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Greek Austerity Measures

Published by marco on

What could happen to Greece and why is it Greece that’s in such big trouble? The short article, When Austerity Fails by Paul Krugman (NY Times) sums it up quite well.

Greece, Spain, Portugal and Ireland are in trouble, but Greece is hit the hardest because it was the government that “borrow[ed] at rates only slightly higher than those facing Germany [and] took on far too much debt.” In Ireland and Spain, the government didn’t borrow too much, but both those countries’ banks did and, at least in Ireland’s case, the government agreed to take on the banks’ debt for them. (For more on Ireland, see the article, When Irish Eyes Are Crying by Michael Lewis (Vanity Fair).[1]) Portugal was “somewhere in between”.

So Greece had a lot of money to pay back and needed to come up with the money somehow. As Krugman notes, though, instead of requiring that Greece crack down on its notoriously lax and corrupt tax system,

“European leaders offered emergency loans […] but only in exchange for promises to impose savage austerity programs, mainly consisting of huge spending cuts.”

These spending cuts are the austerity programs you hear the general populace protesting as their salaries are cut mercilessly while the tax-cheats—who could contribute a lot more—are left untouched. That the ECB (European Central Bank) could impose such conditions is not only cruel but bad policy; Krugman again:

“Objections that these programs would be self-defeating — not only would they impose large direct pain, but they also would, by worsening the economic slump, reduce revenues — were waved away. Austerity would actually be expansionary, it was claimed, because it would improve confidence.”

More than a year later and things have gone from bad to worse. The dire “slump” predicted above came to fruition, revenues are down, more austerity measures are being applied, the screws are being turned and the Greeks, desperate, are back in the streets, protesting for their livelihoods.

“It’s now clear that Greece, Ireland and Portugal can’t and won’t repay their debts in full, although Spain might manage to tough it out.


“Realistically, then, Europe needs to prepare for some kind of debt reduction, involving a combination of aid from stronger economies and “haircuts” imposed on private creditors, who will have to accept less than full repayment.[2] Realism, however, appears to be in short supply.”

So what happens when Greece can’t pay back its debts? Krugman thinks that “[i]f Greek banks collapse, that might well force Greece out of the euro area”. In that case, Greece would have to reëstablish a currency, though they would be hard-pressed to attract investment capital. Such a move “could start financial dominoes falling across much of Europe.” It’s hard to see why the ECB is on such a suicidal course other than blind devotion to a principle. That’s what Krugman thinks anyway—his “guess is that [the ECB] is just not willing to face up to the failure of its fantasies.”—but it could be that the same private investors who call so many other tunes, who head up so many institutions that are “too big to fail”, are also calling the shots on ECB policy, manipulating prevailing ideologies about so-called free-market principles to squeeze short-term gain from a dying market…and to hell with everybody else.


The whole article is long, but the main parts that describe what happened are as follows:

“In the general panic, absent government intervention, the other banks would have gone down, too. [Irish Prime Minister] Lenihan faced a choice: Should he believe the people immediately around him or the financial markets? Should he trust the family or the experts? He stuck with the family. Ireland gave its promise. And the promise sank Ireland.

“[…] if the Irish wanted to save their banks, why not guarantee just the deposits? There’s a big difference between depositors and bondholders: depositors can flee. The immediate danger to the banks was that savers who had put money into them would take their money out, and the banks would be without funds. The investors who owned the roughly 80 billion euros of Irish bank bonds, on the other hand, were stuck. They couldn’t take their money out of the bank. And their 80 billion euros very nearly exactly covered the eventual losses inside the Irish banks. These private bondholders didn’t have any right to be made whole by the Irish government.

“A handful of Irish bankers incurred debts they could never repay, of something like 100 billion euros. They may have had no idea what they were doing, but they did it all the same. Their debts were private—owed by them to investors around the world—and still the Irish people have undertaken to repay them as if they were obligations of the state.”

[2] Based on recent history, this is unlikely to happen. See the footnote on Ireland above where private investors were mysteriously paid back at 100 cents on the Euro for the bad investments, exactly as Goldman Sachs was mysteriously paid back 100 cents on the dollar for its losses in AIG. If one allows for corruption, things become far less mysterious.