Inside Greece’s Economic Problems, and Why It Matters to Us

by Fred Siegmund

Over the last 3 or 4 months, several news analysts have described the debt and deficit problems of Greece. Many of these same analysts decided to compare Greek debts and deficits to the United States.

They cited data on Greece that shows a high and rising ratio of debt-to-Gross Domestic Product that increases the risk of default on their debt payments.

After admitting the United States is not close to such a high ratio and in no imminent danger of default, they ended by arguing that we will be if we keep our spendthrift ways.

But there is one important difference in Greek finance that makes their government finance different than the United States.

How Greece Lost Control of its Financial System

Before Greece became part of the European Economic Community, they managed their economy with their own currency, which was known as the Drachma.

By joining the European Economic Community, they got easier and cheaper access to European markets, but that advantage required them to replace the Drachma with the European currency known as the Euro.

When the change took place, Greece lost independent control of its financial system. Now they have the same relationship to the EEC that California or New York or any of our states have to the Federal Government.

When Greeks controlled the Drachma, there was no situation where they would be unable to make debt service payments because they could always create more money. Now, they need Euros to pay their debts, but they cannot create them if they run short.

Public Sector Austerity and Private Sector Bankruptcy

In a personal or business bankruptcy, a court wipes out defaulted debt. In exchange, the court can seize remaining assets and sell them to pay creditors.

Countries can wipe out their debts by refusing to pay, but whatever else happens depends on investor confidence and politics, but not bankruptcy law or a court.

Greece was able to successfully raise $2 billion, but at a 4.55% interest rate. Investor confidence has to be paid for with higher interest.

Without outside investors, Greece will have to live within its means, cut spending and get their fellow citizens to pay more taxes or lend to their government. Public sector austerity is the equivalent of private sector bankruptcy.

Could the United States End Up Like Greece?

In the United States, there is no situation where the Federal government would be unable to pay their debts. There will never be a refusal to pay, but paying debts with new money can generate inflation and erode investor confidence very similar to Greece.

Right now, inflation and interest rates remain low and there are many people unemployed. Still, the Federal deficit is ballooning to unprecedented levels — but it is not too big yet.

If debt and deficits get too big, we will not be bankrupt and unable to pay our debts. Instead, inflation and interest rates will rise. Economic change will automatically impose the austerity we are unable to bring about through the political process with changes in taxes and spending.

In that way, we could be just like Greece: public sector austerity equals bankruptcy.

About the author: Fred Siegmund covers America's jobs as part of work doing labor market analysis and projections for a client base of recruiters, trainers and counselors. Visit him at www.americanjobmarket.blogspot.com

{ 1 comment… read it below or add one }

Kellen December 12, 2010 at 10:58 pm

Thanks for the succinct explanation here! I loved economics classes in college, but when I try to think things through in macroeconomics terms myself, I end up going in circles and confusing myself!

I think we need to stop worrying about politics and fix the problem. Simply increasing taxes won’t fix it. Simply decreasing government spending won’t fix it. We need to do both, and to become more efficient so we get more services per tax dollar. Of course, we may be far to large to ever be efficient 😉

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