7 Things You Need to Know About the Crisis in Greece

Copyright Trine Juel/Flickr
Copyright Trine Juel/Flickr

With Greece nearly certain to default on a 1.6-billion-euro bond payment due June 30, the long-feared prospect of Hellenic financial chaos is just about here.

The nation’s banks closed this weekend, and the government imposed controls of the movement of capital in and out of the country. A Greek referendum is set for Sunday, in which voters will decide whether to accept more austerity or face the prospect of being booted from Europe’s currency union.

1. How bad is the problem? 

Greece owes foreign creditors about 280 billion euros, including $242.8 billion to public or quasi-public entities, such as the International Monetary Fund, the European Commission and European Central Bank. It doesn’t have the cash to make the interest payment due this week, and the failure to make a deal to restructure and refinance the obligation raises the prospect of an imminent default. The two sides are talking about an 18-billion-euro package to refinance some of that debt.

Greece’s private creditors took a write-down of about 75 percent on debt owed to them in 2012, but the public entities have resisted a similar move.

2. Why have talks broken down? 

The so-called Troika of the IMF, ECB and EC are looking for a combination of spending cuts (the most politically sensitive of which are to pensions that function as the Greek equivalent of Social Security) and tax increases. Greece’s top tax rate of 42 percent already applies to annual incomes as low as 42,000 euros. In addition, the nation has a value-added tax of as high as 23 percent, and Social Security taxes are also much higher than in the U.S. The country is already having huge problems collecting taxes it is owed. Greek Prime Minister Alexis Tsipras, pointing to the nation’s 25.6 percent unemployment rate, argues that Greece can’t handle more austerity.

3. What did the government do this weekend?

Greece’s anti-austerity Syriza party called for an election, hoping voters would back its push to get creditors to back down. It also imposed so-called capital controls to halt the flight of money out of the country and closed banks for a week.

While most domestic transactions are little affected, there is a daily cash-withdrawal limit of 60 euros, and international transactions are subject to approval. Greek banks had been reporting a sharp decrease in deposit balances since at least April, cutting into the banks’ ability to meet their own international obligations. Europe has also been helping Greek banks with a program called Emergency Liquidity Assistance, but Goldman Sachs economist Huw Pill said Sunday that the assistance could end early this week as the rest of Europe tries to cap its total exposure to Greece.

“Although the Greek government has repeatedly stressed that this is not a referendum on Greece’s euro membership, we believe that in practice it is,” IHS Global Insight economist Diego Iscaro wrote Monday. “In the event of a ‘no’ win, Greece’s euro zone membership will be seriously jeopardized. The creditors are unlikely to change their position markedly, and it would be impossible for the Greek government to accept the current proposal after being defeated by popular vote.”

4. How will the mess affect the markets in Europe and the U.S.?

European markets traded sharply lower on Monday, and the Dow Jones Industrial Average opened nearly 1 percent lower in New York. But the effect may be short-lived: S&P Capital IQ published a 70-year historical analysis of past market shocks that found events like this produce an average decline of 2.4 percent on the next trading day, which has been recovered in an average of 14 trading days.

“Greece represents less than 2 percent of the EU’s GDP,” S&P strategist Sam Stovall wrote. “By itself, its default or exit won’t upend the EU. … Yet if this drachma drama triggers a market decline in excess of 10 percent, not seen since October 2011, it may be a blessing in disguise. As history has shown, prior market shocks have usually proven to be better opportunities to buy than bail, primarily because the events did not dramatically alter the course of global economic growth.”

5. What happens if Greece leaves the euro or is forced to leave the euro?

Estimates of how little Greek drachmas may be worth are all over the place, from 340 to the U.S. dollar to as little as 1,000 drachmas to the dollar. Even before Greece is (or isn’t) forced to leave the currency union, there is talk of the government meeting its obligations in so-called “parallel currency,” whose value is highly uncertain.

6. Has the IMF’s austerity program worked so far?

No. Austerity has been the rule in Greece since the first debt-restructuring program was approved in 2010. But Greece’s unemployment rate has nearly tripled since, and annual gross domestic product has dropped 100 billion euros, or almost 30 percent. Greece’s slashed spending and tax hikes brought the nation’s “primary deficit,” or deficit before debt-service payments, into surplus territory in 2010. But the program was the equivalent of slamming on the economy’s brakes: Output dropped so rapidly that the primary deficit is now again 2 percent of Greek gross domestic product even with tough controls on spending. That’s not much different than the U.S., but the U.S deficit as a percentage of output is declining because the U.S. economy Is growing.

7. What does this mean for Greek tourism?

Uncertainty overshadows Greek tourism. And the stakes of not interrupting tourism are high indeed: Tourism accounts for 18 percent of the nation’s economy and employs a quarter of its workers, according to the Association of Greek Tourism Enterprises. Greece attracts as many as 17 million annual visitors, twice the nation’s population, and is virtually the only industry still growing in a nation where an estimated 59 businesses are closing each day.

