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Does the Greek Debt Crisis Pose a Threat to World Economies?

Mises Daily: Wednesday, May 05, 2010 by

"Bailing out Greece is not going to reduce the threat of another economic crisis."

On April 27 the Standard & Poor's rating agency downgraded the Greek government's debt to junk status. Greece has been graded BB+ by the S&P, official "junk" territory. It is now on a par with Azerbaijan, Colombia, Panama, and Romania. The cost of Greek borrowing on a two-year bond was about 1.3% last November. By April 27 the cost stood at 19%. Many commentators are of the view that without outside financial help the Greek government may not be able to serve its debt, which currently stands at around 280 billion euros. As a percentage of GDP, the debt stood at 115% at the end of 2009. The default on the debt is likely to prevent the government from securing more money to support various projects, thereby paralyzing economic activity, so it is held.

Figure 1

Many commentators are of the view that the Greek debt crisis is likely to infect various other economies, thereby setting in motion a new global financial crisis. This in turn, so it is held, poses a threat to real economic activity in the months ahead. Hence fast action, such as bailing out the Greek economy, is called for by various top experts to prevent the Greek economic virus from spreading around the globe. On this matter, commentators are of the view that the virus might have already infiltrated countries such as Spain and Portugal. Various experts have estimated that as a percentage of GDP the Spanish government's debt could jump to 74% in 2011 from 66% in 2010 and 54% in 2009. The figures for Portugal are estimated to be 91% in 2011 against 85% in 2010 and 77% in 2009.

Figure 2

Can Government Fund Its Activities Independently of the Private Sector?

It must be realized that government can't fund by itself its activities on account of the fact that government is not a wealth-generating entity. Government must divert real wealth from wealth producers to support its activities. The following example illustrates this case.

In an economy comprised of a baker, a shoemaker, and a tomato grower, another individual enters the scene. This individual is an enforcer who is exercising his demand for goods by means of force. Note that the enforcer produces nothing. Hence whenever he exercises his demand for goods he offers nothing in return. Consequently his demand for goods can only impoverish the producers. The baker, the shoemaker, and the farmer will be forced to part with their product in exchange for nothing. Needless to say that, as time goes by, this weakens the flow of production of final consumer goods. According to Mises,

There is need to emphasize the truism that a government can spend or invest only what it takes away from its citizens and that its additional spending and investment curtails the citizens' spending and investment to the full extent of its quantity.[1]

It follows that since government doesn't produce real wealth, it requires the support of the wealth creators in the private sector. It also follows that an ever-growing government involvement with the economy curtails the ability of the private sector to generate real wealth, and this in turn curtails the support for the government to serve its debt.

Now, in 2009, Greek government outlays increased by 104% from 1999. Also in Spain government outlays have continued to push ahead, rising by 119% in 2009 from 1999 while in Ireland the rate of increase stood at 157%.

Figure 3

The relentless increases in government outlays imply a persistent diversion of real savings from wealth-generating activities to nonproductive activities, i.e., consumption of real capital. Obviously, this undermines the process of real-wealth generation. Now, why should loose fiscal policy in Greece cause economic havoc in other countries?

We suggest that outlays by the Greek government have no effect on the outlays of various governments in the world. Politicians in various countries determine the pace of their governments' involvements with the economy. This means that the debt crisis in Greece shouldn't have any effect on a particular country's ability to generate real wealth as long as government outlays are well contained.

This is however, not the case with most economies, and in particular the United States. We suggest that massive government outlays have also severely damaged the wealth-generation process there.

The US federal debt outstanding stood in March at $12.8 trillion and by year-end could settle at $14 trillion. As a percentage of GDP in March, the debt stood at a lofty 84%.

Also note that at the end of last year, government outlays increased by almost 90% against 1999. This of course casts serious doubt on the present high rating of US government debt.

Figure 4

Another major factor that undermines the real-wealth generation process is the reckless monetary policies of central banks.

