s which both citizens and foreigners can buy. You give the government some cash and the government promises to pay you back. The interest rate the government agrees to give you depends on a how risky lending them money is. Stable countries have relatively low interest rates because they don't need to entice people to give them money. Unstable developing countries need to pay more to entice people to give them money because there is a real risk that they could default. The free market determines the interest rate on bonds. For example, the current Greek 2-year bond rate is 28% (i.e., if you lend Greece money for two years, they'll give you 28% a year interest!) Compare this to Canada's 2-year bond rate of about 1.5%.
What does "Greece has a debt crisis" mean? What it means, basically, is Greece spends more than it earns, and it can't make regular payments on the debt it owes to citizens and foreigners. As of 2010, Greece owes 165% of GDP to foreigners (mainly European banks) and 130% of GDP to citizens (mainly entitlement programs like pensions and benefits). Because they are having trouble paying people, no one will lend them any money, and if they will, it is at insane interest rates. This is like not being to pay down a credit card with 10% interest, so you get a credit card with 20% interest to try and make payments -- clearly not a sustainable situation.
(I'm going to take a quick aside here. You may be thinking, "Why do countries have to ask anyone for money? Why don't they just print it?" Some countries do that. The U.S. is doing that right now with their "quantitative easing". The problem is that unless you are a totally self-sustaining country, you have to buy stuff from other countries. If you debase your currency too much, the price for other stuff like oil and grain will just keep getting higher and higher. Eventually, when everyone loses confidence in your currency, hyper-inflation happens. For example, Zimbabwe has a $100 trillion dollar bill.)
Since Greece is a part of the European Union, the fact they are in trouble is affecting everyone. The European Union will help them out, BUT Greece has to get things under control. Foreign banks have put pressure on Greece not to restructure the debt they owe to them (restructure is a fancy term for saying: "I'm broke, so do you want some of what I owe you or none?") Internal debt is much easier to muck around with, so that is what Greece is doing.
Just like we raided our child's college fund to pay for our car, countries can do similar things. Eliminating pensions and benefits are one way. Pensions are a liability, whose cost is born by future generation. To get Greece's spending under control (so Greece can continue to pay back debt to foreigners), the EU is asking them to undertake "austerity measure" (also called "belt tightening" or "belt selling and giving the profits to banks"). If Greece does this, the EU will lend them some more money.
Let's create a detailed example to show what is going on. You buy a house, and are paying a $1000/month mortgage. You want a car, so you take the money out of your kids college fund, and are repaying that back at $500/month. Then your wife loses her job so your monthly income takes a hit. What do you do? You start getting credit cards, at progressively higher interest rates to continue living the life you are accustom, plus paying down your mortgage and replenishing the college fund. But things reach a breaking point. No one will lend you more money. So you go to your rich aunt and say, help, I need money. She looks at your situation and says, "Okay, I'll lend you the money, but you need to balance you budget. You can't spend more than your earn, so you'll have to cut back. No eating out and no new video games. If you do that, I'll lend you the money." You say, "Auntie, don't you know the bank manager? Perhaps he can reduce my mortgage so I can pay less per month?" The bank manager is not pleased to hear this, which your Aunt conveys to you. "Sorry, I think you're going to just have to stop paying into the college fund until you get back on your feet." Given all the pressure, you relent. You cut back (but wife and kids aren't happy), and the college fund payments stop, but the mortgage payments continue on at the same rate, and you get some much needed spending money to make it to next month.
Sounds like a reasonable story, right? Wrong. Greece (and Ireland) should do what Iceland did, and that is say "screw you" to the bank. Iceland had huge foreign debt, but rather than destroy their own country for some foreigners, they shared the pain all around. It isn't perfect. But defaulting is a safety valve in the capitalist system, and is required. The reason is there are always two parties to every transaction: a lender and a lendee. Both have to be kept responsible so neither abuses the system. Lenders have to do their due diligence to make sure they are lending money to people who are able to pay it back. Also, lendees have to be responsible and not take on too much debt. But when things get out of control, all parties involved need to share the pain.
Don't get me wrong, countries like Greece have to stop this insane socialist experiment and balance the books. Democratic governments always have this danger: that they will get caught in a cycle of bribing people with their money. As Thatcher said, "Socialism works until you run out of other people's money to spend."
The final issue is this stupid word "contagion". I hate it. It sounds like financial crises are colds that other people can catch. This is nonsense. The reality is if one person in a community gets laid off, then chances are others are getting laid off too. If a recession hits a community and a bunch of people's houses got foreclosed, you wouldn't say, "We've got to get this foreclosure contagion under control before it spreads to other people." The PIGS nations (Portugal, Ireland, Greece, and Spain) are in trouble because they spend more than they earn. If other nations (I'm looking at you Italy) start having the same problems, its not because they were infected with anything, but because they too spent more than they earned.
2 comments:
Excellent exposition, making a complex situation understandable. Just one qualm -- the admonition that Greece needs to "stop this socialist experiment" (especially when Margaret Thatcher is quoted to authenticate the point!)seems to imply that the current situation is an inevitable outcome of socialism. This is, of course, patently false -- there have been, and continue to be, many socialist governments (at both the national and provincial levels) that are very fiscally responsible (check out Scandinavia, and Saskatchewan for example). Close to home, a few decades ago, Saskatchewan, with a socialist govenment, was the first and only government at the time (national and provincial inclusive) to balance its budget. To be sure, some socialist govenments have screwed up fiscally -- but one would hardly call George W. Bush a socialist, and he inherited a balanced budget from the leftist Democrats and created a huge deficit situation that will take decades to recover from -- basically by giving the extremely rich (individuals and corporations) huge tax breaks. The essence of socialism is embedded in the famous "from each according to his ability; to each according to his needs." If implented properly, it merely levels out the distribution of wealth to ensure those with less are not impoverished, while those who have immense wealth share it more generously.
Thanks! I agree with you that there are stable socialist governments. However, socialism will tend to warp the behaviour of society members. All economic systems are about wealth re-distribution, which is similar to some members of society "carrying" other. But carrying others tends to discourage _both_ from walking: the carrier because it is more difficult, and the carried because, well, he's being carried. As long as this warping effect is recognized and the wealth distribution is "gentle", things are fine. But too much, and you break the backs of the "carriers".
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