Financial Crisis Around The World
Anybody who has been paying attention over the past three or four years might have noticed that the world has undergone a financial crisis. Some countries have gained momentum whereas others have only continued to spiral downward. Greece is one of those countries.
The closest example to the Greece financial crisis would be the Argentina default back in 2001, when their economy contracted by 18% while unemployment rose to 22%. Greece has already passed those levels, and has imposed a slight restriction on creditors, managed by the International Monetary Fund and the European Union. However, the debt is still unsustainable, which could mean that the next round of the country’s default would make Argentina’s default of 2001 look positively trivial.
Greece’s banking system is coming close to collapse, which could cause the government ultimately to ban all banking withdrawals. If this happens, the government could establish capital controls and it looks as if Greece is entering that stage now. So what will be in store for the country next?
To answer that, we should look back at the financial and fiscal crisis that started it all. Banks held corporate and government loans as assets. Defaults in a fiscal crisis reduce the values of the former, while the acts of a looming recession undermine the overall value of the assets in question.
This is exactly the problem between the bank and the budget. However, there are links traveling in opposite directions as well: banks deleverage when they offset their losses by cutting credit as the economy slows, which causes the government’s revenue to fall. If the banks require capital injection from any public source, it weakens public finances even more.
The reinforcing forces that usually work together also cancel themselves during the process of a recession. They can also prompt a sudden deleveraging on the banks, which causes a financial system to fail. The outcome technically depends on the confidence of the financial system. Economists worldwide have always understood that if there is an absence of credible lenders, especially as a last resort, banks are vulnerable to types of self-fulfilling financial breaks. That lender can be either fiscal or monetary, and with Greece, both types are in the worst case of debt.
So what would happen if the country were cut off from creditors such as the IMF and EU? Optimists and economists state that Greece is supposed to try to eliminate the primary deficit (the balanced budget minus any interest payments) by 2013, and this implies that Greece could actually pay all of its non-debt bills with the country’s own resources after the use of a default.
However, this view seems to overestimate the country’s capacity for collecting revenues in this type of panic. Because Greece is in an economic free fall and the future is uncertain, many households have just stopped paying their taxes. This means that even if the government defaults on every one of its debts, the only option that it might have will be to ask the European Banking System to print more money so it can meet its monetary obligations. The chances of that happening are remote.
Tips
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