Before the End of the World as We Know It

Greece and other European nations whose economies are failing are just the tip of the iceberg, and Japan's day of judgment is looming as well. While we cannot accurately predict the future, we must take certain steps to ensure that a total, global financial collapse is not part of it

Pinchas Landau
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Pinchas Landau

The end of the world as we know it is on the horizon: Many countries are suffering from a serious economic crisis and others will probably join them in the future. Many separate developments contribute to this process, such as the present crisis in Greece, and it is impossible to know, for example, when an acute financial emergency will erupt in Japan. It is possible, however, to classify countries according to their financial vulnerability and thus map the evolving crises.

As far as the actual "end of the world" is concerned, in general, nothing can be done and there is no point in thinking about what will come afterward - because there will be no afterward. On the other hand, in the social-economic-political context, "the end of the world as we know it" has already occurred in human history, for example, after the end of World War II. It is thus advisable that we think now about what will take place when it happens again because the "afterward" will arrive, most of us will still be alive and we must prepare for it.

There are two major obstacles that prevent us from envisioning the era following the so-called end of the world as we know it, and anyone who overcomes the first can still be expected to fail due to the second. First, most human beings hope for and dream about a better, even utopian, world, but are not willing to consider a world that is inferior in any way to the one they know, not to mention a dystopian world. But even someone who ponders such profound issues will be stymied by a frustrating and unavoidable fact: We cannot predict the future, for good or for ill.

It is possible, however, to state quite clearly that, in financial terms, the old system is gradually collapsing, for reasons explained below, and will be replaced by a new one. We know nothing about the nature of the new system, which is worrisome, although there are some good reasons to believe the future will be much better than the past. But the period of transition from the old to the new is inevitably problematic and dangerous, and therefore frightening.

The main factor spurring "the end of the world as we know it" is the evolving sovereign debt crisis. Many countries, and perhaps the developed world in general, have assumed so many debts and obligations, and such large ones, that they cannot meet them. Because of the close ties among these countries, they are separately but also collectively facing a cruel choice, which until recently would have been inconceivable. These nations must decide between informing their creditors that they are unable to meet their monetary obligations - in other words, declaring financial insolvency - and informing the citizenry of their inability to meet sociopolitical commitments. In effect, it will be impossible to choose one option over the other because the inability to repay debts encompasses both types of commitments simultaneously.

The debt crisis will hasten the end of the era of the welfare state as formulated during the 20th century, mainly during its second half. Since the welfare state with all its ramifications defines our social-economic-political world to a great extent, its end signals "the end of the world as we know it."

The crisis in Greece, based in the main on the assessment that the country has reached a situation where it is no longer capable of paying its debts, has been the focus of global economic-financial activity in recent months. In light of the modest economic-financial importance of this country, it is clear that it may not merit such attention. But Greece is rightly perceived as a kind of archetype of a far more prevalent phenomenon: of a country on the verge of insolvency, which is engaged in an all-out struggle for survival.

The Greek crisis erupted surprisingly at the end of November 2009. The new government in Athens, created following the victory of the Socialist party after preliminary elections in August, submitted its 2010 budget proposal to the parliament. Only then was the world shocked to learn about the country's anticipated budgetary deficit for 2009, which would reach a sum equaling about 12.5 percent of its gross domestic product - as compared to the initial assessment, based on the 2009 budget, of a deficit of only 4.5-5 percent of GDP.

According to the Maastricht rules, which apply to members of the European Monetary Union, or eurozone, and are based on the 1998 Stability and Growth Pact, European countries must ensure that their budget deficits are no greater than 3 percent of GDP. But as a result of the global crisis of 2008, almost all members of the eurozone, as well as most of the developed countries in the world, formulated budgets in which the deficit would exceed 3 percent, in some cases substantially. Such deviations were seen as temporary and essential, in light of the serious crisis.

The main cause of the Greek crisis was and still is the loss of confidence in the country, its government and entire system of governance on the part of its partners in the monetary union and in the European Union in general, as well as in the markets and the global financial system. The crisis in confidence erupted when it became clear that the previous government deliberately misled the EU and the markets regarding the anticipated deficit in 2009, made a false presentation and violated all its commitments to its partners. As far as Greece is concerned, this was not an unusual or one-time deviation. On the contrary: Its membership in the monetary union in 2001 was based on the distortion of budgetary statistics in order to meet the conditions of acceptance. While some details regarding this situation were discovered only recently, the deception was already known.

In addition to the specific problem of the huge 2009 budget deficit, Greece faced a catastrophic budgetary-financial situation, due to the accumulation of deficits dating not only from the time it joined the eurozone, but starting with its acceptance as an EU member in 1981. Greece's average annual deficit since then has been 7.7 percent of GDP - a frightening statistic by any measure. Such chronic deficits inevitably created a very large debt, to the tune of more than 100 percent of Greece's GDP.

