Greek crisis, resulting into Greece’s submission to the IMF and the forthcoming social unrest is related to the Global crisis of finance both in Europe and in USA. The result can very well be a global recession, from which the merging countries like India cannot escape. Globalization has massively increased the vulnerability of the world’s financial and economic system. Every day trillions of dollars is transacted at the speed of light, much of it unregulated. The derivative products or gambling of various kinds on every financial future market have accrued to the level of hundreds of trillions of dollars, unmonitored by any governmental authority. In essence, a vast global financial superstructure has been erected on a fragile foundation by arranging massive loans by some investment banks to countries who cannot afford to pay back. This is just as worst as the sub-prime securities or loans to poor American to buy houses knowing their inability to repay but then selling these loans as assets to the rest of the world.
The situation has already created a fear psychosis all over the world of an impending recession of the world economy. European governments decided to fund a bailout largely out of fear that a Greek default might lead to a new financial crisis and the bankruptcy of other countries, such as Ireland, Portugal and Spain. Credit rating agencies recently downgraded both countries’ debt. If Greece will collapse, others will follow.
Greek Debts:
Greek government of Prime Minister Giorgios Papandreou announced massive social cuts worked out in negotiations with European and International Monetary Fund (IMF) officials to pay off the Greek debt to its international creditors. In exchange for these austerity measures, the European financial ministers decided earlier to implement a €110 billion bailout package for Greece so that Greece will not default, which would ruin the European monetary system and its currency Euro. It’s more than likely that austerity package will be rejected by the Greek people who would prefer to default on the debt. If Greece can get away with a default, that will make the prospect of default for Ireland, Portugal and even Spain a much more realistic possibility. Greece has a national debt of 330 billion Euro out of that about half are due to international banks mainly American, other half are from German and French banks. French banks hold $75.4 billion worth of Greek debt, followed by Swiss institutions, at $64 billion, according to the Bank for International Settlements. German banks’ exposure stands at $43.2 billion. That gives the Greek debt crisis an international dimension with worldwide impacts. One possible way out for Greece is to default on its debts and quit the European Monetary system. This would allow Greece to devalue, to improve its balance of payments with cheaper exports. However, in that case Greece will be unable to borrow in future from the European Central Bank and people will get rid of their own currency to have more Euro to survive the uncertainly. That will exhaust its foreign exchange reserve. A default would hurt French and German banks in particular. They were some of the biggest lenders, holding more than two-thirds of the Greek government bonds in international lenders’ hands at the end of last year.
How Greece fell into the Debt Trap:
Greeks are some of the world’s richest people. The National Bank of Greece, Eurobank, Alphabank and Piraeus bank, have 164 billion Euros in deposits alone. The estimated loans taken from the foreigners are about 216 Billion Euros. Greece has extremely low household debt / GDP ratio; low corporate debt/ GDP ratio; low bank debt/ GDP ratio; a manageable total debt / GDP ratio, but a very poor Government debt / GDP ratio, above 100% of GDP.
In 1980, when Greece has joined the European Union, Government Debt/GDP ratio was 30% and it would have been much lower were it not for the high costs of defense. When Greece joined the EU in 1980, it became a party time. A small oligarchy then was the only source of capital and had the acumen, education and experience to deploy it as the country developed. Old families controlled the steel, cement, foodstuffs and construction companies that rebuilt Greece after the war.
Money that was sent from the European Commission to build the Greek infrastructure, about 6% of Greek GDP for the last 30 years, was funneled directly into the pockets of the oligarchy due to high level of corruption in Greece. Most part of that money could be used in socially desirable projects, but instead the bulk ended up in the pockets of the twenty families who run Greek business and own all the banks. Low rate of interest from the European banks, have allowed the Government of Greece to be borrow more and more but the people on the street never saw the benefit of the 300 billion the government has borrowed. Even then, Greece should not have any difficulty given the deposits and assets of the Greek banks.