But already, tourists are reporting difficulty getting cash, because automated teller machines are running out, and the threat of capital controls had some merchants unwilling to accept credit cards. Over time, leaving the euro and devaluing the drachma would lead to a period where Greek vacations should be very cheap for Western tourists.

How long that would last, and the impact it would have on hotels and other merchants, is hard to forecast. But resort owners are resisting creditor proposals to end or curtail their tax breaks for resorts on more remote islands and to raise the value-added tax on lodging.

Written by Tim Mullaney of CNBC

(Source: CNBC)

How the US is Helping to Sink Puerto Rico

© REUTERS/Ana Martinez
© REUTERS/Ana Martinez

As creditors in Europe look with trepidation at the increasing probability that Greece will default on its debts, investors in the United States are watching a similar situation play out in Puerto Rico, where decades of borrowing and a stagnating economy have, according to the commonwealth’s governor, made default on general obligation bonds all but inevitable.

The government announced over the weekend that banks would be closed on Monday and capital controls would be put in place to prevent investors from taking money out of the island’s economy.

In an alarming report that leaked over the weekend, a team of economists headed by Anne O. Krueger, former chief economist for the World Bank and more recently first deputy managing director of the International Monetary Fund, issued dire warnings.

“Puerto Rico faces hard times,” the authors found. “Structural problems, economic shocks and weak public finances have yielded a decade of stagnation, outmigration and debt. Financial markets once looked past these realities but have since cut off the commonwealth from normal market access. A crisis looms.”

The Krueger report found that the government’s fiscal deficit is “much larger than assumed” and said the only way forward involves massive restructuring of both the government’s debts and those of major public enterprises.

Any move to restructure the commonwealth’s obligation will likely meet stiff resistance from the bond markets. Puerto Rico’s debt is widely held by U.S. hedge funds, mutual funds and other investment vehicles. It has been particularly popular because a special provision of U.S. law for years made it exempt from federal, state and local taxes.

That allowed Puerto Rico to fund large amounts of deficit spending for well over a decade, resulting in a debt load that has placed an enormous fiscal burden on an economy that has begun shrinking. As recently as 2013, Puerto Rico’s Government Development Bank could borrow at between 5 and 6 percent interest. Today, that rate has rocketed to more than 15 percent, essentially shutting the island out of the bond markets.

The combination has left Puerto Rico unable to pay its debts, Gov. Alejandro Garcia Padilla admitted in an interview with The New York Times. “The debt is not payable,” he said. “There is no other option. I would love to have an easier option. This is not politics, this is math.”

The Krueger report notes that Puerto Rico’s close association with the United States is both a benefit and a curse when it comes to the island’s economy.

For example, employers are subject to federal minimum wage laws, despite the fact that the federal minimum of $7.50 per hour is much higher relative to per capita income on the island than it is on the mainland. A mainland U.S. worker earning the minimum wage is making about 28 percent of per capita income in the country as a whole. A worker earning the same in Puerto Rico earns 77 percent of the island’s per capita income. This means that even entry-level workers are much more expensive to hire in Puerto Rico.

Additionally, the report found, social safety net benefits are, given the cost of living on the island and the relative earnings of minimum wage, more generous than on the mainland.

“Workers are disinclined to take up jobs because the welfare system provides generous benefits that often exceed what minimum wage employment yields; one estimate shows that a household of three eligible for food stamps, AFDC [Aid to Families with Dependent Children], Medicaid and utilities subsidies could receive $1,743 per month — as compared with a minimum wage earner’s take-home earnings of $1,159.”

One result is that only 40 percent of the adult population is gainfully employed, versus more than 60 percent in the mainland.

The report paints a picture of an island trapped in a vicious cycle. Poor economic growth, the result of past fiscal mismanagement, has led to an increasing need for deficit spending, which further depresses growth, perpetuating what Garcia Padilla has called a “death spiral.”

With a population greater than that of 22 states, Puerto Rico has economic significance for the U.S., and its extensive use of the bond markets in the past decade means that a widespread default could be a major shock to the markets. (The island’s per capita debt load would also, as the Krueger report points out, involve an unprecedented request for relief from creditors.)

The report posits a “voluntary exchange of old bonds for new ones with a later/lower debt service profile.” That essentially means bondholders would have to take a haircut.

“Negotiations with creditors will doubtlessly be challenging,” the report said. “There is no U.S. precedent for anything of this scale and scope, and there is the added complication of extensive pledging of specific revenue streams to specific debts. But difficult or not, the projections are clear that the issue can no longer be avoided.”

Written by Rob Garver of The Fiscal Times

(Source: The Fiscal Times)