Greece in recession

  The Greek economy is slowing, but it is not in recession.  Yet Athens looks like a city in the midst of a severe recession. 

Not in this picture, of course.  This picture is lovely.  Albeit not really because of Athens.

But on the drive in from the airport, you pass myriad empty storefronts, abandoned buildings, and what appear to be stopped construction sites.  

Downtown, you see much of the same.  Even brand-new construction looks empty.  When the storefronts are filled, you can spot tell-tale signs of empty offices.  And then there's the petty vandalism that haunts downtown:  graffiti on private structures, cracked windows, run-down buildings.  All the telltale signs of property owners who have decided for whatever reason that proper maintenance does not pay a sufficiently high return.  

If it had just been the central city, we would have concluded that Athens suffers from a European version of the American disease.  Or that it was just the after-effect of the December riots.  The thing is, the signs of economic distress are worse in the suburbs.  It honestly looks like someplace that suffered from a real estate bubble that has now collapsed. 

Of course, the central city doesn't look so good either.  It looks like someplace where rioters might indeed attack businesses with petrol bombs. 

That said, downtown Athens is not out-of-control the way much of New York City was in the 1970s and 1980s.  For example, when we got off the bus, the first thing that greeted us was a police raid against African street merchants selling counterfeit luggage.  Yet the prevalence of graffiti also suggests that the police (and the public) is fairly lax about enforcing standards; it's not something you see in Boston or London or Paris, not to the same extent, and not on private property.  (Although, once again, much of New York's outer boroughs looked like this back in the 1980s.) 

In other words, while the Greek economy might not yet officially be in recession, our careful powers of observation lead us to predict that the numbers are going to get much worse very quickly, as the statisticians catch up with reality.

So what's happening?  And what is to be done?

Well, if you'll excuse the pun, the situation doesn't seem at all like a Greek tragedy.  Much more of a Latin one, really.  The country has been hit with a series of external shocks, one after the other.

First, the bottom fell out of the shipping industry, Greece's largest.  It employs only 3% of the workforce, but generates almost 10% of GDP.  Then tourism took a similar hit, a bad one, as recession bit elsewhere in the eurozone and the euro climbed against the pound.  (Of course, it's fallen against the dollar, so that's something.)  Finally, the banking sector started to look shaky.  Of course, some of this had to do with the fact that one of its best customers, the shipping industry, had been knocked flat.  The Greek government has authorized a €28 billion support package and pushed the banks to issue more capital.

So far, so normal.  What else could Greece do?  It can't devalue, and to be honest, I'd doubt that it would do much anyway, not at a time where manufacturing demand is crashing and in a country with huge foreign borrowings. 

But then comes one hitch, one problem that is almost Greek-tragedy-like:  the Greek government can't engage in a fiscal expansion without risking a big run-up in interest rates.  The public debt is at 94 percent of GDP and the yields on Greek bonds are rising fast, which means the country runs a serious risk of entering a debt spiral.  A debt spiral is exactly what hit Argentina in 1998, despite macroeconomic numbers a bit better than what Greece currently faces.

That said, Greece has one advantage that Argentina did not:  it's a member of the eurozone.  An investor in Argentine securities had to worry that the government might devalue; an investor in Greek securities does not.  In addition, an investor in Argentine securities had to worry that the government might impose capital controls; an investor in Greek securities does not.  Finally, nobody stood ready to bail out Argentina if it defaulted; the E.U. would almost certainly bail out Greece. 

In addition, a rise in the interest rates faced by the Greek government does not necessarily mean a rise in the interest rates faced by all Greek borrowers.  It is quite possible for investors to view a government as riskier than the private entities over which that government rules. This is especially true when that government doesn't control the currency and lacks the power to impose capital controls.  Frex, Moody's ranks California as A2, but many companies within the state are rated more highly and borrow more cheaply than the state government.

In the absence of currency risk, Greek government borrowing will only start to directly affect private credit conditions under three circumstances. 

1. The banking system starts to look shaky, and the government looks unable to issue the debt it would have to in order to rescue the banks;
2. Investors start to fear that taxes are going to rise precipitously;
3. Something else causes foreigners to decide that they can't discriminate between private Greek borrowers and the Greek government.

