The Tragedy That Is Greece
by Sally Copperwaite
On May 5th, three bank workers died in a blaze at their Athens office block after violence broke out in a mass demonstration against the Greek government.
This was the tragic result of a decision taken in 1992, to impose a single currency on twelve very different economies.
The European political elite had always wanted a single currency. From 1979, most members of the European Economic Community (the precursor to the European Union) participated in the European Monetary System or EMS. This was an arrangement whereby the member states linked their currencies to prevent large fluctuations relative to one another. This led to the creation of the European Currency Unit or ECU, which was the precursor to the Euro. The participating countries had to prevent movements of more than 2.25% (although Italy had a much wider band of 6%) relative to the other participating currencies.
Periodic adjustments raised the values of strong currencies and lowered those of weaker ones, but after 1986, changes in national interest rates were used to keep the currencies within a narrow band.
Britain finally joined the EMS in 1990, but the strains of keeping the Pound in a tight band relative to the other currencies soon began to show. By 1992, Britain was forced to raise interest rates to punishingly high levels. George Soros saw the writing on the wall. By September 16th, 1992, (Black Wednesday) his fund had sold short more than $10 billion of Pounds Sterling, as he gambled that the British government would have a limit to how much money they would be prepared to lose in supporting the Pound.
On September 16th, the British government announced a rise in Base Rate from an already high 10% to an eye-watering 12% in order to tempt speculators to buy pounds. Despite this, and a promise later the same day to raise Base Rate again to 15%, dealers kept selling pounds. By 19:00 that evening, Norman Lamont, the Chancellor, announced that Britain would leave the ERM with immediate effect. George Soros (in)famously walked away with a profit of over $1 billion.
At the same time, Ireland was forced to raise their key interest rate to 17% in order to keep the Irish Punt within its EMS band, while Italy threw in the towel and withdrew from the EMS on the 17th of September 1992
Ironically, 1992 was also the year in which the European political elite officially imposed their desire for a single European currency on nearly 300 million people under the terms of the Maastricht Treaty.
Despite the problems suffered under the EMS, and clear breaches of the convergence criteria set down in the Maastricht treaty, the Euro project went ahead in January 1999, as eleven EMS member states (including Italy which had re-joined the EMS at a later stage) had their currencies fixed at the rate they were trading at as part of the ECU. The Euro thus became the successor of the ECU, and the European Central Bank (ECB) became the de facto central bank for the Eurozone member states.
Greece became the twelfth member of the Eurozone in 2002. Ominously, it was not able to join the Euro in 1999 because it could not meet the convergence criteria.
Even in 2002, no-one seriously believed that Greece had met the convergence criteria. This credibility gap has always been a major problem with the Euro project. The political elite were determined to carry on with their master plan, no matter what. They assured the people of the Eurozone that they knew what they were doing. They hoped that ordinary people would be so disinterested, or confused, that they would not object.
The ECB’s primary aim was to ensure the acceptance of the Euro by the 300 million people suddenly having to use it. They decided that the easiest way to do this was to keep their key interest rate artificially low from the start – far too low, as it turned out, for many of the new member states.
For decades prior to joining the Euro, short-term Irish Punt interest rates traded around 11%. Short-term rates reached a high of 17% in 1992, as Ireland struggled to keep the Punt inside its EMS bands. As conversion to the Euro loomed ever closer, short-term interest rates in Ireland gradually dropped until by January 1999, they were 3% in line with the rest of the Eurozone.
Spain, Portugal and later, Greece, all suffered the same fate as Ireland – a massive expansion of credit, as the banks in those countries actively expanded deposits and loans. The property markets in all of these countries went through the roof as the ECB did nothing to rein in the credit expansion, despite the ECB President’s constant refrain, ‘We are firmly anchoring inflation expectations.’
In fact, the ECB was not only expanding credit by intervening in the market to keep their key interest rates artificially low, they were also debasing the Euro by indirectly financing the ever-growing debts of profligate member states.
This is due to the way the ECB prints money.
As Phillip Bagus explained in his article of February 11th,
The European Central Bank accepts Greek government bonds as collateral for their lending operations. European banks may buy Greek government bonds (now paying a premium in comparison to German bonds of more than 3%) and use these bonds to get a loan from the ECB at 1% interest – a highly profitable deal.
The banks buy the Greek bonds because they know that the ECB will accept these bonds as collateral for new loans. As the interest rate paid to the ECB is lower than the interest received from Greece, there is a demand for these Greek bonds. Without the acceptance of Greek bonds by the ECB as collateral for its loans, Greece would have to pay much higher interest rates than it does now. Greece is, therefore, already being bailed out.
The other countries of the eurozone pay the bill. New euros are, effectively, created by the ECB accepting Greek government bonds as collateral. Greek debts are monetized, and the Greek government spends the money it receives from the bonds to secure support among its population.
His outlook for the Euro was bleak.
The future of the euro is dark because there are such strong incentives for reckless fiscal behavior, not only for Greece but also for other countries. Some of them are in situations similar Greece’s. In Spain, official unemployment is approaching 20% and public deficit is 11.4% of GDP. Portugal announced a plan to privatize national assets as its deficit is at 9.3% of GDP. Ireland’s housing bubble burst with a deficit of 11.5% of GDP.
The incentives for irresponsible behavior for these and other countries are clear. Why pay for your expenditures by raising unpopular taxes? Why not issue bonds that will be purchased by the creation of new money, even if it finally increases prices in the whole eurozone? Why not externalize the costs of the government expenditures that are so vital to securing political power?
Despite, or more likely, because of the spending undertaken by the previous Greek government, Greece has been in a recession since the credit crisis of 2007/8. Aside from problems accessing credit, the Greek economy has suffered from the strength of the Euro over the last three years. Greece relies heavily on tourism to bolster its economy and the strong Euro was a deterrent to many tourists. Turkey, right next door, was a much cheaper holiday destination.
Many Greek people may not have identified the Euro currency as the source of their problems but they knew that they needed a different government. So, in October last year, they voted in a new Socialist government, headed by George Papandreou, who pledged to fight corruption and tackle Greece’s worst economic recession in years. It was only once the Socialist party took office that they realised how bad the fiscal situation was.
It has fallen to George Papandreou and his Finance Minister to sort out the mess left by the previous government, and this will entail drastic cuts in government spending, higher taxes and an increase in an already high unemployment rate, at least initially. This is why the Greeks are rioting.
Unfortunately, their anger is directed at the new government even though this crisis was caused by the previous government, aided and abetted by the ECB.
LVM and Hayek would be horrified but not surprised by the inflationary activities of the ECB and by the profligacy of governments prepared to do anything to stay in power.
May 11, 2010