Finance and capital markets
Greek financial crisis (part 2)
What Greece could have done if it had its own currency. Created by Sal Khan.
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- Why can't Greece build a bank to print Euros? Why does it need to print Drachma?(41 votes)
- Greece can not print euros because it is a job of European Central Bank (located in Frankfurt, Germany) which prints and manages money supply for the whole euro-zone (currently 17 EU countries). Greece gave up their currency for euros and thus they gave up part of their sovereignty to issue its own money supply. European elites have a different agenda than the people of Greece. It is called "consolidation of power".(139 votes)
- 0:28-0:35: "Greece actually tried to cover this up for many years with some accounting shenanigans."
I have a few questions about this:
1. What were the accounting shenanigans with which they covered it up?
2. What was Greece spending on that Germany, for example, wasn't?
3. In other words, why were the public-debt-to-GDP ratio, and the unemployment so high all along?(25 votes)
- Listen to this for the answer...
- In Sal's third inflation option, wouldn't those who held the entitlement debts (such as those with pension) have to live with receiving the same income while prices on the cost of living double (and possibly protest, riot etc.)? And if those holding those obsolete debts lose spending power because the money they loaned is not worth as much anymore, wouldn't the economy slow as well? How is this different than just taking a 50% cut in spending on those same liabilities?(17 votes)
- Like he said, it's all politics. If you halve people's pensions overnight, they'll riot and throw you out of office. But most people aren't economically aware enough to understand that inflating away their spending power is the same thing. They just see that they're getting paid the same amount each month. There is much more wiggle room for the government to try and fix things if they can keep social unrest in check and stop being underwater on their loans.(31 votes)
- why hasn't the u.s inflated its way out of its debt?(7 votes)
- It would reduce the strength of the Dollar and they could no longer afford to buy all the foreign stuff that they can afford now (electronics, services, war assets).
It would change the whole structure of their economy and could/would damage the economical expansion and rapid growth of China.
It would change a lot of variables and people usually don't like change. (stable economy prevents riots and keeps masses calm)(14 votes)
- If you inflate the cost of goods does that make your pension worth less?(6 votes)
- Sure, because the real value of your pension is not the number that's written on the check, it's what you can buy with it. If the prices of goods goes up, and your pension does not, your pension is worth less than it was before.(3 votes)
- True, but that would reduce future investment sentiment wouldn't it?9:40(4 votes)
- Exactly if you inflate away your debts people who you need to lend to you in the future will say: "Well yeah I trust you to pay me back but what you pay me back in will be worthless so why would I lend to you?"
This would then increase interest rates and thus increase the deficit (which, by the way, doubled along with GDP) meaning that whilst it bought you some time in the short term in the long term the problem is probably even worse.(5 votes)
- Why doesn't the European Union or the IMF inflate the euro? Many other countries in Europe have a lot of debt as well right? So it would be beneficial for them as well.(2 votes)
- High inflation can have devastating effects on the overall economy, especially when that economy is simultaneously experiencing a period of low growth. Also, an increase in prices disproportionately affects the poor and working class.
The German experience of hyperinflation during the Weimar Republic (throughout the 1920s) has left them particularly averse to any monetary policies that may, ultimately, unleash inflation.
[In addition to Germany, the more "hawkish" of the Eurozone members are Austria, Luxembourg, Estonia, and Finland.](4 votes)
- You suggest inflating our way out of our debt obligations. Wouldn't our debt be in euros and we would have to pay it with a denominated drachma? Or you assume we would default on our debt anyway when we go to drachma?(2 votes)
- I believe that in a hypothetical situation, your debt would have originally be in Drachma. That is the point that the video was trying to make. If Greece was still using its own currency, it would have the ability to independently print money.(5 votes)
- Doesn't this fundamentally screw the people who have pensions and the debtors? Let's say you are forced to pay into an entitlement program equivalent to social security your entire working life. Then, all of a sudden, to squirm out of that the government inflates the currency so you get the same nominal entitlement payout, but you are only getting half of the purchasing power you are actually entitled to. Furthermore, if you are lending the government money by purchasing bonds from it, and they then inflate the currency so they only have to pay out half of the wealth that you invested is this also not scamming you out of your money? It seems to me that once people get privy to these kinds of "shenanigans" they may find that being forced to fund entitlements with the "promise" of getting it back some day is not so palatable or politically convenient, and they may also realize that lending money to the government is not as secure as they would have you believe.(3 votes)
- But if that is the case, then how are they then "inflating" away their entitlement liabilities and debts? If it is fixed to inflation, then inflating the currency wouldn't get them out of the deal and Sal would be incorrect in suggesting this as a reason as to why they do this...(1 vote)
- will this cause ww3? i shudder at this thought...(1 vote)
- I can't think of any wars caused by disagreements over economic policy. So the answer to your question would be no.
