It's All Greek To Me: The Greek Debt Crisis Explained

By Timothy Hayes on July 27, 2015

If you’ve turned on the radio, opened a newspaper, or searched through a web news service, you’ve undoubtedly seen something about the little southern European country of Greece. This little country is certainly in your memory from history lessons. It was the foundation of democracy, a hotbed of early philosophy and mathematics, and the originator of modern theatre.

However, how much do you know about the country after 1 AD? Probably not much.

Image by Margaret Barley via Unsplash

Greece, having had very early success, was then on the receiving end of some serious problems. After fending off Persians, Scythians, and a number of other hostile neighbors for centuries, Greece was conquered by the Romans in 146 BC. After the collapse of Rome, Greece remained under the control of the Byzantines who considered themselves Romans. From then on, Greece enjoyed prosperity until the Crusades.

Then between the Muslims and the Christians, who practiced a different form of Christianity than the Greeks, the country changed hands quite a bit. Since then Greece has been one story of invasion, counter-invasion, and counter-counter-invasion after another from the Ottoman Empire all the way up to Germany and Italy in WWII. Post-war, Greece came very close to falling under the Iron Curtain, but because of the U.S., it remained a capitalist monarchy. After a coup d’état in the ’70s, the monarchy was abolished and Greece became a formal democracy after a period of military rule.

Fast forward to 2001 when Greece joined the Eurozone, an economic and political union meant to unite the continent under one currency, one monetary policy, and one government. Formerly using a currency called the Drachma, Greece adopted the Euro like other members of the Eurozone. As part of the agreement to join the Eurozone, Greece had to adopt certain economic policies to become a member and ideally to stay a member.

These included the adoption of the Euro, agreement to print and mint a certain amount of money in Greece for the Euro, have no more of a national budget deficit of 3 percent, and a debt to GDP ratio of no more than 60 percent among other things. That’s a lot of important criteria, but it’s not well understood by the general populace so let’s explain some of this.

First off, why do governments have debt? Don’t they just collect taxes? Well the answer to the first is complicated, but the answer to the second is easy: no, they don’t. Governments frequently get revenue from different places. That might be sales of hardware or services from government departments. However, these don’t procure debt for the government. Debt is accrued with loans.

For example, if you want to start a business, it’s going to take quite a bit of money. You might ask your friend for some money and they’d lend it to you with interest. Well governments can do that too, actually. This money lending is done with bonds and loans. Bonds are simple ways of ensuring that the government gets a needed influx of cash and has time to pay it off, usually 10-30 years. Loans are usually larger investitures though and may be from other governments or private investors. If it’s the latter, the loan recipient’s national bank, like the Federal Reserve or the Bank of Greece, sets the interest rates.

So governments like Greece can borrow money on their own terms, set by their bank. So what do governments do with the borrowed money then? Well, in good economic times, they invest it in the economy and use it as incentives for businesses to expand. This subsidization is a great helping hand to a struggling economy and can then increase business.

With an increase in business, the government sees an increase in tax revenue. Hence, it is actually a good idea for governments to borrow money, as the increase in borrow means an increase in government investment in the economy and in turn economic growth and tax revenue. As a business model this works out pretty well, as long as the loan interest rates don’t get too high and the economy keeps growing.

Here’s where the problem starts.

(chart credited to Eurostat via www.atsbullion.com)

In 2008, the global economy took a nosedive. With the nosedive, investors got scared that tax revenue from governments would not increase and so they stopped investing. By this point, governments had been borrowing for years and had grown to rely on it. Consequently the governments could not pay off debts now owed to investors. To incentivize investment, many national banks like the Bank of Greece increased interest rates on loans to make them more appealing to investors, but on the flip-side made the loans harder to pay off for Greece.

This was tried elsewhere to some great success actually. Many countries pulled up out of the recession and are now doing well like Ireland and Portugal. However, Greece’s economy was largely dependent on two industries in 2008: shipping and tourism. During a recession, consumer spending goes down as people have less to spend so these two industries have historically done poorly in times of recession.

On top of this problem of increasingly expensive loans and decreased revenue from businesses, individuals in Greece are notorious for tax evasion. The country is wracked with corruption and the entire country is notorious for flagrantly evading taxes, even bragging about it. In the U.S., talk like that lands you with gargantuan fines and lots of jail time a la the Internal Revenue Service.

In Greece the problem is so bad that the Social Science Research Network has estimated conservatively that 28.2 billion Euros are unclaimed in Greece! That is, the total value of these taxes represent almost 8 percent of Greece’s debt. With numbers this high, Greece has got to crack down on tax evasion.

So why does all this matter to you? Well for starters, it’s a good idea to keep up on global news, but this is especially important because the U.S. is tied to the Eurozone very closely. Trade between the two is very high so whatever affects one affects the other.

This is also particularly important because the U.S. has a large economic debt. It’s in the trillions! That kind of magnitude is simply too big for most minds to comprehend how big that is. Unfortunately tax evasion is as big of a problem. The U.S. leads the world in tax evasion totals, but Russia leads it in percent of GDP.

So fortunately, it’s not as large of a percentage and thus a lesser problem. The U.S. economy is also robust and diverse, but Greece has lessons to teach us all.

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