Blame Greece’s Debt Crisis on the Euro

The shadow finance minister, Barnaby Joyce, has been waxing hysterical of late about Australia’s “unsustainable” public debt. This is not a new line to take in Australian politics. Last year when the then leader of the opposition, Malcolm Turnbull, began attacking the government’s stimulus package, I argued in “Park the Debt Truck” that there was very little reason to be worried about Australia’s public debt.

This phobia of government debt is not unique to Australia. In the US, national debt is one of the primary bug-bears of the “Tea Party movement” that emerged in 2009. Widespread concern about government borrowing is helped along by the sort of simplistic fear-mongering evident in the so-called “debt clock” (and yes, I am aggrieved to say, there is an Australian version of the debt clock).

The catalyst for the current focus on sovereign debt is the crisis faced by Greece. Stimulus spending to combat the economic fall-out of the global financial crisis has led to significant growth in government debt around the world, prompting fears that Spain, Portugal, Ireland or even the United Kingdom or the United States will be the “next Greece”. This week, Business Insider published what it dubbed “the real list of countries on the verge of sovereign default”. Sourcing its information from a Credit Suisse paper via the FT Alphaville blog, they rank United States government debt as riskier than Estonian debt. That alone should raise eyebrows and suggests that Credit Suisse needs to join Barnaby Joyce in some remedial lessons in economics.

The basis of Credit Suisse’s sovereign risk ranking is mysterious. It supposedly takes into account, amongst other things, the market pricing of credit default swaps (CDS). However, they are clearly not listening too closely to the market, otherwise Argentina would be at the top of their list and the United States at the bottom (the chart below shows the actual Credit Suisse ranking). Of course, the market is not always right: just look at the tech bubble or the US housing bubble. Indeed, I know of one person working in the markets who refers to sovereign credit default swaps as a device for “taking money from stupid people and giving it to smart people”, so perhaps Credit Suisse are right not to put too much weight on these prices.

Credit Suisse Sovereign Risk Ranking*

It would appear that Credit Suisse is primarily concerned about the amount of public debt each country has (although if this was the sole criterion, Italy would rank above Greece).

Many who fret about the risk of government debt appeal to an analogy with a household budget. Just as you and I should not live beyond our means and put more on the credit card than we can afford to repay, so the government should not spend more than it earns in the form of tax. This analogy is simple and compelling. However, just as H. L. Mencken once wrote, “For every problem, there is one solution which is simple, neat and wrong,” this analogy is simple neat and wrong. The circumstances of the government are fundamentally different from yours or mine.

In “How Money Works” I explained the difference between money which derives its value from being convertible to something else, such as gold or US dollars, and “fiat money” for which there is no convertibility commitment. As I wrote in that post,

However, in a country with fiat money, the central bank makes no convertibility commitments…It has monopoly power in the creation of currency. So, the government simply cannot run out of money.

The United States, United Kingdom and Australia are all examples of countries with fiat money with floating exchange rates. None of these countries can ever be forced into default. Contrary to the alarmists, none of these countries are reliant on China (or anywhere else) for their money. Here is a simple thought experiment: when China “lends” the US government money by buying Treasury bonds, where does that money come from to buy the bonds? From US dollar mines by the Yangtzee river? No. All of the money comes from China taking US dollars as payment for their exports. So China is “lending” the US government money that was all created in the United States in the first place. While any of these countries could decide for political reasons not to repay their debt, that is extremely unlikely in current circumstances. So the United States, United Kingdom and Australia and indeed many other countries with fiat money and free-floating exchange rates should all be considered to pose an extremely remote risk of sovereign default.

But what about Greece? Unfortunately for the Greek government, ever since they joined the European monetary union and adopted the euro as their currency, they lost the power to create their own money. While the US government cannot run out of dollars, the Greek government certainly can run out of euros. To make matters worse, they are subject to the tight controls of the Growth and Stability Pact as part of the Maastricht Treaty which severely restricts their ability to use the sorts of stimulus measures Australia, the United States and others have turned to in the face of economic downturn. In fact, their national debt levels are already well over the Pact maximum of 60% of their gross domestic product.

Like the other members of the monetary union, Greece is effectively operating on a gold standard only substituting euros for gold. In A Tract on Monetary Reform, John Maynard Keynes referred to the gold standard as a “barbarous relic” and the European Union is now learning how right he was. They adopted a common currency with an eye on the benefits of streamlining commerce between member countries, but without understanding the implications for times of economic crisis. The Union is now in a bind: do they allow Greece to fail, only to see Portugal, Spain and others tumble in its wake? Or do they ignore the rules of the Pact and bail Greece out, a course of action which would doubtless leave Ireland feeling that their fiscal austerity measures were an unnecessary hardship? In all likelihood, they will find a way to dress up a rescue package with all sorts of tough language and pretend that the union is as strong as ever. The fact remains, that the euro is the real reason Greece finds itself facing a debt crisis.

But what of Estonia being less risky than the United States? The Estonian kroon is pegged to the euro, so despite not yet being part of the European currency union, Estonia has chosen to give up sovereign control of its currency. As long it goes down this path, Estonian government debt has to be considered a far riskier proposition than US government debt. Clearly Credit Suisse’s sovereign risk analyst does not understand this. Little wonder it is lost on Barnaby Joyce.

