You may have heard lately of protests in Greece. These are quite bad protests, involving tens of thousands of protesters. In a very troubling move the police have also begun to use violence against the protesters, including tear gas, and water cannons.
These protests are against something called the Greek Austerity Measures. These are measures exacted by creditors before they will give Greece any more money to pay off its outstanding debts. These austerity measures include things like cutting government spending and salary freezes. As you can imagine, these are not popular measures, leading to the protests.
How did Greece Get into Such a Mess?
Explanations vary: one school of thought says that Greece, in a bid to stave off the recession of 2008-2009, borrowed more money than it should have to spur growth. This increasing debt, coupled with growing lender distrust, led to higher interest rates, making repayment even more difficult, creating a circular effect.
In another theory, when Greece joined the euro in 2001, it already carried a debt load of 100 per cent on its GDP. However, joining the euro zone allayed fears about inflation, lowering interest rates in the bond markets. A lower cost of borrowing led to more debt, and the government may have doctored some figures so that they could meet the strict financial criteria of the EU.
Following elections, when the true extent of the debt situation became clear, markets panicked, and a default became imminent. The EU stepped in to bail Greece out, along with the International Monetary Fund, but without more money, Greece warns that it may still be forced to default in November, and there is no consensus yet on whether more funds will be forthcoming.
What is So Terrible about a Default?
Well, for one thing, defaulting on debts erodes lender confidence, just as it would in your life or mine. If we lent money to someone, and they didn’t pay us back when agreed, we would hesitate to lend them money again. Or if we did, we would charge a higher rate of interest to cover against losses on our investment.
In much the same way, interest rates could skyrocket, and faith in the Greek economy would plummet, which could also affect bond markets.
Also, Greece owes much of this money to banks. For many of these banks, this is a substantial amount of money, without which they may fold. Now, most Greek debt is held by other banks in Europe: for example in Germany and France. If those banks failed, the collapse could spread to those countries as well, leading to a much wider economic crisis.
But What About the Other Countries in the EU?
Greece may be the most talked-about poster child of the European debt crisis, but it is far from the only one. Ireland, Spain, Portugal and Italy have all been talked about in the past two years as victims of the same disease. However, the story is a little different in each case.
In Ireland, the situation was similar to the United States, in that a real estate bubble had been allowed to form. What this basically means is that the value of real estate (houses and land) had been allowed to appreciate far beyond their actual value. When the crisis came, the bubble burst, and banks were once again threatened. In an effort to calm the markets, the Irish government guaranteed the losses of the banks. This turned out to be a mistake. The budget deficit grew to unmanageable proportions, the banks continued to fail, and eventually the government was swept out of power.
These conditions are replicated across the EU zone. As concern over economies spreads, interest rates rise and borrowing becomes more expensive, growing the deficit. Similar threats face Spain, Italy and Portugal, all of which may need bailing out. Meanwhile, slow growth rates across the region have led to downgrading of the debt by financial agencies, which has, of course, meant — can you guess? Higher interest rates, of course!
What can be done about it?
The general fear is that trouble in one part of the euro zone may spread to every other part, given both the common currency and the strong economic ties in the region. This is why the EU, led by France and Germany, has repeatedly handed out bailouts, which are low interest loans or debt write-offs to the ailing countries.
However, discontent is growing. How long, say some countries in the EU, can they be expected to pay off the debts of other countries in the region? This is, of course, a somewhat shortsighted view. Unfortunately in the interconnected world we live in, it is impossible to distance ourselves from developments in other parts of the world. If other people suffer, in the end, in some way or other we suffer too.