At least one word has stood out to you in the financial gibberish section on the newspaper, “Greece.” A beautiful, scenic Mediterranean country, often evoking images Greek Mythology characters and historical monuments, now dominates headlines for its so called debt crisis.
The debt crisis simply describes Greece’s inability to repay what it borrowed. Some may ask, “Why is Greece, a country, borrowing money in the first place?” The questioned could be answered if we think of it this way. I would like to draw an analogy to a student club. If you have been part of the board of a student club, perfect. If you have not, well, try to think like one, just for the sake of all the free pizza you got from the club anyways.
A country, like a student club, needs revenue or funding to run. A country needs to pay its government employees, services, and unemployment,disability, or other types of social payments. A club needs to rent out event space, buy equipment, hire performer, and buy food, the one thing that probably drew you to most of the events. Also, both a club and a country have two primary ways to get their revenue and funding. A club earns its revenue through selling t-shirts, show tickets, and perhaps collecting membership fees. A government makes its revenue from tax and service fee collections. A club and a country’s source of revenue are easy to understand, but their source of funding requires a bit more of thinking.
A student club applies to the university for funds.Depending on the content of its event, the university may fund the club for its positive influence or social contribution. This could range from promoting world peace and diversity to hosting a breast cancer fund raising dance. In short, monetary support from the university is exchanged for the club’s promise to host an event. Similarly, a government receives money and in exchange promises something, the promise to pay back the money borrowed and more. While a college student may ask his or her buddies to spot for a movie, borrowing money at zero interest, a government pays a yield, the additional amount, to whoever it borrowed from. This yield rate is determined by the market and determines how much more a government has to pay back. Also, instead of just taking a mental note or jotting down Mike owes me ten buck on the iPhone, a government borrows money by issuing bonds. When a person buys bonds, he or she is lending the government money. The person who buys the bond, also known as the bond holder, helps finances the government’s activities and agrees to the government paying back at the end of the maturity date.
Just like it would be hard for a club to keep on feeding its members boxes of pizzas and throwing concerts based on t-shirt sales and ticket sales, a country also cannot rely on its revenue to finance all its activities.As a result, a country often relies on its bonds to cover its budget deficits.This holds true for most of countries and during good times, this is not a problem since government bonds, believe it or not, sell pretty well. While people bought bonds out of patriotism during WWII, as seen in Captain America, people usually buy bonds because of what is in it for them. Well, what is in it for them is bond’s low risk and steady return. People now understand the importance of investment because it seems like the quickest way to get rich, but they all have their own investment philosophies and strategies. For expert stock pickers or gamblers, some will put their money in the stock market. For people who just want their money to grow steadily, many will look into bonds. As a result, bond market has grown quite a lot especially since the 2008 financial crisis. Some may now ask, “If bonds are so popular and it is so easy for governments to borrow money, why does Greece have trouble borrowing money to pay back its old debt?”
This question takes us back to 2009. Countries usually do not have trouble borrowing money, but in 2009 Greece did. What happened is that people started to realize that Greece’s economy is not doing well, the government is spending handsomely, and Greece owes others, well, a lot. Before,Greece could borrow money with a low yield rate, but after the market panic,people began to demand a higher yield rate. Almost overnight, Greece has become that grimy friend who always pays you back late or rounds down on the amount owed. Like that friend, it is a lot more difficult now for Greece to convince people to buy its bonds. As a result, the yield rate soared. People now are only willing to buy its bonds only if Greece is willing to pay them a lot more in yield. Greece could continue to borrow money to pay back its owed debt, but continuous borrowing at such high cost only delays and worsens the problem, similar to procrastinating on a difficult problem set till the day its due. Greece is indeed in a difficult predicament.
Does Greece’s problem sound far removed from you and is unreletable? Well, let’s go back to the student club comparison. First, imagine a student club who loves to feed people with overdoses of pizza, but is not very good at fund raising, evident in its large leftover t-shirt inventory from four years ago. Though the club spends more it earns, the club stays afloat because the university funding. Then imagine the club,despite the lack of funding, has booked a big time performer and worst of all, the performer already completed the travel arrangements and is coming next week. You can imagine the panic at the next club meeting then. The club is faced with two options. It has to either come up with a genius plan, such as a ridiculously successful bikini car wash, to fund raise, or to beg the university for money.
This was essentially Greece. It spends more than it earns and similar to the performer contract, old legislation has promised to spend money on different things and people. Unlike the student club though, Greece cannot raise taxes to boost its revenue nor should it keep on borrowing expensively through bonds. What’s is left for Greece to do is to find other places to borrow money from and try to cut down on its spending. Three years since 2009, Greece has done exactly that.
Greece has found the International Monetary Fund (IMF) to lend them money. Even more similar to the way a club receives funding from the university,Greece is now subjected to listen to IMF. IMF has lent Greece money on the conditions of Greece cutting down on its spending. Similar to the university’s reaction to the club’s mishap, the university may fund the event but expect them to cut down on future event expenses or reach a certain membership quota.In short, both Greece and the club are able to secure the funding, but are now subjected to stricter standards in comparison to before.
One difference is that the Greek bond holders have also agreed to a pay cut in what they are owed. Considering Greece was on the brink of bankruptcy, many bond holders accepted to receive less money back than potentially nothing back at all. Perhaps in the student analogy, the performer has also agreed to give the club a break by giving a discount. Also, since Greece used bonds to borrow money to repay its old debts, periodically Greece runs into trouble again and again on having to pay back bond holders. As a result, IMF and other organizations have bailed out Greece time and time again. While Greece still spends more than it earns, the crisis has died down somewhat in Greece. Mainly due to the increase bail out support from different organizations, Greece now is able to borrow money from more than just the bond market. It now has the backing of the International Monetary Fund, the European Central Bank, and the European Commission in case of a resurgent crisis.
Greece is out of the news headlines for now, but it is still a relevant question because European Union countries are still struggling with their economies and debt issues.
Please find the links below for key definitions