* India, which ranks between Egypt and Italy, is not shown in the chart because no CDS data is provided. The “CDS spread” represents the annual cost of buying protection against an event of default. This cost is measured in basis points (1 basis point = 1/100th of a percentage point). For example, in the chart above, the CDS Spread for Australia is reported as 50 basis points (i.e. 0.5%). This means that to buy protection against default on $100 million of Australian government bonds would cost $500,000 each year. A typical credit default swap runs for five years.

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11 thoughts on “Blame Greece’s Debt Crisis on the Euro

  1. Neerav

    “one person working in the markets who refers to sovereign credit default swaps as a device for ‘taking money from stupid people and giving it to smart people’ ”

    – that quote is refreshingly honest :-)

  2. Marco

    Good article, Stubborn. I wish you resume your modern monetary theory tutorials soon.

    But -to tell the truth and I mean no offense here-, as is often the case, people in economics overlook politics. It was Turnbull and Hockey who started the latest debt scaremongering episode in Australia: with their “indebting our children’s future”. Pretty much like The Simpsons’ Mrs. Lovejoy “Think of the children”.

    Other than the punch line, it was the same story: public and private debts together, as if they were the same thing.

    Asked about what they would have done differently, they both pointed to cut down the “cash splash”.

    What Joyce is doing is just to rehash the same BS, now replacing the “children’s future” with the “sovereign debt default” (I suppose that Joyce can actually read, and has read that there’s a country called Greece, that has debt problems; ergo, let’s say the same about Oz, as it sounds scary).

    Regarding CDS: there are rumours that Goldman Sachs has aided Greece in hiding their debt, while betting that the euro will fall. And Joe Stiglitz and others have advanced the hypothesis that part of the crisis is due to an speculative attack against the euro, similar to that credited to Soros against the pound.

    Let’s wait and see.



    PS: I’ve read your Mortgages in Australia piece and I found it extremely useful, for a variety of reasons. Although it may not be as glamorous as other topics (like sovereign debt defaults!), I believe as a matter of public interest, it’s superior. And you write in a very didactic way, such that the public in general can understand your ideas!

  3. Stubborn Mule Post author

    Marco: I’ve have heard some of those Goldman Sachs stories. Now I’m just waiting for the Rolling Stone exposé!

    When it comes to politicians, they can get things wrong out because they do not understand what they are talking about or they can choose to misrepresent the facts for political ends. I’m not sure what is worse: an ignorant politician or a dishonest one. Unfortunately in the case of Barnaby Joyce, I fear he is politicking and ignorant when it comes to the national debt.

    Thanks for your comment about the mortgage piece…as you correctly identify, sometimes the topics that interest me most and the topics of broadest interest are quite different!

    Also, I do plan to keep going with the monetary theory posts.

  4. Marco

    Now, my friend, have a look at what the Business Council of Australia is proposing to solve the “fiscal deficit”:

    Balancing Act: Fiscal and Policy Priorities to Support Growth

    This is the analysis I submitted to another friend’s website:

    “At the moment, I don’t dare to state what could be the end result of this move by the BCA.

    “At one hand, the Rudd government is starting to feel that voter support is falling. This might make them reluctant to move openly to satisfy their corporate masters.

    “On the other hand, Rudd has boasted of being a ‘fiscal conservative’ and we know what that means.

    “And Abbott and co are not beyond trying to depict themselves as champions of the oppressed: remember the short-lived ‘Abbott’s battlers’? They could resurrect it.

    “As the RBA will not be changing their policy of raising interest rates, the combination of higher interest rates, fiscal cuts and worsening global economic outlook could have severe recessive consequences by middle to end of the year.

    “These people should be grateful that stupidity, incompetence and greed are not crimes punishable by death.”

  5. CV

    “The fact remains, that the euro is the real reason Greece finds itself facing a debt crisis”. That’s true but there has also been a lot of bodgy public accounting going on for many years, and they are paying the price in the markets for that now. Greece will survive but the ride is going to be most unpleasant.

  6. Stubborn Mule Post author

    CV: you are certainly right that there was contributory negligence on the part of the Greek government. It seems did their best to hide much of their borrowing with help from Goldman Sachs (funny how they seem to have their fingers in every aspect of the crisis). Still, if they had control of their own currency, they may never have been tempted into that sort of creating accounting in the first place and would certainly have had far more flexibility to address their economic woes. Whether or not they would have used that flexibility wisely is another question.

  7. Marco


    As a follow up to my last post: as sometimes a go ballistic with this kind of things, I prepared a more elaborate and hopefully level-headed one on the BCA Budget Submission. You can find it here:

    You will find that I abstained from commenting the Submission from a chartalist perspective. I did this deliberately in an attempt to use the very neo-classical logic to show its short-comings.

    I also abstained from commenting parallel debates overseas. In the UK and the USA this is a major topic and one that will have further repercussions here. But I decided, for brevity’s sake, to let this debate for another opportunity.

  8. blue monkey

    Greece and Spain won’t pay back. The only thing Germans can do is:
    REPOSES 170 Leopard 2AEX Battle Tanks from Greece, and 190 Leopard 2A6E Battle Tanks from Spain.
    U.S.A must REPOSES 170 F-16 Jet Fighters from Greece, the rest is gone with the wind …forever …
    Greece must stop paying lucrative pensions with borrowed money, reform the health care system, and cut 4 times the military budged.

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