Since 2009 Greece has been a barometer of the Eurozone’s continued viability. The rake’s progress of the four years to early 2009 had been remarkable. It had run current account deficits (relative to GDP) of 7.6% in 2005, 11.4% in 2006, 14.6% in 2007 and 14.9% in 2008 or, over the four years combined, of about 50% of GDP. The big external creditors included international banks, particularly European banks, which had acquired large holdings of Greek government debt and made loans to Greek banks. The extra debt could be serviced in the long run only if Greece reduced its current account deficit substantially. A devaluation against the currencies of its main trading partners was therefore sensible, in order to motivate the necessary switch of production towards exports. Unfortunately, as a member of the Eurozone single currency area Greece could not devalue. It could leave the Eurozone, but that would shatter the geopolitical dreams of the Eurozone’s architects in Germany and France. For them the single currency area was a permanent structure which foreshadowed ever-increasing economic and political integration in the European Union. As devaluation within the Eurozone was impossible, the focus of the policy drive to improve Greece’s financial position was on the budget deficit. The Eurozone sovereign debt crisis escalated in early 2010. Since then negotiations have been held between international bodies (usually “the troika” of the European Commission, the European Central Bank and the International Monetary Fund) and the Greek authorities, about targets for the reduction of budget deficits and public debt. The Greeks have repeatedly missed the targets. Fiscal austerity and the implosion of the banking system have been associated with a drop in real GDP of almost a quarter in five years. The GDP decline has further pushed up the debt/GDP ratio. This note examines the latest developments. Although the budget deficit numbers have been better in 2012 than in 2011, the macroeconomic trauma is so severe and unrelenting that Greece must leave the single currency area as soon as possible.
Banking is full of surprises. Governments in the leading advanced countries are agreed that banks must have higher ratios of capital to assets to make them safer and so to prevent a recurrence of the crisis of 2008/9. But there is a paradox – the paradox of excessive bank regulation – here. Capital/asset ratios can be increased in two ways, by boosting capital or shrinking assets. If banks shrink their assets, their deposit liabilities will also decline. But deposits can be used to make payments and are money. In other words, the current drive to make banks less leveraged and safer is having the perverse consequence of destroying money balances. This destruction of money damages company liquidity, hits asset prices and reduces spending. Bizarre though it may sound, the current regulatory pressure to curb the risks in bank balance sheets strengthens deflationary forces in the world economy. That increases the risks of a double-dip recession in 2010. In the USA the private sector is repaying bank loans, so that the stock of bank loans has been falling recently about by about 1% a month. Banks’ efforts to raise capital/asset ratios are a large part of the explanation. The result is that in recent weeks US broad money has also been falling, raising at least the possibility of a double-dip recession. Similar concerns have to be expressed about the Eurozone and Japan. (Fortunately, the UK – with its programme of quantitative easing – is following a different monetary trajectory.)