Greece then fell into the trap of debt due mainly to a financial derivative called Credit-Default Swap. The contract, known as credit-default swaps, means if a company or, in this case Greece, an entire country, fails to pay its debts, Banks and financial institutions who own these swaps stand to profit. It’s like buying fireinsurance on your neighbour’s house — you will be motivated to burn down the house of your neighbour so that you can receive a huge insurance payment subsequently. Similar conditions were created for Greece by a number of Banks, some of which are Greek. Greece was encouraged to borrow heavily by these banks to finance its budget deficit. At the same time, Goldman Sachs, JP Morgan Chase and about a dozen other banks had created an index that enabled market players to bet on whether Greece and other European nations would go bust.
As banks and others rush into these swaps, the cost of insuring Greece’s debt rises. Alarmed by that signal, bond investors then started rejecting Greek bonds, making it harder for the Greece to borrow. That, in turn, adds to the anxiety that Greece cannot repay its existing debts by borrowing more. Anxiety now covers other troubled economies like Ireland, the Baltic States of the former Soviet Union, Portugal and Spain.
Role of the US Financial Institutions and the Financial Derivatives:
Greece has come under pressure recently to explain allegations that it used complex financial products, provided by US investment banks, to conceal the true state of its debt pile over the last decade. Goldman Sachs and other banks set up a new index or derivative, in plain English a bet, in September of 2001 that investors could use to bet on the likelihood that Western European countries like Greece would default on their debt. The very same company that created this index set up a similar index in early 2006 that allowed investors to bet on the likelihood of defaults in the subprime bond market in USA. That index was a collaboration between two companies Markit and CDS IndexCo, a consortium of 16 banks, including Goldman Sachs. The acting chairman of CDS IndexCo was Goldman Sachs managing director Bradford Levy. Goldman Sachs and a hedge fund manager John Paulson, who made billions betting against the subprime sector, were the major buyers of these Index or derivative.
Goldman is, in fact, using swaps to bet heavily on the likelihood of a Greek default, At the same time that it is helping Greece to hide its debts. The game plan is fairly simple: create government bonds to hide true levels of debt, then make profitable bets that the government will fail to pay off . This would create a financial crisis. The country would expect other governments and the International Monetary Fund would take the responsibility for its debt. The bets will earn enormous profits for these investment banks.
Goldman Sachs and John Paulson did this with AIG before to create the financial crisis in USA and subsequently for the world, devising complex securities known as “synthetic CDOs” which were composed entirely of bets on a set of mortgage loans given to poor Americans who can not afford these. Paulson has collected the contracts for these mortgage loans, selecting the ones that were most likely to have default. Goldman then created the securities combing these mortgage loan contracts and sold them as investments to investors like AIG ( American Insurance Group). The bets were essentially designed to fail, with Paulson (and Goldman) on the winning end. The hidden cost of default was massive enough to make AIG bankrupt, threaten the world financial system, and necessitate a help from all G-20 countries.
These bailout funds were then passed on to Goldman Sachs. Due to the activities of Goldman Sachs and Paulson, according to the Securities and Exchange Commission of USA, Royal Bank of Scotland and Germany’s IKB Deutsche lost about $1 billion on the deal, which was later financed by the respective governments of Britain and Germany. Similarly, Greek government now has to borrow money from the International Monetary Fund for the game Goldman Sachs and Paulson played. John Paulson’s investment firm earned more than $15 billion in 2007 and Goldman Sachs earned $4.79 billion in the last quarter of 2009 alone. The Greek crisis is created using the similar technique, when Greek banks have enough assets to walk over the crisis.
However, when Greece is dealing with the prospect of financial ruin, Goldman Sachs and Paulson have been speculating heavily in Greek debt markets with a team of 20-30 traders focused on the country. As New York Times reported, that on Jan. 28 and 29 2011 this year, analysts from Goldman Sachs Group Inc. took a group of investors on a field trip to meet with Deputy Finance Minister of Greece and head of other private banks in Greece. Greece appears to have been negotiating for its economic future with Goldman Sachs and its network of hedge fund colluders, many of whom have taken large speculative positions on Greek debt. The Wall Street Journal reported on a Manhattan dinner party where a group of hedge fund managers discussed their bets against the Euro, which is now seriously affected by the crisis in Greece and possible crisis of Spain, Portugal, Ireland, and Italy.
