While many are hoping that Greece pulls itself out of the debt mess soon, let me play the villain in saying that giving Greece more money probably won’t be enough to solve its debt problems.
1. Illiquidity vs. Insolvency
Greece’s debt is a problem of solvency and not liquidity. Before I go into the details, let me clear up a couple of terms:
• Liquidity – The ability to supply or have access to funds
• Solvency – The ability to pay off one’s debt obligations when they are due
Sure, Greece can receive all the money it needs to cover its deficit for now but bear in mind that these are also LOANED funds. This basically means that they are just paying debt with more debt! Sooner or later, Greece will have to cough up enough cash to pay off these debt obligations. This could set the stage for another default down the road…
What Greece probably needs right now is a drastic restructuring of their finances in order to make sure that the massive bailout package doesn’t go to waste and that the debt crisis doesn’t relapse. If Greece is able guarantee that it will be able to pay back its loans later on, more investors might be willing to extend them credit.
The question is this: Would Greece be able to pull it off? This leads me to my next point…
2. Refinancing Isn’t Socially Sustainable
Economists predict that the combination of the EU–IMF loan package and austerity measures would help reduce Greece’s debt-to-GDP ratio to 154% by 2016. Take note, without their help, the debt-to-GDP ratio could swell to more than 200%!
I don’t know about you but five years of severe austerity measures is a very long time. Remember, this is at least five years of frozen salaries, no annual bonus payments, increased taxes (21% to 23%), and a high 3.5% inflation rate. While everything around you is getting more expensive, at the same time, the amount of money you have available for spending decreases.
Social unrest, anyone?
3. The Euro Can’t Be Devalued
Now that I think about it, Greece’s inability to make any moves reminds me of what happened to Argentina way back in the good ol’ days when Pip Diddy actually had a full perm.
Just over a decade ago, Argentina was going through a recession of its own. At that time, government spending was out of control, which led to some serious budget deficit problems. And with the Argentine peso pegged to the US dollar, the Argentine government effectively had no control over monetary policy to help stimulate the economy. This left the government no choice but to implement some tight austerity measures. Naturally, this didn’t sit so well with the public.
While the euro isn’t pegged to any currency, the fact that Greece is part of the euro zone means one thing: They have no control over the value of the euro and are at the mercy of the European Central Bank. Why is this important? Allowing a currency to weaken could effectively help make paying back debt cheaper since the currency has less purchasing power.
In addition, Greece must rely on the ECB to set monetary policy for them. So why can’t the ECB just do this? Well, the central bank can’t accommodate Greece just like that. Remember, there are 15 other countries that the ECB has to worry about, which makes catering monetary policy in favor of one country pretty difficult.
When the going gets tough, the ability to control your own monetary policy could go a long way!