The eurozone central bank policy rate stood at 1% in April against 4.25% in September 2008. The yearly rate of growth of the central bank balance sheet (the monetary pumping) climbed by November 2008 to a lofty 55%.

In response to this, the yearly rate of growth of our monetary measure AMS climbed to 15.8% by August last year. This massive increase in money supply implies a big increase in the exchange of nothing for something, i.e., a large diversion of real savings from wealth generators to the holders of newly created money. All this amounts to a weakening of the process of real-wealth generation.

It must be mentioned here that the members of the eurozone cannot print money independently. This means that they are constrained in this regard by the European central bank's monetary policy. As we have seen, however, the members are less constrained and have more freedom with respect to fiscal policy.

We suggest that those member countries that pursue relatively more conservative fiscal policy are inflicting lesser damage to the wealth-generation process versus those members that have adopted a more reckless stance.

The combined effect of loose monetary and fiscal policies is currently manifesting itself in the so-called debt crisis in Greece. We hold that as time goes by this combined effect is likely to manifest in various other eurozone economies such as Portugal, Spain, and Ireland.

Figure 5

In other countries such as Germany, France, and Italy we envisage lesser damage to the wealth-creation process on account of relatively more conservative government outlays. In France, outlays have increased by 49% in 2009 against 1999, in Italy by 45%, while in Germany by 18%.

Note again that reckless pumping by the European central bank has inflicted severe damage also to these economies. On account of reckless monetary policy in the United States, coupled with very loose fiscal policy there, we also envisage difficulties for US wealth generators in the months ahead.

So far in April, the federal-funds-rate target stood at 0.25% against 5.25% in August 2007. Observe that the yearly rate of growth of the Fed's balance sheet climbed to 153% by December 2008.

As a result the yearly rate of growth of our monetary measure for the United States jumped to 23% by August last year. We suggest that, in similarity to the Greek government, the US government is also at risk of not being able to service its debt if the private sector's ability to generate wealth has been severely weakened, as we suspect could be the case.

We can conclude that the threat to world economies is not on account of the Greek debt crisis as such but on account of the loose fiscal and monetary policies of various governments and central banks.

Bailing out Greece is not going to reduce the threat of another economic crisis as long as the main causes that undermine the wealth-generating process stay intact. On the contrary, bailing out Greece or any other economy will only further weaken the world's wealth-generation process. (Note that bailing out Greece means diverting real savings from wealth generators of other economies). According to Mises,

An essential point in the social philosophy of interventionism is the existence of an inexhaustible fund which can be squeezed forever. The whole system of interventionism collapses when this fountain is drained off: the Santa Claus principle liquidates itself.

Hence, what is currently required to prevent a further weakening of the process of real-wealth generation is to drastically curtail government outlays and monetary pumping by central banks.

Summary and Conclusion

On April 27 2010 the S&P rating agency downgraded the Greek government's debt to junk status. Many commentators are of the view that without outside help, the Greek economy could plunge into a severe economic slump. This, it is held, could infect the rest of the world's economies. Hence most experts are of the view that fast action is required to prevent another world economic crisis.

Our analysis however indicates that the main reason for the possible new economic crisis is not Greece itself but the reckless fiscal and monetary policies of most governments and central banks. We suggest that loose fiscal and monetary policies have severely undermined the ability of the private sector to generate real wealth.

As a result of the weakening in the process of real-wealth generation, the ability of governments to serve debt has been severely compromised. Remember that government is not a wealth-generating entity — without support from wealth generators it cannot fund its activities. Given the pressure on the ability to generate real wealth, a bailout of Greece or any other economy can only deplete the amount of real wealth at the disposal of wealth generators, thereby making things much worse. Contrary to popular thinking, what is required is to curb government outlays and curtail central banks' ability to push massive amounts of money out of "thin air."


[1] Ludwig von Mises, Human Action, 3rd revised edition, Contemporary Books Inc, p. 744.