Greece may account for only 2.5 percent of the economy of the 16 countries where the euro has replaced national currencies, but its financial woes are having a huge effect on the future not only of “euroland,” but also of the 27-nation European Union. And on the United States: The problems of Europe’s debt-ridden PIGS—Portugal, Ireland, Greece and Spain—have highlighted the finances of nations that are running huge budget deficits, including ours. As investors and rating agencies put it, the problems of the PIGS have put national balance sheets in play. We are on notice that our triple-A bond rating is under review.
Economists have always wondered whether a single currency, circulating in countries with 16 different budgetary and fiscal policies, could long survive. After all, the area’s central bank would have to find a one-size-fits-all interest rate that would control inflation in countries with overheating economies while at the same time stimulating growth in economies in recession or growing too slowly to maintain full employment. Answer: It can’t be done. At least, not very well.
But it turns out that is the least of euroland’s problems. The inventors of the euro have always known that monetary union without political union would be unsustainable. Germany would keep its fiscal house in order, a result of its historic experience with the consequences of inflation, while other countries such as Greece might go deep into debt, borrowing at attractive interest rates because investors assumed that should it run into repayment problems its euroland colleagues would somehow bail it out.
In anticipation of this problem the inventors of the euro required that all members sign on to a Growth and Stability Pact, pledging not to allow their fiscal deficit to exceed 3 percent of their GDP, or total debt to mount to more than 60 percent of GDP. European federalists always saw this as a temporary measure, eventually to be replaced with formal political union and the emergence of a United States of Europe, never mind that voters in many European countries want no part of such a surrender of nationhood.
Greece, eager to trade its drachma for the euro so that it could borrow at the lower interest rates that membership would make available, readily agreed to the 3 percent limit on its deficit, was inducted into the exclusive euro club—and then went on a borrowing spree concealed by a variety of accounting tricks and some outright economizing with the truth. With the help of Goldman Sachs and other banks, Greece engaged in exotic financial transactions and also sold future income streams such as revenues anticipated from landing fees at its airports for current cash, and then concealed the liabilities with a variety of off-the-balance-sheet devices that Goldman now admits were insufficiently transparent. (At one point the Greek government considered selling off future revenues from the sale of admission tickets to the Acropolis, but it finally decided that headlines like “Greece Sells the Acropolis” might attract unwanted attention to its financial shenanigans.)
Investigators from the European Central Bank, aided by experts from the International Monetary Fund, are still trying to determine the size of Greece’s deficit, a process not made easier by a strike of Greek Finance Ministry staff in protest against efforts to cut their benefits or raise their retirement age. The best guess is that last year’s deficit came to almost 13 percent of GDP, total debt is well in excess of 100 percent of GDP, and unless spending is cut and taxes raised, the flood of red ink this year will be no lower. Problem: Greece has to borrow about $75 billion to repay debts due this year, and unless the deficit is brought under control investors are either going to just say no or demand punishingly high interest rates to make their capital available. Unless, of course, Greece’s euroland or EU colleagues guarantee repayment, setting the stage for similar requests from Portugal, Spain, and perhaps Italy and Ireland. Call it moral hazard.