Effects of the Rescue Plan for Greece:
The IMF plan to have any chance of success will tighten Greece’s austerity plan further. Greek GDP will fall further if the IMF demands a further tightening. The Greek government is seeking to reduce the budget deficit from 14 percent to 4 percent of Greece’s gross domestic product (GDP), which stands at roughly €245 billion. As it absorbs the impact of these cuts, the Greek economy is expected to contract by 4 percent this year.
Public sector workers face another cut in their official wages, which will then be frozen until 2014. Pensioners also face massive cuts. Sales taxes—which fall most heavily on the working class—will be increased. Greece also plans to privatize mass transit and utilities—moves that will doubtless dramatically increase user fees, just as workers face plunging wages and rising unemployment. There will also be large cuts in spending on hospital equipment and medical care.
How USA got into involved in this crisis:
More than 70 % of America’s GDP is derived from consumer spending. Accordingly, in this time of economic crisis, the government must substitute for the downfall in retail and business activity by regenerating demand in the economy. In the America that gave birth to the global financial crisis and credit crunch, the government’s finances have been driven to the brink of bankruptcy by vastly excessive military expenditures, run amok by a losing war in Afghanistan and an unnecessary war in Iraq.
America’s superiority was based on its military infrastructure, and the capability to project power thousands of miles from its shores, inflicting “shock and awe” on any foreign enemy. However, that military industrial complex required a massively productive and successful economy to maintain itself. During the last ten years, while America replaced its ability to create goods that the world needed with complex financial instruments and securitized mortgages as its primary export product, it relied on foreign creditors to subsidize the American military establishment and the cost of the foreign wars it was engaged in. That bubble has busted. European banks are not in a position, due to the defaults of several smaller European countries like Greece, to extend loans to USA.
The consumer demand of the U.S., driven by debt, is now collapsing with the growing jobs crisis. This is leading to demand destruction for those export goods developing economies around the world depend on to employ their teeming masses. During the course of the year the jobs crisis will clearly be a global phenomena, as are all the other factors that characterize the ongoing World Economic Crisis.
For USA, to finance the massive amount of spending planned by the Obama administration; at least a trillion dollars of additional money have to be borrowed from abroad. The American stimulus package alone has cost over one trillion dollars in the last two years. This comes on top of the $700 billion program of George Bush initiated. The only way the U.S. will be able to attract foreign credit in this context is through much higher interest rates. This will kill private borrowing, stifling investment and ultimately defeating the purpose of the stimulus spending. The other alternative is to simply print the money, and produce the hyperinflation, as Nixon did in early 1970s. The viable alternative is to reduce USA’s massive defence spending, which is the cause of its huge budget deficits.
The American consumers, always over-burdened with debt, are always ready to purchase more by the easy access to credit. Now they are denied this. With the collapse of consumer demand in the United States, factories in China, Japan, Taiwan, and Southeast Asia are throwing millions of employees out of work. This in turn is collapsing internal consumer demand in those countries, further exacerbating the shortages of global demand. The Asian contraction in consumption is leading to global demand destruction in commodities, facilitating the deadly virus of global deflation.
Policy Recommendations:
There were two reasons behind the financial crisis of 2008; both of them are the result of this liberalization of the economy started since 1980s. The first is the idea that people can take care of their housing needs without any help from the government. The second is to consider liability as asset by building some new financial schemes to turn speculative gambling bets on future market as respectable assets. Neither of these can happen if there is a public ownership of financial institutions and if the government takes the responsibility for the basic needs of the people. Greece is now a victim of both the speculative activities of the global investment banks and corruptions and greed of the private sector companies and banks of Greece.
