Understanding the Greek Debt Crisis and Its Impact on the Eurozone

The biggest Greek debt-holders now are Eurozone governments (62 percent), the International Monetary Fund (10 percent), and the European Central Bank (8 percent). Of the 62 percent held by governments, Germany has the largest total exposure, France is second, and Italy is third. (However, Germany’s exposure is only 2.3% of its overall GDP.)

So you have to ask yourself, “Why does a country that, according to the IMF, is only the 44th largest economy in the world with a population about the same as Ohio—11 million people—still dominate the financial news?” It is because the Greek story is really about the survival of the euro.

British economist Charles Goodhart, an emeritus professor at the London School of Economics and former advisor to the Bank of England, said in 2004, “The defining moment for the Eurozone will arrive when a country is required by the treaty to take a deflationary fiscal action at a time when its economy is suffering worse stagnation.”

That moment has arrived. Before the euro, a country in the financial condition in which Greece put itself would have risked inflation by printing money, hoping a cheaper currency would allow that nation to export its way out of its problems.

Because Greece no longer controls its money, its only way to get competitive is through massive unemployment and pushing down wages, with the hope that lower wages will increase exports. However, twenty-five percent unemployment is incompatible with democracy—as unemployed and underemployed voters demand jobs from their elected politicians.

The Greece dilemma of needing money but being unable to create it goes to the core of the euro. The Greek economy needs money, but the European Central Bank, not the Greek government or Greek Central Bank (their Federal Reserve), creates Greece’s money.

Banks in Greece, like banks worldwide, can create money by making loans, but that money can easily be moved to banks in other Eurozone countries. Moreover, that is precisely what is happening. Wealthy individuals and companies in Greece are moving their bank deposits to financial institutions in France and Germany; that way, they are protected if Greece defaults or leaves the euro, thus creating a potential moneymaking opportunity for themselves. If Greece exits the Eurozone, its new currency—most likely the drachma—will be cheaper than the euro, and any money sitting in euros in German and French banks can move back into Greece and buy more than it could have before.

Why should European countries continue to lend money to Greece if much of that money is merely ending up in banks in Germany and France? Why don’t the strong countries just toss Greece out of the Eurozone? If Greece gets booted out, the other nations with high debt levels, the so-called PIGS—Portugal, Italy, Greece (who might already be out) and Spain—throw Ireland in as well, might see what Greece recognizes today: if you don’t control your money, you can lose control of your country.

The strong countries have a lot invested in the euro. If other countries besides Greece leave the Eurozone, then German and French citizens might end up with a great T-shirt: “I Survived the Euro Crisis,” or something like that. But they won’t get what they really wanted: a reserve currency that competes with the U.S. dollar.