Back in June, I warned that Europe is heading for another government-debt crisis. I noted that one reason for this is that almost all European governments continue to operate with structural deficits. Hungary is a notable exception: it had essentially eliminated its structural deficit before the 2020 pandemic.
Another reason to predict a new debt crisis is that Europe is likely on the edge of a new recession. The continent is not there yet, but as I noted on September 14th, it will take a small miracle to keep Europe out of a recession. It will not take much to hurl Europe into an economic downturn, especially if the self-inflicted energy problems, green-power driven inflation, and foreign energy dependence continue their downward spiral.
One of the ridiculous consequences of Europe’s energy-inflation problems is that individual governments are now setting themselves up for new budget deficits. The spending vehicles for this new borrowing are handouts to households and businesses to cope with runaway energy costs.
In Austria, the national legislature started talking already in March about subsidizing household electricity bills. Since then, a large energy company has caught onto the idea of asking for taxpayer support. On September 5th, the Swedish parliament passed a bill to do just that: bail out power companies. The European Union, of course, wants in on the action: as our writer Tristan Vanheuckelom recently reported, the energy ministers of the 27 EU member states have “discussed measures to bring urgent financial relief to European companies and households.”
Given that Europe’s energy situation is a structural problem, from production to retail pricing, it is a safe bet that any government that dips its toes into ‘support’ for households and businesses, will soon find itself in a downward deficit spiral. Unfortunately, the High and Mighty do not seem to want to hear about the limits to their own power. Our own Bridget Ryder has drawn attention to how EU Commission President Ursula von der Leyen has proposed “a cap on Russian gas prices” imposed by the EU itself.
Yes, you heard that right. The EU, a buyer of natural gas from Russia, is considering telling its supplier that they are not going to pay more than a certain price.
Maybe I, an American, should call Mercedes over in Stuttgart and tell them that I would like to buy a new car from them, but they will have to accept a price cap that I set.
It is not hard to predict what Russia will do if Brussels tries to price-cap its gas purchases. Hopefully, people closer to reality will prevail in Brussels and put an end to the phenomenon where tax-paid officials think they can solve a very difficult problem by waving a magic wand of government powers.
This attitude is problematic enough when applied to energy policy, but it becomes downright dangerous when scaled up to address more systemic problems in the economy. We saw one of those problems in the Great Recession a decade ago, in the form of unending budget deficits and extreme austerity responses from the European Central Bank, the European Union, and the International Monetary Fund.
Back then, one country was hit harder than any other: Greece. The ECB-EU-IMF troika forced a plan upon the government in Athens that would supposedly eliminate the Greek budget deficit. But since it was designed by government bureaucrats, who in turn were advised by government-paid economists, the detached-from-reality plan ended up massacring the Greek economy.
Just like the measures now being considered as a ‘solution’ to the current energy crisis, the austerity plans forced down the throats of the Greek people did nothing to solve the underlying problems of the debt crisis. All it did was suppress the symptoms—and in the bargain destroy one quarter of Greece’s gross domestic product, GDP.
None of the measures being discussed among European governments today as a remedy for runaway electricity costs will do anything to solve the underlying problem. Likewise, none of the austerity measures from Greece a decade ago helped Athens solve its structural-deficit problem.
On the contrary, that structural deficit is still there. The combination of that deficit and a slew of counterproductive EU-wide energy policy measures is enough to raise worries that Greece is on the cusp of another debt crisis. There is another reason to take the debt-crisis threat seriously: the looming recession.
Some analysts deny that Greece can once again fall into a debt crisis. Back in June, economics writer Eirini Chrysolora with the English-language Greek news publisher Kathimerini explained:
Greek bond yields may have evoked nightmares from the past—with the benchmark 10-year debt exceeding 4.7%, levels unseen in five years—but economists, bond market players, government and European officials assure Kathimerini that there is no risk of another debt crisis—at least for now.
As 60% of the country’s debt is held by the official sector, which has lent it at a fixed rate of 1.4% and averages just over 18 years, its financing needs are limited.
Regling’s observations regarding Greek treasury securities are based on a false sense of security (pardon the pun). According to the latest figures from Eurostat, in the first quarter of this year treasury securities accounted for 23.5% of the consolidated Greek government debt.
In the first quarter of 2010, the same share was 88%. This is a much more normal number; for comparison, the Danish government’s debt is currently 77% made up of debt securities, while the same instruments account for 87% of Spanish debt and 89% of French government debt.
In other words, Greece has a highly unusual debt structure, where the locked-in cost of treasury securities is of very limited consequence to the Greek government’s annual budget. The big item is ‘loans’, which have dominated the debt portfolio for the past ten years. These loans were granted by Greece’s debt ‘bailout’ partners, including the ECB-EU-IMF troika members and other euro-zone member states.
