The financial problems of Greece have threatened financial meltdown in Europe, and the economic recovery in the U.S. and elsewhere. It feels like 2008 all over again, when the collapse of U.S. investment banks seemed to threaten the entire financial system. Even more déjà vu came May 10, when European leaders announced a nearly $1 trillion package of loan guarantees to shore up debt concerns across the continent - a move reminiscent of the $700 billion TARP program to bail out U.S. banks. William Bernhard heads the political science department at the University of Illinois and is an expert on central banking and the link between politics and markets in the European Union. Bernhard was interviewed by News Bureau social sciences editor Craig Chamberlain.
Why has the debt crisis in Greece caused such panic in Europe and even globally?
Anytime there is a threat that a government will not be able to pay its debts, it affects financial markets. In this instance, the Greek crisis is even more urgent for two reasons. First, Greece is a member of the eurozone, linking it to 15 other European Union countries using the euro currency. Second, the crisis threatens to undermine an already weakened global financial and banking sector. About 80 percent of Greek debt is owed to non-residents, much of it to large banks in the eurozone and the United States. Should Greece default, no one knows how that would rebound through the global banking system. We learned in recent years just how tightly connected these financial institutions are, so if Greece did default, it could have major consequences throughout Europe and the world.
There's talk that Spain, Portugal or Ireland could be next on the list. What is the central problem and why is this happening now?
The central problem is that these governments have lived beyond their means for many years, racking up very high levels of government debt, including high levels of debt that is owed to non-residents. During good economic times, these debt levels seemed manageable. But now, during a recession, governments collect fewer tax revenues and must spend more to compensate citizens, exacerbating the fiscal imbalances. Since so much of the debt is owed to non-residents, the situation is even more problematic. Italy has high debt as well, but most of that is owed to Italians, which means the government is more likely to see it come back in tax revenues.
The approval of a rescue package for Greece led to violent riots there. Why the strong reaction?
Greek citizens will have to pay the cost of the crisis through reduced government spending, less public employment, higher taxes, and more tax enforcement. These costs are substantial and will result in a lower standard of living for many Greeks. More generally, this public response is related to economic globalization. For many years, Greece has relied on international capital to fund its budget deficits. That is the upside of globalization: By borrowing money on international markets, the Greek government was able to maintain its "social contract" with its citizens: high social spending, large public sector employment, and relatively low taxes - because many Greeks simply did not pay them. Further, Greece's adoption of the euro allowed it to borrow more cheaply than it could have outside the eurozone.
The downside is that those bills have to be paid at some point, and that means Greek citizens have to make adjustments. Making it worse is that those adjustments will enrich "faceless foreign speculators," allowing opponents to play up a backlash against globalization. Hence, the violent response in Greece. We saw a similar but less violent response in Iceland, where voters almost unanimously rejected a referendum question on whether the government should honor deposit guarantees for foreign investors who had placed money in Icelandic banks.
Should we see parallels between this crisis in Europe and the U.S. in 2008, and is the global financial system threatened in the same way?
In both situations, governments are providing guarantees to protect the overall financial and banking system. In the U.S., the problems stemmed largely from the overextension of private debt. In Greece, it is a public debt crisis. The challenge is to contain the damage from these crises, so that they do not have widespread and deep consequences for the global economy.
How much has the response to the Greek debt crisis been complicated by European Union politics?
Well, one could argue that EU politics has been complicated by the Greek debt crisis! Greece is one of 16 member states (out of 27 total) that share the single currency, the euro. Although these member states have given up control over monetary policy, they still retain control over their own finances and fiscal policy, and have wildly different public debts. Germany, for instance, likes fiscal balance. Countries like Greece and Italy are, let us say, less concerned with deficits.
In negotiations over the euro in the 1990s, Germany was concerned that, at some point, it would have to bail out one of the more profligate member states - that as the richest state in the EU, Germany would get stuck paying everyone else's bills. So the euro agreement includes safeguards such as limits on member state budget deficits and a "no bailout" clause. These provisions are now essentially meaningless, lost to the recognition that a Greek default would spread to other countries and cripple the entire European economy.
Controversy about the bailout delayed a European response. French President Sarkozy argued early on for EU aid to Greece. German Chancellor Merkel, however, more stubbornly insisted on honoring the "no bailout" clause and only gradually came around to the imperative for EU action.
She faces hostility at home for her policy switch, as Germans are angry about paying for countries that can't balance their budgets. Her party just lost a regional election due, in part, to voter backlash. Thus, the European Union response has been gradual, rather than decisive. Moreover, they have finessed some of the technical details about where the bailout money is coming from and who is ultimately responsible.
What will this crisis mean for the EU? In some quarters, we've seen pundits suggest that this crisis means the end for the euro, that the currency will split up. Unless the crisis spreads exponentially, this is an unlikely outcome. Others argue that this crisis demonstrates the need for decisive policy action at the European level, suggesting that the result will be more policy authority in EU institutions, rather than relying on member-state bargaining to solve problems
Are there any lessons for the U.S. as we struggle with our own growing national debt?
The U.S. national debt, of course, has grown in the wake of the fiscal stimulus and other measures designed to stimulate growth. As many in the Obama administration recognize, the federal government must begin to bring the budget back into balance in order to head off debt problems in the medium-term. Although the possibility of a U.S. debt crisis seems remote, action is required soon to keep the U.S. off an unsustainable debt path.