Greece and the Eurozone: An Update


From reading the media, one gets the impression that bailing out its banks is the most serious economic problem the Eurozone faces. This problem could easily be avoided. As I have explained elsewhere, not allowing banks to sell off loans they make would resolve this problem.

But bank problems aside, the Eurozone countries appear to doing better. According to FocusEconomics (Table 1), the aggregate GDP growth rate for the region was 1.5% in 2015 and is projected to increase to 1.7% in 2016. Of course, this is hardly impressive as compared to the US with an actual and projected growth rate of 2.4% for both 2015 and 2016. But keep in mind that the Eurozone’s GDP declined in both 2012 and 2013 due to the “weak sister” performance of Cyprus, Greece, Portugal and Spain. Positive growth for the region started in 2014 and continues.

Table 1. – GDP Growth, Unemployment, Debt, 2014-16

Source: FocusEconomics

The “weak sisters” appear to be doing somewhat better. Cyprus, whose GDP fell in 2014, now seems to be progressing. Spain’s unemployment rate remains high, but its projected GDP growth in 2016 should help. Portugal has a worrying level of debt but growth also there has picked up.


And then there is Greece. GDP fell in 2015 and is projected to fall again in 2016. Since 2008, its GDP is down 27%. Unemployment remains high with and youth unemployment is just under 50%. And then there is its government debt. The IMF repeatedly says it debt rate is unsustainable, but the Euro countries have shown little interest in dealing with it. And once again, street protests are on the rise. And Greece has the additional burden of being a major entry point for migrants from the Middle East into the Eurozone.

One does wonder what form the resolution of the Greek crisis will take.

To get a handle on the problems facing Greece, the following selections from the IMF’s “Sustainability Analysis” summarized below are helpful (comments in brackets [ ] are mine):

  • About a year ago[summer 2014], if program policies had been implemented as agreed, no further debt relief would have been needed to reach the targets under the November 2012 framework (debt of 124% of GDP by 2020 and “substantially below” 110% of GDP by 2022). But the significant shortfalls in program implementation during the last year led to a significant increase in the financing need.
  • The financing need through end-2018 is now estimated at €85 billion and debt is expected to peak at close to 200% of GDP in the next two years. Greece’s debt can now only be made sustainable through debt relief measures that go far beyond what Europe has been willing to consider so far.
  • Greece is expected to maintain primary surpluses for the next several decades of 3.5% of GDP. Few countries have managed to do so. The reversal of key public sector reforms already in place—notably pension and civil service reforms—without yet any specification of alternative reforms raises concerns about Greece’s ability to reach this target. Moreover, the failure to resist political pressures to ease the target that became evident as soon as the primary balance swung into surplus also raise doubts about the assumption that such targets can be sustained for prolonged periods. The Government and its European partners need to address these concerns in the coming months. [??? – FocusEconomic’s consensus forecasts have Greece running government deficits (as % GDP) from 2015 through 2017 of 2.1%, 1.9%, and 1.6%, respectively.]
  • Greece is still assumed to go from the lowest to among the highest productivity growth and labor force participation rates in the Euro area. This will require very ambitious and steadfast reforms. For this to happen, the Government—which has put on hold key structural reforms—would need to specify strong and credible alternatives in the context of the forthcoming program discussions. [Not going to happen]

These four issues were identified by the IMF last summer as critical. They have not been addressed.

Also last summer, the Eurozone countries agreed to give Greece an additional €86 billion. To get this money, Greece agreed to a list of reforms. As every day passes, the growing anger and protests of the Greek people make it quite clear that no Greek government will be able to enact the reforms required to meet the reform targets.

Today, it appears that all parties are “sleepwalking” and not facing up to the realities of the situation. As every crisis comes up, the Eurozone countries release some monies to temporarily stem whatever problem has emerged.

The Banks Again

And with all this pending, the European Central Bank has just identified a €14.4 billion shortfall in the capital of Greek banks. The banks are taking steps to remedy the problem. Some think these bank problems are key. As quoted in Bloomberg: “The recapitalization of Greek banks, perhaps the most critical problem for the Greek state today, has entered its most critical stage,” Emilios Avgouleas, professor of international banking law and finance at the University of Edinburgh, and Levy Institute President Dimitri B. Papadimitriou, said in a report on Thursday. “Instead of repeating the mistakes of the past, recapitalization should create an environment of hope amidst renewed efforts to repair the Greek economy.”

I do not share the views of Avgouleas and Papadimitriou. How is recapitalizing banks going reduce the poverty and high unemployment of the Greek people?

The Road Forward

As the IMF has pointed out, Greece’s debt level cannot be sustained. And protests in the streets are growing over the austerity measures the Eurogroup has forced the Greek government to accept to obtain its latest bailout.

Where will this lead? In all likelihood, negotiations will follow the same path of earlier ones: they will stall and lead nowhere. In the meantime, the Greek economy will worsen, particularly as the austerity measures the Greek government does enact “bite”.

But at some point, Greece and the Eurogroup will have had all they can take from one another. At that point, Greece will do something it should have done several years back: leave the Eurozone, launch its own currency and default on its debt. This sounds horrific. It will cause great unrest and uncertainty, but there is really no alternative. To understand why, read on.

What happens to countries that are not “competitive” at the Euro exchange rate? They will not be able to sell their goods and services either domestically or abroad. The current account goes negative as imports grow and exports fall. In addition, unemployment goes up since nobody wants to buy the country’s production. In theory, these problems would be eliminated as wage rates and other production costs fall to a point where the country is again competitive. But mature nations have cost rigidities built in so things are not easily worked out – witness the IMF’s failed efforts in Greece.

I have earlier covered in some detail how Greece and other “weak sisters” could leave the Eurozone. Since all countries have downward cost rigidities, they need a currency that will devalue to keep them competitive in world markets. Greece will never be as productive as Germany and other Eurozone countries. The only lasting solution is for Greece to leave the Eurozone and return to its own currency. That way, currency rates will adjust for competitive differences.

It is worth keeping in mind that currency rate adjustments were what kept the US competitive with Japan. The dollar weakened from (¥360/$ in 1971 to ¥120/$ in 2015). And that change made Japanese goods three times more expensive to Americans.

Stock Market Investments

I have an investment friend. He likes to buy on “dips”. Since the Athens Stock Exchange (ASE:IND) has lost 72% of its value since 2011 and Eurozone stocks as reflected by iShares MSCI Eurozone (EZU) are down 27%, he wondered if this would be a good time to buy either. I told him I did not have a crystal ball: I did not anticipate the bank collapse in 2008 nor did I see gas prices collapsing as they have. However, I am certain Greece and the Eurozone will encounter numerous disruptions and real crises before matters are resolved.

The content above was saved on the old Morss Global Finance website, just in case anyone was looking for it (with the help of
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