It is good, of course, that the Greek government has the cost of its current debt under control. However, that is not the problem. What should worry the Greek government is instead its soon-to-come need to build up new debt.
To see the challenge in new borrowing, let us take a look at the history and composition of Greek government debt. Figure 1 reports how that debt has evolved, as share of current-price GDP, since the turn of the millennium; Denmark, France, and Spain are included for reference:
The dramatic rise in Greek debt, mirrored in good part by Spain, began during the Great Recession a bit over a decade ago.
Note the weird ‘kink’ in the Greek debt curve: the quick rise comes to an abrupt end in 2012 when it is replaced with an artificial drop. This is the partial debt default that the ECB-EU-IMF troika ‘negotiated’ with Greece’s creditors. It resulted in Greece writing off one quarter of its own debt.
What the media at the time called a ‘haircut’ for creditors was in reality a sure-footed way to destroy Greece’s credibility as a borrower. It was also the main reason why Greek debt since then has been dominated by loans, not debt securities. Figure 2 illustrates this shift, with Denmark thrown in for comparison. The Greek numbers are represented by the dashed lines, with red representing debt securities and blue representing loans, as share of total government debt:
Greece replaced debt securities issued by its own treasury, with loans issued by its bailout partners. This, of course, was only a restructuring of the debt. It took until 2016 for the debt to stop rising relative GDP: at that time, the Greek government had implemented so many austerity programs, raised so many taxes, and cut so much spending, that the budget was balanced by brute fiscal force.
The price for the Greek people was unimaginable. The country lost one quarter of its economy during the first half of the 2010s.
There was a logical idea behind this debt restructuring: you don’t default on debt and expect sovereign-debt investors to like you. It worked, at least in the sense of getting debt costs under control. The problem is that this logical idea rested on a premise that was unsustainable over time, namely that Greece would never need to borrow money again.
That premise won’t hold, and there are signs that the Greek government is aware of this. They are trying to pay off existing loans as fast as possible, faster even than the loan conditions prescribe. According to Reuters,
Greece will repay ahead of schedule 2.7 billion euros of loans owed to euro zone countries under the first bailout it received during its decade-long debt crisis, finance ministry officials told Reuters on Thursday.
In April, they paid off IMF-issued loans due in 2024. Reuters also notes that Greece’s borrowing costs have increased significantly so far this year, likely prompting further premature loan payoffs.
Here is the problem with this sped-up loan payoff. For the Greek government to do this, they obviously need excess tax revenue. This in turn keeps taxes higher than they otherwise would be, which in turn is another drain on current economic activity; households and businesses part with money that does not return to the economy.
When government runs a budget surplus in order to pay back debt prematurely, it actually contributes to creating a need for new borrowing. The excess taxes drain the economy of private-sector spending, causing a decline in productive economic activity. With this decline, government faces a drop in tax revenue.
Given that Europe is on the doorstep of a wider recession, the question is what Greece can do to save itself from another fiscal meltdown. Since a budget deficit is inevitable in a recession, it only has two real possibilities: to rely on new loans from either other euro-zone members or from the ECB, or to sell treasury securities.
Unlike the last debt crisis, the ECB cannot lend Greece any meaningful amounts of money this time around. This excludes both cash loans (even indirect ones) and purchases of treasury securities. The ECB is in the process of normalizing its monetary policy, which means it is trying desperately to get interest rates high enough to curtail inflation, stabilize the euro, and restore some kind of dignity to the European credit markets. Another money-printing bailout of Greece would ruin all its efforts at becoming a credible central bank again.
Other member states are unlikely to lend money to Greece. Some of them have their hands full with finding ways to bail out the domestic energy sector, while others will be in fiscal trouble not unlike those that Greece will be facing.
Essentially, the IMF would be the only lender that Greece could once again turn to. It is questionable but not impossible that they could provide enough credit to bail out the same government for the second time in less than a decade.
If Greece returns to the sovereign-debt market on a larger scale, the country will do so based on the premise that it has re-earned the trust of global lenders. It is reasonable to assume that they have; the only question is if they can do so without having to pay prohibitively high interest rates. Even if Greece has rebuilt its credit status, the unforgiving trend on the international debt market today is one of higher yields.
This, of course, means higher borrowing costs for governments like Greece. Let us hope the sharp minds in Athens have a plan for how to cope with rising debt costs, declining tax revenue, and all the other aspects of a recession—without falling into the same austerity abyss that crushed one quarter of their economy.