Financial markets all across the world have been in a delirium in the past month. The Greek stock exchange continued its plunge as it fell over 41% in the past year! The anxiety related to the Greek default also spread to all major markets in the world. Everyone from NYSE to FTSE is experiencing a sell off!
The countdown to the Greek default and the avalanche of financial hardships that it will bring along seems to have begun. Many experts believe that the Greek government is now bankrupt and that it has no means to pay off its debt. The creditors including the International Monetary Fund (IMF) on the other hand are hopeful that if the Greeks accept austerity measures maybe they might be able to pay up on the loans. Hence there are a lot of opinions and counter opinions that are flooding the financial world as of now. Nobody seems to be sure of whether the default can be averted? Whether it should be averted? Or what are the consequences of such a default?
In this article, we will try and answer some of these questions about the ever escalating crisis situation in Greece.
The Greek Extend and Pretend Game
Any expert who was looking at the situation from a purely mathematical perspective would have known years ago that the Greek debt is simply not payable. The real mess had been created when loans were being given out to the Greeks. That was the time when debates would have made sense. Around 2009, when the world woke up to the Greek crisis, it was already too late!
Greece, in 2009, was like a college student who had somehow gained access to multiple credit cards and now had such a huge balance that bankruptcy seemed like the only option. The revenue generated by the Greek government from taxes was not even enough to pay the interest due on the debt! So the Greeks simply did not have the wherewithal to hold on to this debt till eternity even if they wanted to. They were going to default even if they simply made an attempt to pay the interest due on the loans.
Instead of accepting the situation and letting the inevitable happen, the IMF and others came up with an ingenious plan. They would lend the Greeks more money at an outrageous 14% interest rate. The money that they lend to the Greeks will be used to pay back interest on the very loans that were due to them.
So in essence they were lending money and taking it back right away. However, the huge 14% interest rates on the new loans caused the old Greek debt to grow. As a result of playing this extend and pretend game for five years, the Greek loan has now become much larger than it originally was.
When looked at in retrospect, the Greek bailout attempt seems to be an attempt to obscure losses in reality. The math simply revealed that the Greeks are obligated to pay much more than what is mathematically possible. Hence, by extending even more credit and pretending that things will get better over time, the IMF seems to be attempting to obscure the losses of the investors who have made the investments. The Greek population has been forced into extreme austerity as this "extend and pretend" game is causing massive unemployment there.
The Greeks recently faced a situation where in the IMF would not extend more credit unless Greece accepted humiliating terms and without the IMF's assistance, Greece basically did not have the cash to pay its obligations. Therefore, a default was all but inevitable. As a result of this, there was a lot of panic in all the financial markets in the world. If Greece defaulted on their loan, they would also end up exiting the Euro.
Therefore, most Greeks were trying to get hold of their Euro denominated deposits and were trying to convert it to gold or some other real asset that would hold value even if the Euro became worthless in Greece. The result was massive bank runs wherein the already bankrupt Greek banks were struggling to pay back any money to the depositors triggering fears of a financial collapse.
As a result, the Greek government reacted by shutting down banks till the crisis was resolved. They limited the amount of withdrawals to 67 Euros per day per account. This was the amount of money that a family would require just to survive the day. Regardless of the restrictions imposed, there were people queuing up outside banks and waiting for hours to withdraw as much of their money as they could.
The Greek Prime Minister was unsure about how to deal with the IMF and the creditors. He therefore let the public decide whether they should accept the humiliating terms offered by the IMF or whether they should simply default. Over 61% of the Greek population voted in favor of the default. Hence, the Greeks refused to accept the IMF bailout at first sending markets across the world into a tailspin. However, later a deal has been struck out between the creditors and Greeks and Greece is not defaulting on its debts, at least momentarily.
The latest bailout of Greece merely appears to be an addition to the "extend and pretend" game being played. The fundamentals of the greek economy have not changed and they are still as bankrupt as they previously were. There doesn't seem to be a way out of the Greek crisis and extending more credit definitely does not seem like one.