The stream of virtual money or derivatives are nothing but some kind of gambling bets on the expected future prices of various commodities, gold, shares of companies, rate of interests and exchange rates of various countries and of course the price of these Mortgage Backed Securities. It has created gambling casinos in the futures market, where different financial institutions are betting for the future values of various financial instruments. These betting have resulted into more and more bankruptcies of famous institutions like Barring Bank or Equitable Life Insurance Company. The game went on describing what can be called dangerous financial risks as assets just by attaching values on them. The fundamental idea is that past bahaviours can predict the future. However, there is one very important lesson from the past is missing here: the experience of 1930’s crash of the US Stock market, that speculative bubble would burst sooner or later and no mathematics can predict when that would happen.
However, their greed has no limit. After nearly destroying the financial system of both USA and UK in 2008, they are now trying to ruin country after country by offering them loans and creating derivative or bets that the country cannot pay back the loans. They know that richer countries like Germany and IMF would not allow a country like Greece to go bankrupt. However, ultimately the people of Greece will have to pay, for the corruption and short sightedness of its Government and the corruption and greed of the captains of its private sector, in terms of their much lower standard of living.
India has a lesson to learn from the Greek tragedy. Indian companies are borrowing heavily in the international market to acquire properties abroad; more than half of Indian foreign borrowings are of these private business companies. India also allows huge amount of short-term borrowings by its institutions from the international market. International private financial institutions are allowed to operate in the Indian stock market, real estate market and in the food and agricultural market, thus creating inflation. Thus, India is getting more and more exposed to the speculative games that these financial institutions play to ruin a country. In 1998, several East Asian countries became their victims, in the same way as Greece and several European countries are today.
The cause of the problem comes from speculation, as it was the cause for the great depression of 1930s as well. Before the 1930s depression for about 15 years there was totally free speculations where most of the companies, banks and financial institutions were free to behave, as they wanted. Since 1980 as well we have seen the same deregulation process to free the companies from many obligations to the society at large. Now added to the speculation in the share market we have also speculations about possible future movements of every financial or economic indicators and prices of commodities and services, which are called ‘Financial Derivatives’. Added to that we also have a new financial innovation called ‘Mortgage Backed Securities’ which are nothing but loan obligations of the banks, which were sold as assets to the world banking system. People were told that they are buying shares of properties, but in reality they were sold existing ‘debts’, which are hard to recover.
There are two types of solution short-run solution so that the economic system of the world will not collapse creating mass unemployment. There is also a long-term solution, so that this type of crisis would not occur in future. Short-term solution must look at the immediate causes of the crisis and try to resolve these. The long-term solutions must be aimed at reforming the present system so that this type of crisis would not occur in future.
Immediate cause of the crisis is lack of resources in the banks to maintain the credit system flowing so that companies that depend on the banking system can survive. Another cause is the huge stocks of worthless option, derivatives and mortgage backed securities, which are now reduced to the status of junk bonds. Throwing money to the banks and the companies will not solve the problem, as the US government is trying to do now. Nationalisation of the entire banking system along with the major companies is needed to solve this problem. Nationalisation will help the government to refinance the depleted stock of the banks and to help major companies to survive. That will help their supplier companies and their sales outlets along with the trading companies to survive.
For the long-term solution we need to go back to the advice of two great economists, during the 1930s depression, which were so far rejected by the world. In 1934 Ragner Frisch (Circulation Planning: Proposal for a National Organization of a Commodity and Service Exchange”, Econometrica, 1934) has suggested a National Exchange replacing the stock market, where the companies will be allowed to sell their shares only if they will provide complete information about their business. Investors must keep these shares for a specified period and cannot do speculation trading with these. If they want to sell the shares they must sell these back to the company itself. The company can sell more of its shares only if it permitted by the National Exchange provided it has good prospect. Thus, the valuation of a company will not depend on the speculation and rumours in the stock market but on the honest information collected by the National Exchange about these companies.
