Echoes of Greece's Debt Crisis

In 1973, 100 Greek Drachmas would get you $3.33. By May 2000, that was down to 27¢. That's the way the currency crumbles in a smallish, less than rich nation beset by government budget deficits, inflation and a spotty record of economic policymaking. Convincing foreign investors to buy your debt is a struggle. Financial life is difficult in ways scarcely imagined by inhabitants of the lucky (and not large) club of nations with solid currencies.

In June 2000, though, Greece was lucky enough to join that club. By the skin of its teeth, it met the criteria for admission to Europe's new currency union. First, the drachma's value was fixed to that of hard-money countries such as Germany and the Netherlands, and its long decline against the dollar slowed. Then in 2002, the drachma exited the currency stage, giving way to the euro.

Greece suddenly found itself with a solid, reliable currency. Its government and businesses could borrow at lower interest rates than before. The country boomed, with real GDP growth topping 3.8% for eight straight years. (During the same 2000-07 run, U.S. GDP growth never hit 3.7%; Germany didn't make it past 3.2%.) It seemed as though Greece had landed a one-way ticket to economic good times.

The reality was more complicated. Greece now had a solid currency--but it wasn't Greece's currency. The euro was managed by monetary wonks at the European Central Bank in Frankfurt for whom the Greek economy was but a blip. And the decision makers in Athens with responsibility for fiscal policy continued to blunder. The country kept running big deficits in the boom years. Then came the Great Recession. Last fall, a new government revealed that the 2009 budget deficit was much higher than previously disclosed--nearly 13% of GDP. Ever since, the world's financial markets have been going through another of their periodic losses of faith in Greece. Only this time, it isn't just Greece's problem.

Three other nations on the fringe of the euro zone--Portugal, Ireland and Spain--are caught in the undertow of Greece's crisis. All three have displayed better fiscal behavior than Greece, but they suffer from the same disconnect between their dire local economic conditions and the monetary policymakers in Frankfurt with other things on their minds. Meanwhile, a core euro-zone country, Italy, has also fallen out of favor with investors because of its high government debt. In a sure sign that these troubles are serious, market analysts have assigned them a catchy acronym: PIGS, for Portugal, Ireland, Greece and Spain (or PIIGS if you include Italy). In early February, the panic began to spread beyond their borders, with markets flailing in Europe and then around the world.

What is the endgame here? Greece has big debts relative to the size of its $357 billion economy (about 120% of GDP). It no longer has the option of eating into those debts by inflating its currency. In fact, it has no power to use monetary policy to ease its pain, as the Federal Reserve has been doing in a big way in the U.S. The only options for Greece are to 1) scrimp and save to convince creditors that it can keep paying them off, 2) convince its fellow euro-zone countries--or maybe the International Monetary Fund--to bail it out, 3) default on its debts or 4) pull out of the euro.