— Other Liabilities

Is the Euro Zone Crisis Over?

In the previous episode of the late bailout show, Greece missed an IMF repayment and the EU reminded them that outstanding debt might be recalled according to the bailout terms. Molon Labe – Come and get it! – was the response of frustrated Greece Finance Minister Yanis Varoufakis, at that time.

Now that Varoufakis is gone, Greek is implementing structural reforms demanded by the Troika with an astonishing speed and updated its budget figures in line with creditors demand.

Greece managed to improve its tax collection abilities and managed to turn its government deficit to a €2bn surplus in 2016. Greek treasury is reimbursed with the last tranche of its third bailout fund, €2.8bn in the last month thanks to its efforts. However, there are plenty of reasons for disbelief that this bailout scheme will heal the troubled economy.

Steve Hanke, Professor of Economy at John Hopkins University believes this is a structural problem, and it can only be resolved by focusing on the underlying causes. “Like past bailouts, the third one will fail to stop Greece’s economic death spiral” he wrote in his article for Globe Asia. According to him, Greece was allowed to adopt the euro on false pretences. “Yes, the experts at the Hellenic Statistical Authority had cooked the Greek books, and the experts at Eurostat knew the Greek data were phony. Still, Greece was allowed to enter the euro zone”, he says.

In 2009, the newly elected PASOK government in Greece declared the preceding government understated the deficit figures, and the country might be at the brink of bankruptcy. One year later Greece entered a 110€ billion bailout agreement with IMF. Since then, bailouts became a reality of the EU.

Between 2008 and 2012, IMF had a busy bailout schedule; it had to set aside €7.5bn for Cyprus, €67.5bn for Ireland, €78.5bn for Portugal, as emergency bailout funds. All of the countries fulfilled their bailout terms and regained market access, only Greece standing as an exception.

Now, Troika, IMF, ECB and the EU commission are having their own disagreements about Greece. While euro zone, mainly influenced by the German finance minister Wolfgang Schaeuble insists on a full redemption; IMF contends the Greek debt is unsustainable and calls for a haircut to get Greek economy on track. IMF also stated that it could refrain from providing further funds to the troubled economy in line with its own credit assessment throughout the year.

The EU officials called for austerity measures to lower the amount of debt which surpassed 180% of GDP in Greece. So far austerity measures failed to revitalize business activities as Greek economy grew by only 0.2% in the second quarter of 2016. This did little to improve the high debt to GDP ratio.

The euro crisis was not a replication of sub-prime mortgage crisis, however both had a similar starting ground: indebtedness of entities lacking the capacity to repay.

Euro zone is still trying to cope with its member’s increasing debt burden and systemic trade deficit. Especially issues with debt is likely to occupy a higher place in the monetary union’s agenda. For example, non-performing loans of Italian banks is not a secret for Brussels, which amounts to €360bn according to IMF. David Folkerts, an analyst from Deutsche Bank said that the EU will need a €150bn bailout to recapitalize its banks.

The inception of the common currency euro, lowered the cost of borrowing for countries with a history of high inflation. Lower interest rates caused construction sectors to flourish and drive up the GDP growth in those countries. The belief that all the euro countries had the same risk also provided incentives to increase debt funded government spending. This fallacy came to an end as the bitter truth hit the surface with the example of Greece.

What triggered the sub-prime mortgage crisis in 2008 was aggressive derivatives holdings of investment banks in the US. Leveraged financial instruments helped them to boost their profits in the preceding years, alas made them insolvent as the markets went sour.

Former Fed chairman Ben Bernanke, explained the mortgage crisis as a combination of regulation failing to keep up with the pace of markets, an era of low interest rates and the systemic risk posed by the spill-over of derivatives in his book ‘The Fed and the Financial Crisis’.

Debt can drive growth, but only if it is used for the right investments. How to implement this ideology to a heterogeneous political structure? This is the million dollar question for the euro zone at the moment.