Finance and capital markets
A primer of why Greece is in a tough situation (more in future videos). Created by Sal Khan.
Greece and the crisis in the European Union has been in the news for some time now, so it's long past due that I did a video on it and just so we have a time context that you might be watching this video far in the future. This video is being done in May, 2012. So we really don't know how all this is going to play out, but I hope over the next few videos to lay out the potential scenarios and what might be the risks and drawbacks, uh, drawbacks of each of them. So this right over here, that is Greece. And so let's just think about it on a very high level, what the situation that they find themselves in. So when you look at this chart right over here the most obvious thing and it actually pops out from this top line right here, their public debt is growing at a dramatic level and their debt to GDP...this is actually the more relevant thing because you might have a huge amount of debt but if your GDP, if the productivity of the country is high, that might not be that big of a problem. What matters is how much you owe relative to how much that you can actually produce. And we see right over here the debt to GDP ratio is a percentage so this debt is a percentage of GDP , it's well over 100%. It is well over 100% for Greece. And you can see a large part of that is because the public revenue, the taxes that the Greek government gets is consistently lower than their public expenditures. So let me write this down. So you have taxes. Taxes are less than spending which lead to deficits...deficit is how much you couldn't afford, or how much, how much spending you have above and beyond your revenues in a given year. And so they have deficit spending on a year by year basis which increases their debt. The debt is the total amount of money that they owe, that's this top line right over here. So this leads to increasing debt, increasing debt right over here. But that's not the only problem. Because as their debt keeps increasing, people start to become more and more suspicious of whether the government is actually good for their I.O.U.'s, whether the government will actually pay back that debt. And so as the government's debt becomes riskier and riskier, people start demanding higher and higher interest rate. So the debt goes up. And as the debt goes up, people think that they're not a good borrower. So they want higher interest, interest goes up. But now that makes things even worse, because we were already running deficits, we were already spending more than we were bringing in taxes, now we have to spend even more on the interest on our debt. So if you were spending 10% on your interest in one year, so if you had $100 billion dollars, you just spend $10 billion, now if the interest rates go to 15%, you have to spend$15 billion on that. So that's going to make your spending on interest go up, so that's going to make the debt go up even more. So Greece finds itself in a situation like this. So you might immediately say "well, you know there's seems to be a fairly straight forward solution here. Why don't they do some combination of increasing taxes?" So why don't they increase taxes? "And maybe even more importantly, why don't they decrease spending? " Why don't they decrease spending? Now the first cut is a political situation. Because this spending right over here, these are for the most part, these are promises to people, these might be government obligations, these might be pensions, there might be retirees that are dependent on this, there could be other types of government programs. So if you decrease that spending, the people who are losing out on those entitlements, they are not going to be too pleased with you. So politically that's probably not the best thing to do. But there might be a brave Greek leader that say "well no, this is what we have to do to save the country, we're willing to cut that spending." But that by itself, even if someone was willing to do it, it still isn't clear whether it's a good idea. Because you might have noticed this other line right over here. This other line, "Real GDP Growth" . Greece right over here is in a fairly severe recession. They have a lot of unemployment, clearly factories aren't producing at the levels that they could actually produce. So if you either do some combination of increasing your taxes, increasing the government revenue, and decreasing spending, that actually will suck air out of the economy. So this combination of things, and you've probably heard this word a lot, this combination of things, and it tends to focus on the decreasing spending in a very significant way, this is referred to as "Austerity." The word "Austere" just generally means someone who doesn't have a lot of frills, they just deal with the most bare necessities they really kind of cut things to the bone. And so when a lot of people say "Hey Greece you have to do Austerity measures" --and there's actually already been a couple of rounds of austerity measures. "you need to decrease your spending in a big way." But the problem is Austerity sucks money out of the economy, and so Austerity leads to the economy slowing further, and if the economy slows further, that actually going to hurt your taxes. So the economy slowing makes your taxes, your actual revenue that you're getting, go down, and that can actually make your deficits even worse! Because now people say "oh my God, their economy is bad, they're even less likely to be able to pay." Interest rates go up, and since the tax revenue goes down, and a lot of the spending isn't tied to the economy, a lot of the spending actually goes up with the economy. It might be unemployment insurance, it might be people retiring, pensions, and so that can actually make things worse. And that's actually what has happened over the last few years. Because, and we'll talk more about this, the Greek's were given some help from the rest of the European Union. In exchange, the rest of the European Union said "well, if we're going to help you, you gotta take some pain. And the pain that you had to take were these Austerity measures right over here." But these Austerity measures actually made the economy do even worse, which made debt as a percentage of GDP even higher, because now the GDP itself was shrinking at a even larger and larger rate. So if you think, just all of these aspects, there was no obvious answer here. You do Austerity, it's kind of a bad situation because that's going to hurt the economy, you're going to become even less productive, at least in the short term. And on top of that it's hugely politically unpopular, to the point to where we have such high unemployment that it's becoming politically unstable. So I'll leave you there, I'll let you mull over this situation, and in the next video I'll talk about what a normal, independent country, truly independent, both fiscally and monetarily independent country, would do in a situation like this, given Greece's situation. And then we'll talk about why Greece kind of can't do it in its current context.