Greece is the new kicking dog of the financial world. Everyone loves to malign it. Of course, it’s easy to do. It is outright ludicrous to think that the Greek fiscal and debt crises were a surprise. Like Spain, Greece received billions of euros in European Structural and Cohesion Funds. However, unlike Spain, which has thousands of kilometers of high speed trains and highways to show for it, much of the Greek funds disappeared mysteriously. Then, there was the issue of the 2004 Olympics, a masterpiece of cost overruns, fraud and corruption. And, there was the infamous incident of September 2006, when Athens suddenly decided to recalculate its Gross Domestic Product in order to reduce the fiscal deficit as a percentage of GDP. In order to do so, the national statistics agency was commanded to include all economic activity that was not previously included. As a result, Greece’s GDP jumped by almost 25%–thus pushing the fiscal deficit to within an acceptable range. Interestingly, the market was unperturbed by this behaviour. Credit Default Swap (CDS) spreads for the Hellenic Republic were only 4 bps more than Germany’s 5 bps in 2006. Of course, the market was in the throes of the global credit boom, and investors were willing to look the other way of any financial improprieties. The fact that people are now concerned about Greece, as well as other highly leveraged countries such as Dubai, Ireland, Jamaica, Spain, Iceland and Portugal, is more a reflection of what is going on in the global credit markets rather than something that is endemic to the Hellenic Republic. However, this crisis brings a new headache to the senior members of the European Union that was long overdue.
The European Union rose out of the ashes of World War II, but the monetary union was a more recent phenomenon. The objective a single currency was established at the end of the 1960s. The Maastricht Treaty was not signed until 1993, and the euro was launched on January 1, 1999. At first, the European currency did not fare so well. The euro traded well below the dollar for three years, dropping to a low of 82 cents in October 2000. However, the collapse of the tech bubble, the start of the U.S. military adventures in the Middle East and the erosion of the U.S. fiscal accounts allowed the European currency to steadily appreciate against the dollar. At the same time, the Fed’s lose monetary policy provided the globe with ample liquidity to finance countries with persistent trade and current account deficits. Greece was one of the many states that took full advantage of the credit boom, using accounting sleight of hand to mask its shortcomings. The rest of Europe was not duped. Brussels was fully aware of what was going on, but it was also the beneficiary of the economic boom. Therefore, it ignored the issue and enjoyed the party. However, a day of reckoning was somewhere on the horizon.
Now, after years of procrastination, Europe has a nightmare on its hands. French and German banks have a combined exposure of more than $180 billion to Greece—not an insignificant number for a sector that is still reeling from the events of 2008 and 2009. Moreover, the collapse of Greece could lead to the unravelling of the entire monetary union. Everyone knows that Portugal, Ireland and Spain are hanging on by a thread. However, Italy is also in dire straits. Moreover, it would only take a few nano-seconds for the crisis of confidence to spread to other highly-leveraged European states, such as Belgium and Luxemburg. In the aftermath of the Lehman debacle, policymakers around the world will do everything in their power to avert a disorderly collapse—because it can lead to rapid and uncontrollable contagion. This is the reason why France and Germany are at the forefront of the Greek rescue initiative. They are the ones who have the most to lose. The question is whether they can design a plan that will be palpable for their electorates. One thing is rescuing bankers of one’s own nationality. The other thing is bailing out a completely different country—and one with very little common national interests. The Greeks already have a well-established track record of undermining any sort of economic austerity and oversight. Furthermore, the Greek’s reception to the recent fiscal measures was very poor. This means that the prospects for a sustainable solution to the problem are not good. The euro was a very interesting and pleasant experiment during the period of high global liquidity, but it will be a painful lesson in deflation and austerity as capital flows dwindle. In other words, Europe’s hangover will be brutal.