Greece Austerity Diet Risks 1930s-Style Depression: Euro Credit

Bloomberg

By John Glover and Radoslav Tomek - Oct 22, 2012 11:23 AM GMT+0300

Greece is spiraling into the kind of decline the U.S. and Germany endured during the Great Depression, showing the scale of the challenge involved in attempting to regain competitiveness through austerity.

The economy shrank 18.4 percent in the past four years and the International Monetary Fund forecasts it will contract another 4 percent in 2013 as Greece struggles to reduce debt in exchange for its $300 billion rescue programs. That’s the biggest cumulative loss of output of a developed-country economy in at least three decades, coming within spitting distance of the 27 percent drop in the U.S. economy between 1929 and 1933, according to the Bureau of Economic Analysis in Washington.

“Austerity has been destroying tax revenue and therefore thwarting the intended effect,” said Charles Dumas, chairman of Lombard Street Research, a London-based consulting firm. “There’s no avoiding austerity, though, because these people have no borrowing power. The deficits are there.”

Greece’s restructured bonds have benefitted amid speculation that creditors are poised to release more bailout funds. Greek bonds maturing in 2023, which yielded more than 30 percent at the end of May, now yield about 16.4 percent. The next block of aid is slated to total 31 billion euros ($40.5 billion), mostly to recapitalize the nation’s banks.

1930s Experience

Wage and pension cuts have heightened tensions in Athens and other Greek cities as the economy shrivels and an anti- foreigner party flaunting a swastika-like insignia won 18 seats in Parliament. Polls suggest Golden Dawn is the third-most popular party in Greece, backed by about 14 percent of the electorate. That pits it against Marxist-inspired Syriza, the main opposition grouping, in a standoff recalling that between Nazis and Communists in Weimar Germany.

“The experience of the 1930s says you need to stimulate the economy,” said Vassilis Monastiriotis, a senior lecturer in political economy at the London School of Economics. “The rise of the far-right in Greece isn’t something ephemeral that will go away when the crisis ends. And it’s very dangerous if the rise of the right causes relations with neighbors like Turkey, Macedonia, say, to deteriorate.”

The German economy contracted by about 34 percent in the years after 1929 and resulted in Adolf Hitler becoming Chancellor in 1933, according to data from the Federal Statistical Office in Wiesbaden. Even after growth resumed in Germany beginning in 1934, it took until 1937 for output to exceed the level enjoyed in 1929, the data show.

Yield Moves

In Spain, where unemployment is running at 25 percent, Catalonia is demanding independence, while in Italy anti-euro populists led by former comedian Beppe Grillo may garner 18 percent of the vote in elections due by May, polls suggest.

Yields on Italy’s 10-year securities were little changed at 4.77 percent today, after dropping 32 basis points this month. Spanish 10-year note yields rose 2 basis points to 5.39 percent after falling 26 basis points last week. Moody’s Investors Service affirmed the nation’s Baa3 rating after previously signaling the grade would probably fall to junk.

The IMF’s prediction for a 4 percent contraction next year suggests Greece may surpass Latvia as the nation suffering the deepest recession in the European Union. The Baltic country’s output started to shrink in 2008, erasing 20.7 percent of the economy in three years. The country, which has a 7.5 billion- euro lifeline from the IMF and the EU, has now resumed growth.

Broken Banks

“Getting the banks lending again is the key thing,” said Gabriel Sterne, an economist at brokerage Exotix Ltd. in London. “Right now, the Greeks don’t have a banking system like anyone else understands it. Greek banks hardly do any new lending.”

Growing evidence that cutting for growth isn’t working as intended, combined with the ability of large economies such as Spain and Italy to resist pressure to deflate, is forcing European leaders to scale back demands for increased austerity.

“The German stance has softened,” said Holger Schmieding, chief economist at Berenberg Bank in London. “The German stance is now that fiscal shortfalls caused by an unexpectedly deep recession are largely acceptable if countries stay on the right reform track.”

French President Francois Hollande said Oct. 19 he’s open to loosening budget-deficit rules, explaining that “EU rules do say we must think in terms of structural deficit.”

Domino Effect

The IMF also has reviewed its assumptions, saying that the knock-on effects of cuts to government spending, called fiscal multipliers, may be more than three times greater than previously estimated. That means that a given spending reduction risks erasing a larger amount of output, causing revenue to fall and deficits to increase.

Greece joined the euro in 2001, when gross domestic product at constant prices was about 165 billion euros, according to the IMF. The nation could borrow for 10 years at an average yield of about 5 percent. GDP peaked at 209.7 billion euros in 2007. It will slump this year to 171.2 billion euros, about the same level achieved in 2002, the IMF estimates. Public debt will climb to 182 percent in 2013 from 171 percent this year, the IMF said.

The IMF forecasts that government expenditure this year will fall to levels last seen in 2006, while unemployment will reach almost 24 percent of the labor force, more than double the pre-crisis average, and the government’s debt will be 344 billion euros, higher than in 2010 and about double the level Greece claimed in 2003.

The government has agreed on another 13.5 billion euros of budget measures for 2013 and 2014 after pushing through 3.1 billion euros of additional cuts in February to persuade creditors to release a 130 billion-euro second bailout package. The government also implemented a reduced pay scale for civil servants, lowered pensions paid by the state and hacked 576 million euros from its medicines bill. It is now expected to follow those cuts with measures including raising the retirement age to 67 from 65.

“Greece has done all that without achieving anything,” said Barbara Ridpath, chief executive of the International Centre for Financial Regulation in London, who headed Standard & Poor’s ratings activities in Europe until 2008. “That’s the sad thing.”

To contact the reporters on this story: John Glover in London at johnglover@bloomberg.net; Radoslav Tomek in Bratislava at rtomek@bloomberg.net

To contact the editor responsible for this story: Mark Gilbert at magilbert@bloomberg.net