However, as explained in the videos, a bad economy can cause political instability, which could, potentially (and purely hypothetically in this case) be grounds for civil war. As a consequence of the debt crisis, Greece's electorate has already scattered towards more radical left and right-wing parties.(3 votes)
So let's review the situation that has been emerging in Greece. And then dig a little bit deeper as to their options. So as we saw on the last video, Greece was spending a lot more than it was bringing it in tax revenues. So it was running these deficits. And year after year, these deficits we're piling up. And the national debt was increasing. And to make matters worse, Greece actually tried to cover this up for many years with some accounting shenanigans because there were some European Central Bank rules about how much debt you could take on. And so it was trying to not trigger those rules while still being able to take on more debt so that it could fund this spending right over here. But then, in the last few years, it became clear. The shenanigans were cleared up. And when they were cleared up, one, it made people realize, wow, that was kind of shady what they did. But on top of that, they had a much larger government public debt burden than people thought. And the combination of the two-- the combination that this country was actively trying to not make its obligations to be transparent to the markets, and on top of that, that this debt burden was so huge, it made people wary of whether the country would actually be able to fulfill its obligations. So trust. Investor trust. When I talk about investors, I'm talking about the people who would invest in Greek bonds. So, essentially, the lenders to Greece. Their trust went down and they expected higher interest. So they expected higher interest from the Greek government. And that made things worse. Now, not only did they have to keep spending on all of their entitlements, but now the cost of funding that existing debt that they already and any new debt that they had to do to keep spending at that rate, the cost of that debt itself went up. And that only added fuel to this ballooning debt problem. Now the last video, we explored a couple of options. In particular, we said, what about austerity? What about the situation where you just really, mainly, you could try to increase your revenues or slash spending. But people really try to focus on the spending side. What if we really just try to slash the spending in a very severe way? Really just cut straight to the bone? Well, there's a couple of problems there we thought about. One problem was that it's not popular at all. It's not popular at all. And then the bigger problem was, is you're already in a recession. You're already in a recession. And this could make the recession more severe. And frankly, it was not popular. It's never popular. But it became-- even as we move now in 2012-- it's even less popular because Greece has already gone through a couple of rounds of this austerity. This is not a new problem. They've been bailed out in small ways. And I'll talk more about what a bailout is. But as part of that package, the people who've been billing them out says, look, if we're going to give you something. If we're going to use some of our own taxpayer money to help you out, you've got to cut your spending. But what's happened in every round of austerity so far, is that helped slow the economy even further. That recession kept deepening and deepening. And it's comments sense that it would. If the government stop spending in a big way, it slows down an already slow economy. Now, the other thing that you might be saying, why doesn't Greece just stop paying its debt? Why doesn't it just default on its debt? So why doesn't it just default? Say, hey, we're a country. I'm sorry, investors, that you had to take a loss here. But we're just not paying any more. Well, the problem is, it has a situation where it's spending more than it's bringing in. And its obligations are all in the Euro. It does not have its own currency. And so, if they were to default on their debt-- obviously, the people who lent the money will be very upset-- and there's no way that they're going to lend more money to Greece. And if they don't lend more money to Greece-- if they don't lend more Euros to Greece, Greece is not going to be able to continue spending Euros the way it has. It's promising all of the pension, retirees, the unemployed insurance-- it's paying all those obligations in Euros. And if they default, they're not going to be able to borrow more Euros to do those obligations. And, once again, it'll be a very fast and violent austerity because there wouldn't even be the money to fund that. You would have this very drastic, almost, shut down of the government. So this right over here is not a good option. Now to start exploring the third option, and this is the option that it seems likely that Greece might have to go in, let's think about what Greece could have done if it had monetary independence. If it had its own currency. So just remember, this is completely hypothetical. Greece did have its own currency, the Drachma, before it joined the Euro. But let's think about what it could have done in this situation, if it actually did have its own currency. It's not cut