Charles Gray | A modern-day Greek tragedy
The Gray Area | The European debt crisis was driven by the arrogance of leaders
November 15, 2011, 12:14 am·
The Gray Area
The ancient Greeks and their Roman successors were obsessed with the idea of hubris.
Hubris was built around the concept that overconfidence in one’s abilities, especially for a society’s leaders, would lead to disastrous results.
Last week, 2,500 years after hubris dominated ancient dramas, we saw these concerns play out in front of us. We witnessed the downfall of the leaders of modern-day Greece and Italy, George Papandreou and Silvio Berlusconi, who were forced to resign due to the European sovereign debt crisis.
We should all be very concerned right now. Just like in the summer of 2008, the media is not really paying attention to an economic crisis built on debt. This time, we’re not only talking about the failure of banks but also about the widespread failure of countries.
Why are we in such a dire position?
The seeds of the crisis lie with the creation of the euro over 10 years ago by technocrats and politicians who felt they could outsmart the financial system. They thought that having a strong currency would provide a tremendous advantage by allowing nations to purchase very cheap debt. Why not pool together the vast population and productive capacities of mainland Europe to build a stronger currency than any individual country could build? Nations would be able to buy debt at lower rates and therefore encourage even greater growth through investment.
This shortcut worked for a while, but there was a problem: there was no enforcement mechanism in this monetary union to ensure that individual countries kept similar levels of debt, as promised.
A crisis began about a year and a half ago when Greece announced that its debt levels were much higher than what it had been telling the world. As a result, markets lost confidence in the country’s finances, and the price of debt skyrocketed.
This concern then spread to other countries on the periphery of the eurozone that also had high levels of debt — Portugal, Spain, Ireland and Italy.
Now that the cost of 10-year Italian bonds has reached 7 percent, it is almost impossible for investors to believe that growth can outpace the high interest payments the country must now make. In other words, the country’s debt burden only increases, and the market gets more skittish. It’s a circular pattern downward.
If these troubled nations had their own currencies, there would have been a short-term solution to each country’s problems. The central bank of each nation would have simply devalued its currency, which would have lowered prices — making its goods more competitive.
While this solution would have been temporary, it would have given these governments time to cut spending while still maintaining growth in their economies, alleviating the concerns of investors.
But because they are members of the eurozone, they are subject to the demands of other countries that have been fiscally responsible and don’t want to devalue the currency.
Instead, Greece, Ireland and Portugal all received short-term bailouts that required them to cut spending without addressing the wider problems preventing economic growth. To solve a debt problem, whether in Europe or in the United States, government spending cuts must be accompanied by reforms that encourage growth.
Greece is long past saving. The question is not whether it will default on its debt; it is a matter of how and when. And now that Italy’s price for short-term debt has reached 7 percent, it is headed down the same path.
“The only sane option Italy really has is to earnestly implement austerity, drop the euro, remark public and private debt in the reestablished lire and let a falling value for lire in currency markets impose a haircut on private creditors,” macroeconomist Peter Morici wrote in a column published on his website last week.
A year and a half ago, Greece could have left the eurozone and focused on the productive capacities of its people rather than maintain an artificial currency. Eurozone leaders had a window of opportunity to allow defaults to occur. Instead, they decided to go for the short-term fix — the bailout that was bound to fail and that increased systemic risk by expanding contagion to other countries.
And that is why this crisis is so fascinating. It demonstrates on a wide scale the danger of the self-confidence of politicians who feel that their short-term fixes can solve a much wider problem.
Papandreou and Berlusconi thought they could defeat the markets. Unfortunately, as the ancient writers predicted, their hubris may not only bring down themselves but also their own countries — and maybe even the world economy.
Charles Gray is a College and Wharton senior from Casper, Wyo. His email address is email@example.com. The Gray Area appears every Tuesday.