Greek debt will be paid, but by whom?

The eurozone has been grappling with Greece's financial trouble for more than a year. But after billions worth of loans, recovery prospects are grimmer than ever.

Greece, the poster child of the European malaise, is sinking in a sea of debt and suffering from a grave crisis of governance. So far, the country is presented with two options — a default on debt obligations, or a European bailout. But both scenarios come with heavy baggage.

The government of Prime Minister George Papandreou survived a crucial confidence vote that will keep it alive and buy it time until the next austerity bill, set to be tabled by the end of the month. But the thousands who protested the decision on the streets of Athens will likely riot again when any new cuts come.

"The political system is rotting … The country is not being governed the way it should be," said Socialist deputy Nikos Salagianis. "A reshuffle will not resolve the country's problems."

'A lesson might be learned about spending beyond your means' —Money manager Leon LaBrecque

Last week, German Chancellor Angela Merkel and French President Nicolas Sarkozy expressed continued support for Athens and called on the European private sector to contribute to the rescue plan — but did not offer any details on how that will be done.

Questioning that ambiguity leads to the crux of Greece's trouble: the country is billions of dollars in debt. Regardless of whether the government decides to default or not, that money will have to be paid, or lost, by somebody. Austerity measures will be implemented all the same.

"There are no easy answers to this mess — but, again, ultimately some will bear the brunt more than others," U of T political science professor Phil Triadafilopoulos said. "The interesting political question is who it will be."

"The Greek people as principal bearers of the pain of austerity? Europeans, whose taxes provide the money used for bailouts? Or the bondholders and European banks that stand to lose if Greece does indeed default?"

The Default Dilemma

Greece has been struggling live up to the terms of austerity measures demanded by its European and IMF creditors who agreed to a 110 billion euro ($153-billion) bailout package in May 2010.

Public criticism of the austerity measures reached a boiling point this month, when Papandreou tried to pass through parliament a new program of tax hikes, spending cuts and selloffs of state property. This triggered a rebellion within his own party and angered labour unions and public workers, who took to the streets in violent riots.

In addition to his own party and rioters in the streets, Papandreou also has to hearten worried creditors. Default means any pension fund or bank that lent money to Greece or its private banks will suffer huge losses. The European Central Bank alone owns 49 billion euros worth of Greek bonds. That could be enough to spread the contagion to the rest of Europe, setting off a financial chain reaction that experts say would be catastrophic.

"Some suggest that a default would have global effects," Triadafilopoulos said.

Fears that a messy Greek default may be in the offing has sent the euro down nearly four cents last week below $1.41 and triggered widespread selling in stock markets.

When it was bad, it was horrid

In the early 2000s, eurozone economy was in its heyday, which led to some lax due diligence in terms of admitting new member states. Italy, Portugal and Greece were somehow allowed to join despite not fulfilling the requirment of having no more than a three per cent budget deficit as a share of the GDP.

It worked fine, for a while. Between 2001 and 2007, Greece's economy grew at a 3.75 per cent annual pace. The government, feeling overconfident, borrowed billions of dollars from the ECB.

Then the devastating recession hit in 2008. When growth slowed, Greece's budget deficit rose to more than 13 per cent of its GDP in 2009. Its total debt load now sits at 144 per cent of its total economic output, the EU's statistics office Eurostat estimates.

Essentially, EU membership gave Greece a credit card with a limit that was too high. After the economic crisis hit it could not pay back the debt, which has been piling ever since.

"The Greeks will suffer," said Leon LaBrecque, managing partner and founder of LJPR, who manages over $350 million in assets. "[M]aybe a lesson might be learned about spending beyond your means."

Greeks are now looking for solidarity from other EU members, but bailout policies are becoming an increasingly tough sell in Europe, especially in countries that are doing well, like Germany.

Chancellor Merkel has suffered political setbacks for her sustained support of the bailout policies. Her logic rests on the assumption that defaulting could be much worse, and even more expensive than a bailout. A full-scale restructuring of Greek debt would have "completely uncontrollable"consequences on the financial markets, Merkel said Tuesday.

Domestic woes

The Greek people are angry and humiliated. Protesters are frustrated with both their own politicians and eurozone commissioners. Trust in the government is waning.

Last year, Papandreou promised Greeks that short-term pain to get the country back on its feet. But after 12 months of talking with little action, Greece's debt load has increased.  Now, the people are not convinced the government knows what to do if this latest austerity campaign doesn't work.

Protesters feel that the working population should not bear the brunt of crises brought on largely by the mistakes of bankers and investors. They are resentful of bailout conditions, and they are not alone.

Many Irish also believe they have been treated unfairly by the ECB. The Irish government did the continent a favour by stepping in to bail out their own banks and saving foreign investors from suffering losses.

A recent Irish budget, labeled as the "toughest budget in many years," made significant cuts on health services and employment benefits in order to prop up Irish banks. The costs of the bank rescues pushed Ireland's government deficit to over $66.4 billion — almost a third the country's GDP.

In both cases, the people resented what they perceived to be an outside influence in their affairs. In both cases, the EU sent foreign commissioners and analysts to manage their country's finances and implement changes.

People may protest all they want but it's clear that even if Greece drops out of the EU and devastates eurozone unity, it will still have to implement the same painful austerity measures.

There is no way out of paying the debt — Greece can either submit to EU rules, or abandon ship and go through the same painful measures alone.

Looking ahead

Simply put, somebody has to cover the debt costs, but nobody wants to. What to do?

Some say the first step is to appeal to the Greek public, who will have the final say one way or another. Austerity meaures should be carefully researched and implemented, in order to convince the people that they are necessary for a brighter future, and not just a means to satisfy external creditors. 

Some say a new kind of austerity might work better. Argentina's former Minister of Economy Dr. Domingo Cavallo and former Undersecretary of Economic Policy Dr. Joaqu'n Cottani have called for growth-focused deficit reduction, which entails the elimination of Greece's huge employer contributions to payroll taxes, thus reducing wage costs and enhancing competitiveness.

The sweeping, non-targeted nature of austerity measures so far could be to blame.

"Greek politicians are doing horizontal measures," Dr. Gregory T. Papanikos, President at Athens Institute for Education and Research in Athens, told Voice of Russia. " [they] say: we cut all wages 20 per cent."

But there are wages that should be cut, and there are some wages that should be increased, he said. "You do it differently … you do it structurally," he said.

Restructuring wages in favour of the private sector, where salaries are lower than those of than public employees, would be a good start, Papanikos said.

Evangelos Venizelos, former defence minister and newly appointed minister of finance, sounded confident and optimistic on Friday. "The country must be saved and it will be saved," he said. "I am leaving defence today to go to the real war."

That war will be over the minds and hearts of the Greeks. If the domestic turmoil of the last two weeks offers any lesson, it is that the wild card in any new attempt to resolve the crisis is the people. As Harvard professor of international political economy Dani Rodrik put it, "when globalization collides with domestic politics, the smart money bets on the home team."