The Greeks' Austerity Problem

The Greek GDP is the lowest it's seen in decades and the solutions that sound so simple for recovery may be easier said than done.

As the Eurozone discusses possible outcomes, Greece is still on the fence about dropping out of the safety net that is the European Union. With the chance for the drachma to be reintroduced, the chances of inflation are astronomical -- but it might be Greece's only hope.

A full transcript follows the video.

Gaby Lapera: It's all Greek to me. This is Industry Focus.

Hello, everyone! My name is Gaby Lapera and I'm the new host of the financials edition. Joining us this week are John Maxfield on the phone, and Kristine Harjes, the new host of the Industry Focus podcast on healthcare. We've got a great show lined up this week on the Greek debt crisis and austerity measures.

For a little bit of background, I know we've talked about Greece and its financial woes on the program before, but can we get a little bit of an idea of exactly how dyer the current economic situation is, Maxfield?

John Maxfield: Absolutely. If you look at where Greece is today, it's basically where the United States was during the great depression, if not a little bit worse. There's two figures to throw out there. First, between 2009 when Greece's GDP maxed out and today, according to Trading Economics, it's fallen by 42%.

During the great depression, the United States fell a maximum of 30%. Looking at GDP alone it's roughly 50% worse than the great depression. Then the second piece is unemployment. Unemployment in Greece right now is 25%, and that was the peak in the great depression in the United States.

Gaby Lapera: What does unemployment look like right now in the United States? Just for reference.

Maxfield: Right now the Federal Reserve says a rate between 5% and 5.2% is the target rate you want the United States economy to be at. We're just above that right now at 5.3%.

Lapera: Good for us! The GDP seems to be a really important metric, or component to thinking about this. What about debt? That's what everyone is talking about when it comes to Greece.

Harjes: One of the really important things to look at when you're thinking about debt is the ratio of the deficit to the GDP. Looking at Greece right now, they've got this huge figure around 175%. When you look at that it's not sustainable at ll. I think it's the second worse debt to GDP ratio in the world, right after Japan.

When you look at that, the question is raised: is the situation so dyer because of the debt, or is it really the other side of the ratio? Is it the GDP?

Maxfield: That's exactly the point. If Greece's GDP had stayed the same as it was in 2009, and you consider how far its debt level has fallen since then, its debt to GDP ratio would only be 100%. That may sound like a lot, but in the whole scheme of things it's actually pretty small. It's almost the lowest level that Greece's debt to GDP has been in roughly a decade.

Lapera: The GDP to debt ratio for other countries -- for Germany, or someone like that -- is it higher, or lower than Greece's is right now?

Maxfield: I actually don't know what Germany's debt to GDP ratio is right now. Traditionally, Japan is a good example because it has a very robust financial market for its debt securities. That's really the big issue. Will you be able to sustain those debt levels? Investors will continue to buy your government bonds. Japan is well above 200% in its debt to GDP ratio.

If you're looking exclusively at that -- and there's a lot of other pieces to this puzzle -- but if you look only at that, certainly at 100% if its GDP has stayed the same, Greece's its debt to GDP ratio is very reasonable.

Lapera: Are there any options for the Greek government to address the situation? I know we talked earlier about monetary and fiscal policies. Is there a difference between those two?

Harjes: This is something that's fundamental to understand when you're talking about the levers that one can pull when you're trying to address an economy that's in crisis. On one hand you've got your fiscal policy. That's your government spending. On the other hand of that you have monetary policies. These are two very separate things.

Monetary policy has to do with the control of the supply of money in a nation, the management of interest rates and it's traditionally carried out by a central bank. The problem is, if we're talking about the U.S. there are plenty of levers that our central bank can pull.

The thing is, when you look over at Greece, they don't have those options available to them because they're part of this larger economic and political union where the European Central Bank are the ones that would be pulling these levers, and they're not making decisions based solely on Greece. They have the entire union to look at.

Lapera: What about fiscal policy?

Maxfield: When you're talking about austerity, what is austerity? Austerity is where you decrease the amount of public spending a particular government is spending. You want to decrease government expenditures. That's what austerity is.

What we have seen over the past 100 years, at least in the United States, is when you do that in the midst of an economic downturn it will aggravate the situation. We saw that in 1937 in the second piece of the great recession when we started scaling back government expenditures after the new deal. That kicked us into another deep economic downturn.

The difference between how the United States dealt with the most recent crisis, relative to how Europe has dealt with the crisis, in 2009 we came in with an $800 billion stimulus package. Even though a lot of economists didn't think that was enough, the central bank supplemented that with a number of non-traditional monetary policy tools known as "quantitative easing".

Since we did that we were able to reverse what was happening with our unemployment rate and bring it back down to 5.3%. Now that those expenditures have gone in the opposite direction for Europe, a lot of mainstream economists -- or the consensus view is -- that decrease in public expenditures is what caused unemployment to go to the rate that it has, and it aggravated that decline in GDP.

Harjes: One of the interesting things that you're bringing up with this issue is, there's been a resurgence of belief in the Keynesian Economics. This is the scope of economics where the theory says that the government can actually stimulate and economy by spending, particularly when the economy is going through a rough patch.