This will rule out speculation altogether, as the secondary stock markets today do not contribute directly to the investment funds of the companies, but only create artificial often misleading valuation of the companies. Those today depend on these artificial valuations of the stock market and do trading can be ruined easily. This is the situation for most of the large investment funds, pension funds, unit trusts, which were mislead by the stock market and now facing bankruptcies ruining the lives of millions of investors and pensioners. Other speculative instruments like options, derivatives, and future prices must be disallowed as well by the National Exchange, who would advice the banks to invest directly to the companies as they do in both Germany and Japan today. Both Japan and Germany are comparatively more stable than the Anglo-American world.
John Keynes suggested another long-term solution in 1948 at the time of the foundation of the International Monetary Fund to redesign the world’s financial architecture (‘Shaping the Post-War World: The Clearing Union’, in The Collected Writings of John Maynard Keynes. Vol. XXV. Activities). The idea is that no country will be allowed to keep more than a certain amount of its surplus from the balance of payments. Today, China’s reserve of foreign currencies has exceeded a trillion US Dollar causing blockages of the financial flows. Keynes idea was that the member countries of the IMF might keep up to one year’s import costs as reserve of foreign currency. The rest they have to deposit to the IMF, so that these surplus can be distributed to the countries in need of investments.
However, these are not enough. American crisis is the result of a trading system that provides no supports for the workers who are the consumers. If the American workers have no jobs, their consumption spending will fall, creating less and less demand for the domestic economy, creating more unemployment and less tax revenues for the government. This cycle of misery was created about 20 years ago, when serious effort to dismantle trade restriction was initiated. The result is the massive rise of China, who has kept its exchange rate at a very low level artificially by having a fixed exchange rate, which does not depend on the international currency market. Yet China, which has no trade union, with massively abused worker with very low wages, control on all aspects of investments, was admitted in the World Trade Organization as a market economy, because China supplies cheap products to the Western corporations, who consider their profit more valuable than the fortune of their own people.
For all countries, it would be better to have a trade management system in which each country pays for its imports with its own currency. A country cannot import if its currency has no demand or in other wards it has nothing to export. In that case, an exporting country would be obliged to buy from the country to which it exports. Thus, China will be obliged to buy from USA if it wants to export to USA. The system would not lead to a massive surplus for one country and a deficit for another, but rather to a balanced trade regime that benefits everyone. The WTO, instead of being an arbitrator and promoter of “free trade,” should be an advisory council for planning such a trade system so as to maximize the interests of everyone.
Conclusion:
Nationalization of the banks, including the Federal Reserve System of USA, which is a private enterprise, will help countries to regulate the financial market for the benefit of the economy and the people. Abolition of speculative activities in the secondary stock market will protect the genuine investors. Abolition of derivative market and the credit-debt swap market and their reinsurance, which has caused the debt crisis in Greece and other European countries to provoke them to borrow more than their ability to pay, will help cool down the financial madness and help the banking system to survive. A managed trading system will rule out economic exploitation of one country by another by destroying economy of one country by another with cheap export items manufactured by slave labourers and an artificially low exchange rate, as China is doing now. Debt crisis in Greece, Ireland, Spain, Italy were caused by the investment banks like Goldman Sachs who provokes countries and companies to take loan and then create derivative that they will fail to pay off. As a result, the debtor country suffers along with its companies and the people but the investment banks make gigantic profit. Debt crisis in USA was caused by excessive defence spending to finance the invasions of Iraq, Afghanistan, Libya and possibly now Syria and the same speculative lending by these same investment banks to the American poor who could not afford to buy houses. The crisis of unemployment in USA, UK, and Japan are caused by a trading system where China has managed to ruin their manufacturing industries through its cheap exports. In India as well, about 26 percent of the manufacturing industry is now taken over by the Chinese exports causing serious unemployment.
The solution cannot be available within the given economic system. Thus an outside-of-the-box solution is needed. This is the real demand for the demonstrators in front of the Wall Street. They don’t want to destroy the system but want the system to respond to the needs of the people.
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