The Mother of All Bubbles Huge National Debts Could Push Euro Zone into Bankruptcy
Part 2: Living Beyond Their Means
The whole world lives on the principle of hope: hope that it will be possible to repay the debt that has accumulated in past years, that governments will manage to clean up their ailing budgets, thereby averting the worst, and that life will go on, just as life has always gone on, somehow, after earlier crises.
All of the major industrialized countries have lived beyond their means for decades. Even in good times, government budget deficits continued to expand. The United States, in particular, paid for its prosperity on credit. The poor example set by the state was contagious -- US citizens began buying cars and houses they couldn't really afford, and banks speculated with borrowed money.
Things couldn't possibly go well forever and, indeed, the financial crisis put an end to the days of unfettered spending. To avert a collapse, governments came to the rescue with vast sums of money, guaranteed their citizens' savings and jump-started the economy with massive stimulus programs -- all with borrowed money, of course.
A Huge Bubble
The world was saved, temporarily at least, but since then it has accumulated more debt than ever before in peacetime. The national deficits of the 30 members of the Organization for Economic Cooperation and Development (OECD) have grown almost sevenfold since 2007, to about $3.4 trillion today. Their total debt burden has also grown dramatically, to a record-setting $43 trillion. In the euro zone, national deficits have even grown 12-fold in the same time period, with the euro-zone countries accumulating $7.7 trillion in debt.
The current government debt bubble is the last of all possible bubbles. Either governments manage to slowly let out the air, or the bubble will burst. If that happens, the world will truly be on the brink of disaster.
When Greece faces a possible bankruptcy, the euro-zone countries and the IMF come to its aid. But what happens if the entire euro group bites off more than it can chew? What if the United States can no longer service its debt because, say, China is no longer willing to buy American treasury bonds? And what if Japan, which is running into more and more problems, falters in its attempts to pay for its now-chronic deficits?
The conditions that prevail in Greece exist in many countries, which is why governments around the world are paying such close attention to how -- and if -- the Europeans gain control over the crisis.
Warning Shot to the Markets
Athens' empty coffers were already of concern to the financial markets early last year. At the end of January 2009, yields on Greek government bonds had jumped to almost 7 percent, the highest level since Greece joined the euro zone.
At the time, there was already speculation over possible bankruptcies in Europe and a breakup of the euro zone. What at the time looked like scaremongering has now become bitter reality -- because politicians didn't take the warning signs seriously.
At an event organized by Germany's center-left Social Democratic Party bearing the hopeful title "The New Decade," then-German Finance Minister Peer Steinbrück uttered a sentence that, for many, shook the euro to its very foundations. If one of the euro countries ran into difficulties, he said, "all of the euro-zone members would have to help."
The sentence was a warning shot to the market, and the markets paid attention. The risk premiums on Greek bonds declined continuously. In early October, the country was still able to borrow money at about 4 percent, a rate only slightly higher than what Germany was paying.
This period was probably the EU's last opportunity to force the Greeks to introduce truly effective austerity measures. But the window was left unexploited.
On Oct. 20, a new era began for the Greeks. On that day, the newly appointed finance minister, George Papaconstantinou, announced a "correction" of the country's deficit figures.
According to Papaconstantinou, the national deficit would not amount to 5 percent of gross domestic product, as the government in Athens had reported to Brussels, but 12.5 percent. Things happened very quickly after that.
Greek government bonds have been continuously downgraded since then, most recently to junk status, and European governments have been negotiating the conditions under which they are willing to bail out the country. Finally, on Friday, April 23, Prime Minister George Papandreou officially asked the IMF and the euro zone countries for help.
The German government is partly to blame for allowing things to reach this point. The coalition government in Berlin, which brings together the center-right Christian Democrats (CDU/CSU) and the business-friendly Free Democratic Party (FDP), which got off to a haphazard start, has also acted unprofessionally in what has been its most difficult test to date. While the Greek debt problem was expanding into a risk to the global financial system, the coalition remained stubbornly focused on another problem: state elections in North Rhine-Westphalia on May 9. The vote is crucial to German Chancellor Angela Merkel because it will determine whether the Christian Democrats and the FDP are able to maintain their majority in the Bundesrat, Germany's upper legislative chamber which represents the interests of the states.
'Iron Chancellor' Image
To ensure that the citizens of Germany's most populous state would be favorably disposed toward her party, Merkel, to the applause of the powerful tabloid newspaper Bild, sought to portray herself as the "iron chancellor." She subtly stirred up resentment against the Greeks, staunchly resisted approving an early financial bailout for Athens and sent completely different signals than the most important member of her cabinet, Finance Minister Wolfgang Schäuble.
While the chancellor argued for IMF intervention, Schäuble proposed a purely European rescue package. And when Schäuble suggested a new type of bankruptcy proceeding for euro-zone countries, Merkel publicly questioned its feasibility.
It was clear to the finance minister that Germany would ultimately be unable to refuse to take part in an international rescue plan. The chancellor, on the other hand, sought to portray herself as a tough opponent of German help for Greece, at least until the critical state election on May 9. The phrase "no money for Athens" was more than just the rallying cry with which the tabloids inflamed public opinion. It was also a recurring refrain within the coalition parties.
Under these circumstances, it was no surprise that the CDU and the FDP took the same stance when the struggling government in Athens finally requested financial assistance from Brussels much earlier than planned. "The loans coming from Germany can only be approved if the holders of Greek securities share in the risk," said Leo Dautzenberg, finance spokesman for the Christian Democrats' parliamentary group.