We also have to take into account the fact that Greece suffers from a built-in economic weakness, and that the overall situation of its economy was not good even before it joined the euro bloc. In the past, economically week countries, such as Italy, Spain and others, could compensate themselves for the fact that their companies were less efficient than those of their counterparts in Germany and the northern European countries, by devaluing their currency every few years. But Greece's membership in the eurozone destroyed its independence vis-a-vis exchange rate and interest policies (since it no longer had a currency of its own ): The euro interest rates are decided by the European Central Bank, based on an overall perspective of the EU, of which Greece represents only 2-3 percent in GDP terms.

The premise was that, as a result of joining the eurozone, the weak EU countries would have to adopt a series of structural reforms in their economies, which would enable them to compete in the intra-bloc competition against Germany and its partners. The 2001 Lisbon Convention demanded as much of them, but Greece and the others were unable to carry out the reforms or meet their own commitments. As a result, their ability to compete was gradually but systematically eroded. For example, it was not worthwhile to manufacture products in Greece when the cost of a given product unit was far lower in Germany. Even though salaries there were higher, superior productivity easily compensated for that.

A decade after the establishment of the euro, economic deterioration had reached an advanced stage, Greece's situation was accordingly shaky and the gap between it and the northern European countries was steadily widening.

Finally, we must look at Greece's political agenda. The country's acceptance into the EU in 1981 stemmed from the political desire of countries like France to embrace it and to bring it into the union's democratic and liberal framework. Only in 1974 was Greece liberated from the military junta that took power in 1967, and its governing record was weak, if not pathetic. The hope was that bringing it into the club of developed countries would spur both its political and economic development.

But Greece has remained weak, in terms of mechanisms of governance. Payment of taxes, except on the part of salaried workers, is considered to be optional. Corruption, ranging from nepotism to bribery, is the norm in the country's inflated public sector, and permeates the entire economy. And paradoxically, this defective behavior is made possible thanks to generous assistance from the EU, via the many mechanisms and pipelines put in place to enable the strong countries to support the weak ones.

This economic and political background explains the intensity of the debate that took place within EU institutions during the entire first quarter of 2010, while the Greek crisis was steadily worsening. The Germans at first refused to proffer assistance, and said Greece should turn to the International Monetary Fund, like any other country in crisis. When the IMF conditioned its assistance on tough economic edicts against Greece, German Chancellor Angela Merkel and her advisers were pleased, and thought to let the Greeks stew in their own juice.

But French and EU officials in Brussels warned that a member country could not be abandoned, and that even if there was no predetermined means for bailing one out in such a situation, it should be invented now. In the end, as has been customary in the EU, a compromise was reached. On the one hand, a mechanism was set up for providing assistance, for the most part from the EU and its individual members. On the other hand, the IMF was brought in, as the body that will bear the financial burden, but will also be compensated by being allowed to condition its assistance on imposition of tough economic conditions. The fact that the IMF is serving as a supervisory body and will enforce the arrangement makes things much easier for the EU.

The conditions that indicate a crisis - in which a country is incapable of raising money in the markets and is forced to seek salvation from external bodies - are as follows: the accumulation of a very large debt relative to the size of the economy (GDP ); a history of careless fiscal administration over the long term - in other words, the creation of chronic government deficits; a weak or inferior economic situation, which prevents a country from competing in the global economy; political weakness; and the loss of confidence of the international financial system.

Of all these conditions, the last is the decisive one. Although loss of confidence is almost always related to a specific event, it is definitive in terms of investors, and thus ignites a crisis. Often there is a drawn-out process during which confidence gradually crumbles until something takes place - even a seemingly marginal event - that is the final straw.

The moment confidence is destroyed, a country is finished . In terms of Greece, we have to ask a question: Why are the other European countries making such an effort to rescue it? In light of the appalling data it presents, and its disgraceful conduct, what reason and what use is there for assistance programs?

One possible answer is that the countries are helping because of their commitment to the partnership anchored in the two unions: the EU and the European Monetary Union. But it is clear that the motives, even those of the countries most eager to provide assistance quickly, are based mainly on their own interests, as they see them. There is no question that all the European countries have weighty reasons for rescuing Greece.

The foremost objective, which is known and understandable to everyone, is to prevent Greece's problems from spreading to additional countries. The situation in Portugal, Spain, Italy and even Ireland - the group that, along with Greece, constitutes the PIIGS (Portugal, Italy, Ireland, Greece, Spain ) countries - ranges from serious to critical. Therefore, precisely because Greece is a small economy that can be rescued relatively cheaply, there is a concerted effort to do so. If additional countries suffer similar problems, the sums that they will need for an assistance or rescue program will be too great for even the entire EU collectively.

But there is another, lesser known interest involved here. Every debt crisis has two sides, that of the borrower and the lender. In this case, the borrower is Greece and its debts really are astronomical - at the beginning of this year, they were valued at more than 250 billion euros. In order to grasp the significance of this number, a few comparative statistics are in order.

