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Finance and capital markets
Course: Finance and capital markets > Unit 8
Lesson 7: 2011-2012 Greek debt crisisGreek financial crisis (part 2)
What Greece could have done if it had its own currency. Created by Sal Khan.
Want to join the conversation?
- 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".(140 votes)
- - 0:28: "Greece actually tried to cover this up for many years with some accounting shenanigans." 0:35
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...
http://www.thisamericanlife.org/radio-archives/episode/455/continental-breakup?act=4(17 votes)
- 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)
Video transcript
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.