Fortunately for Greece, so far the banks don't look that bad.  There is no reason to think that Greece will have to issue massive amounts of debt to recapitalize them in the near future.  That's Ireland's problem.  So (1) is off the table.  For the moment, at least. 

Unfortunately for Greece, numbers (2) and (3) still apply, if not as much as they would were the country not in the E.U. 

And even more unfortunately for the Greek government, it has issued so much debt in the past that private investors really do have reasons to worry whether they'll be able to pay it back.  So the issuance of more debt is causing interest rates to rise, causing the Greek government to need to spend more on interest payments when its debt is rolled over (or new debt issued), causing the government to need to issue more debt.  It's the dilemma of emerging market Keynesianism, only in this case it's the fault of past Greek governments for racking up such high debts in the past.

Or at least partially their fault ... other countries get more benefit of the doubt, even with high debt-to-GDP ratios.   But still.  The downturn wasn't made in Greece, but it seems to me that the country could have been better prepared for it.  Had it gone into the downturn with less debt, the government would have more scope to issue bonds right now to backstop the banks and put people back to work building high-speed trains or fixing that godawful place Athens calls an airport or something. 

Leastways, that what it seems like to us.

Once again, I end with a call for information from those who know more. 

Comments

[Bernard Guerrero]

"Finally, nobody stood ready to bail out Argentina if it defaulted; the E.U. would almost certainly bail out Greece."

How does that square with the (public) German reluctance to bail out the Eastern Europeans? Is Greece getting a bye because it's Old EU?

(BTW, the error appears to be confined to my work machine, but only to your site. Quite odd. I'll get you the precise message on Monday.)

[Noel Maurer]

There are a few issues here. First is, there's a difference between a eurozone defaulter and a non-eurozone defaulter, although both types are likely to get an E.U. bailout.

Second thing, of course, is that the Eastern Europeans haven't defaulted. We don't know what Brussels (with, obviously, a de facto German veto) would do if that looked likely.

Third thing is that the Germans have, as you say, raised the possibility of bailing out eurozone members should they default.

There are three likely reasons for that. (1) A eurozone-member default is more likely to do bad things to eurozone capital markets and economies than a default outside the eurozone; (2) eurozone governments in Ireland and Greece (and to a lesser extent Spain) are closer to default (AFAIK --- Hugh?); and (3) Germany believes that the E.U. can make eurozone members suffer enough for defaulting (or directly control what they subsequently do) that moral hazard won't be an issue.

How they actually structure any bailout, should it be necessary, is a whole 'nother kettle of fish. My money is that the European Investment Bank would be turned into a de facto bond-issuing agency for the entire E.U. But mileage varies.

Hopefully it won't come to that. But my current opinion is that the eurozone would be behooved to admit more strongly that they're going to bail out euro-using countries that get into debt spirals because of the current crisis, rather than run the risk of seeing a country slide into an Argentine-style debt spiral.

[pc]

I see you've got blue jeans on in on picture. George Will does not approve

[Bernard Guerrero]

"the eurozone would be behooved to admit more strongly that they're going to bail out euro-using countries that get into debt spirals because of the current crisis"

That's been my take. It seems to me like they run a serious risk of contagion otherwise, and the entire "European Project" has been under enough political strain as it is.

As an aside, I recall running into a website taking non-monetary bets on the possible demise of the Euro when I was doing a project on OCAs at NYU. I believe I took a mid-'07 box under the assumption that the business cycle should have turned by that point, and there was no way the Germans were going to pony up for more transfers or that the Italians were going to make it without a devaluation. I think I called the cycle close, but possibly I underestimated the Germans (though perhaps not their rhetoric.)

"Germany believes that the E.U. can make eurozone members suffer enough for defaulting (or directly control what they subsequently do) that moral hazard won't be an issue."

Heck of a lot of fiscal pain for non-defaulters, though. My read would have been that geographic transfers in the US make some level of local austerity acceptable. California can cut because the Feds are always there as a backstop. If, say, the Italians need to do the same, though, both the transfer system and the political ties are weaker.