In 1998 Russia became insolvent and caused a global financial crisis; its total debt then was 51 billion euros, only about 20 percent of the current debt in Greece. Three years later, a major crisis erupted in Argentina, which also became insolvent, due to a debt of 57 billion euros. The European country considered closest to Greece in economic terms is Portugal; its debt totals some 93 billion euros, in other words less than 40 percent of that of Greece. And in Ireland, which has already suffered a serious crisis because of the collapse of its banking system, the debt is "only" about 75 billion euros, 30 percent of Greece's.

In the face of these astonishing statistics, one asks oneself: Who are the idiots who loaned unheard-of sums to Greece? According to the data of the Swiss-based Bank for International Settlements, which oversees all the central banks in the world, the French banks have Greek assets (including government bonds, and loans to banks and companies ) totalling about 73 billion euros. Perhaps more surprising, and certainly more frightening, is the fact that Greek assets held by Swiss banks are estimated at 60 billion euros, while German banks are sitting on assets valued at about 39 billion euros.

What is hanging in the balance now is, therefore, not just the future of the unfortunate Greek citizenry, which will have to lower its standard of living painfully for quite a few years. If Greece becomes insolvent, it is liable to bring down many European banks, including large ones, and in any case will spur a serious global financial crisis, at least as bad as that of September 2008 - if not worse - which will this time be centered in Europe.

But Greece is not an isolated case. The list of developed countries with a debt-to-GDP ratio of 100 percent or more was short until the 2008 crisis, but the number is steadily increasing and is expected to continue to do so, in light of prevailing budget deficit trends. These are no longer the "usual suspects," like Italy, Greece and Belgium, but countries considered to be the pillars of the global economy, such as France, Great Britain and even the United States. If they do not effect programs designed to reduce the deficits by raising taxes, cutting back expenditures or - more logically - combining those two tracks, their debt-to-GDP ratio will reach 90 to 100 percent during this decade.

The developed country with the worst situation in this regard today is Japan. For 20 years, it has been mired in a grave economic-financial situation, characterized by deflation (a constantly declining price level due to the weakness of demand in the economy ), poor growth and accumulation of huge budget deficits. The debt-to-GDP ratio in Japan has reached the unheard-of level of 200 percent, and therefore we have to wonder: Why didn't it suffer a serious crisis long ago?

If we add to that the fact that the interest rate on government bonds in Japan is far lower than in other developed countries - the annual yield of 10-year government bonds in Japan is about 1.3 percent, as compared to 3.9 percent in the U.S., and 3.8 percent in Germany - then we really have to wonder what madman is willing to get such a low return against such a high risk.

But there isn't really any great mystery here. The person financing the Japanese government is Mrs. Watanabe - the Japanese equivalent of Mrs. Cohen from Hadera, the legendary housewife who represents the general public in Israel in every discussion of the capital market. Mrs. Watanabe and her counterparts in the Japanese public are very cautious. They save a great deal of money, put it in the safest place - the national postal bank - and invest it mainly in what they consider the safest way: in Japanese government bonds.

This situation is what has enabled Japanese governments, since the huge real estate and stock market bubble burst in 1990, to accumulate huge deficits, but also to pay amazingly low interest on their debts. If the citizens have behaved this way for so many years, although it sounds absurd to the rest of the world, why shouldn't that situation continue for another 10 or 20 years, or forever? But the Japanese population is aging rapidly, at rates unparalleled anywhere in the world. The legions of new pensioners are being forced to start using the savings they have accumulated. As a result, the national savings rate is steadily declining and is now approaching zero.

The first to suffer from this situation is the Japanese postal bank. And in fact, the investment manager of that bank recently said that his institution will not be able to increase its holdings in government bonds this year, because it has no new money to invest. That is the nature of demographic processes: They develop slowly, but in the end even the long term arrives, and with it the end of the game.

So what the Japanese government needs to do is undertake a drastic change in economic policy, which will in effect eliminate the ongoing deficit so there will no longer be a need for new loans. But in fact, exactly the opposite is taking place. Last summer, after 55 years of almost uninterrupted rule, the Liberal Democratic Party was defeated in elections, and the opposition parties formed the government. As in Greece, the campaign of the victorious parties was based on the desire "to benefit the people" - i.e., to increase public expenditure.

As opposed to Greece, the Japanese government is still trying to fulfill at least some of its promises. For instance, it presented a budget with a large deficit, which necessitates an additional, significant hike in the level of government debt. But as Mrs. Watanabe's money is gradually running out, a new source of capital is necessary. The most accessible one is the central bank, and the government is in fact strongly pressuring it to purchase increasingly large quantities of government debt- in other words, to finance it by printing money.

Anywhere else in the world, the result would be rampant inflation, but in Japan deflation is steadily increasing. Meanwhile, the country is continuing to maintain a foreign trade surplus and to accumulate more foreign currency reserves. Indeed, Japan is competing with China for the title of the largest investor in U.S. government bonds.

But at a certain point in the not-too-distant future the Japanese government will discover that it is unable to finance itself any longer from internal sources.



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