This theory had lost popularity around the '70s, but we're now seeing more of a resurgence of it, particularly after the great recession. Now looking at Greece there are quite a few people that are pointing to Keynesian's Theories again and questioning whether or not that could come into play here.

Maxfield: What's interesting about Keynesianism is, we talk about investing a lot, and you can make a really close analogy between what Keynesianism tells us about how to manage a government economy, and how to successfully invest. We know that in investing the way you'll have the most success watching people like Warren Buffett and the like is to act counter cyclically. When stocks and other securities are low, that's when you buy. When they're high you sell.

It's kind of the same idea in terms of government finances. When the economy is going really well, that's when you want your government to save and build up a surplus. When the economy is doing poorly you want it to come in and backfill that drop in consumer demand to stop the economy from spiraling downward out of control.

Harjes: Of course, when you look at GDP those are some of the components that you just mentioned. GDP is composed of consumer spending, government spending, investment spending -- what the businesses of the country are spending on capital, not investment in the way that we think of it at The Motley Fool -- and then there's also an element there of the nation's total net exports.

To your point about consumer spending being lower, the theory here is that's only one component of this GDP equation. If you can boost the government spending part of that then you could boost GDP, theoretically.

Maxfield: That is exactly right. I'm glad you broke it down like that because the other component of GDP is the difference between your net imports and your net exports. What that tells us is, in a situation where your exports have the flexibility to increase by a large amount, they can actually help offset some of that decline in consumer demand.

Then the question is: how do you boost exports in a situation like this? Traditionally, if Greece was still on the drachma and Germany was still on the mark, what would happen is, with Germany's strong economy and Greece's weak economy the drachma would fall in value relative to the mark. That would make things like olives, olive oil, and ships built in Greece cheaper to export or purchase from other countries, which would then come back in and help that GDP figure.

But because all the European countries are locked into a monetary union, for better or worse -- and I have a tendency to believe it's for the best when you look at things geopolitically -- because they're locked in at those exchange rates that mechanism to adjust is not available anymore for Greece.

Lapera: A few weeks ago there was a confrontation between the Eurozone leaders in Greece and Greece threatened to leave the Eurozone and go back to the drachma. Would that have worked out great for them based on what we're talking about?

Maxfield: You have to look at that in both the short term, and long term implications of that decision. As a general rule, if Greece were to leave the European Union -- the way that union was structured, much like the United States when we put our together -- there isn't an exit strategy. They didn't anticipate that. They probably didn't anticipate it on purpose. They probably didn't want it to seem like you could just break apart this great union easily.

Short term, the drachma would probably devalue very quickly, which would cause substantial inflation. That seems to be the most likely outcome, but that would then boost its exports over a slightly longer term. That would give it the chance for its economy to improve over a decade or two.

The other thing to keep in mind over the long term is, you have three really large currencies in the world right now between the euro, the Chinese currency, and the U.S. dollar. A small currency like the drachma would be like sailing a tiny raft in a huge storm on the sea. You'd be thrown around all over the place. It would be a very difficult environment in which to operate for Greece.

Harjes: That's a really awesome visual.

Lapera: It is.

Maxfield: We've seen this with the south and Central American countries over the past couple of decades. They're small economies, so they'll try to figure out ways to reduce these large increases, or decreases in capital flight from their countries because of these changes in currencies. It's proved to be a nut that they haven't been able to crack yet.

Lapera: It sounds like Greece still has a rocky road ahead, along with the rest of the Eurozone as they try and figure out what exactly they're going to do. It seems austerity measures might not be the answer since they've tried that for a while and it doesn't seem to be working. Are there any last thoughts that either of you want to add?

Maxfield: My last thought is, it's not that we can say definitively one way or another whether austerity will push an economy, or make it as bad as it is in Greece; but we can certainly say that these extreme austerity measures have done nothing to push Greece out of its crisis.

Harjes: I think that speaks on a broader note. We've talked a lot about economic theories on this episode. I want throw out there that all these theories are based on these assumptions about people being rational and all the components of our economy working together in this very sensical sort of way.

We don't have the art of economics down yet. It is an art. It's not quite a science. There is that scientific element to it, but it's really much more of a fluid study. So we can't predict what's going to happen next. We don't have perfect theories yet. When we're looking at an issue like this, anyone that comes in and says "Keynesian economics can save us," or "austerity measures are going to save us". It's probably not going to be any one thing that does.

I think it will be really interesting to watch this going forward and see what school of thought ends up being the most prominent and potentially solving this issue.

Lapera: That was extremely well-said. I would like to end on a good note, just like that. That being said, as always people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against. So, don't buy or sell stocks based solely on what you hear. Thank you very much for joining us on this week of Industry Focus financials edition. We're going to miss you very much, Kristine.

Maxfield: I will second that. I'm very excited to work with Gaby, but Kristine; it's really been a pleasure working with you.

Harjes: Thanks. You as well, John. I definitely hope to be back as a guest contributor for plenty of future episodes.

Lapera: Excellent.