and dry here because Greece was actually able to, and historically, borrowed very cheap rates because it was part of this Eurozone. But let's just think about it, if it was in this situation, what it could have done if it had its own central bank. So this is some of the stats from our last video. And if it had its own central bank-- and let me make this very clear. This is all hypothetical. Greece does not have its own central bank right now. All of the Eurozone countries-- the Euro is printed by the European Central Bank. It's not by any one country. But, hypothetically, let's say that Greece does have a central bank. So Greek Central Bank that prints it's own-- let's call it the New Drachma. And so that Greek Central Bank, in this type of a situation, could just start printing Drachma. And, essentially, use that Drachma to buy government bonds. So it could buy government bonds. So it's, essentially, printing that money. And when it buys government bonds, its lending it to the government. It lends to the government. And so the government could spend on entitlements. Government could spend on all of its various obligations. Now that might seem very convenient. Essentially, one part of the government, or something pseudo associated with the government, prints money, essentially lends it to the government, funds its obligation. But the immediate thing you might say, well, if you just print currency like this Willy-nilly, won't this right over here lead to inflation? And the simple answer is, it probably will. But that actually might be the solution if you're in a conundrum like what Greece is in. First of all, inflation might not be so bad. Right now, the country's in a deep recession. So there's all this extra capacity. So you might even have a little bit of a price cushion. And, just in general, the inflation rates aren't alter dramatic. They're not super low, but they're not super high either. So you might have to worry about a hyper-inflationary situation. But on top of that, the government probably wants a respectable amount of inflation. It might not want 100%, 1000% inflation. But it might like 10, 20, or 30% year inflation. And to think about that, think about the idea, in this hypothetical Greece, all of its obligations would not be in Euro, its obligations would be in the Drachma. And so you can imagine a world. So let's think of a hypothetical Greece. And I'm going to use hypothetical numbers just to make things more simple to understand or to do in our heads. Let's take this hypothetical Greece-- it could be Greece or really any country. And let's say it has a GDP of-- let's call it 100 of its currency. Let's say 100 Drachma as its GDP. And let's say it has entitlement obligations-- and this is all on an annual basis-- of, let's say, 10 billion of its currency, of its Drachma. This isn't the situation in Greece. All of its obligations are in Euros. But let's just think about the situation. And let's say that on top of that, it has debt obligations-- so the total debt. The total value of debt. Let's say that it was-- I don't know-- another 150 billion of its currency. If you were to inflate-- let's say you inflate over a couple of years. So inflation occurs. And let's say you have 100% inflation over a few years. But in real terms, your GDP doesn't change. This is really just more of a thought experiment. So then, in real terms, if you have 100% inflation but you're producing the same amount, the nominal value of your GDP will now be 200 billion. It's the same amount of goods and services, but everything now costs twice as much. So you would value it at 200 billion. If you're inflation adjusted, it would still be at 100 billion. The good thing-- and it's very seldom the use inflation in a good context-- but what would be good about Greece in this situation, is that these entitlement obligations, they would still be 10 billion. You're still going to say, I'm still going to pay you 10 billion. Even though that 10 billion is going to buy people half is much. That is much easier to do politically than telling people overnight that I'm going to reduce your pension by half. That's political suicide. But to inflate away the obligations, nominally it looks like you're paying the same thing. But just buying less. It's a little bit more viable to do. And the same thing is true of your debt obligations. Your debt obligations won't adjust to inflation. And so you would still owe 150 billion. But as a percentage of GDP, you've now halved how big that debt is. You've halved how big the entitlement obligations are. So that's actually a viable solution. And in this hypothetical situation, it's probably the best solution for government to, essentially, inflate away its obligations. So I'll leave you with that. Something for you to think about. And then we could think about what could Greece actually do in this direction. But more importantly, let's think about-- and you could start to think about-- why is the whole world so scared? All of this is Greece. It's a relatively small country. Why is the whole Eurozone so scared? Why are people thinking about bailing out Greece in some way to prevent all of this craziness from happening? And what are the repercussions in the larger, global market? But I'll leave you there and leave you to think about all this stuff.