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How could Greece borrow so much?

June 7, 2012

A single currency (like Euro) should have kept Greek sovereign debt in check. 

Without ability to print money, the government’s debt is no longer risk-free. This ensures (should ensure) that markets lend less money to Greece at high interest rates.

How did Greece manage to borrow so much?

India’s state of Bengal is in poor financial shape.

Depsite India’s fiscal union, Bengal’s inability to print money and lack of a central guarantee limits its debt (its Debt to State GDP is only ~ 50% and still it cannot borrow anymore).

Greece, despite poor credit worthiness, could borrow so much (Debt to GDP close to 200%) at low interest rates for 2 reasons:

  • Greek central bank regulations required Greek banks to load up on sovereign debt even though it was not safe
  • Eurozone politicians kept lying to the markets that no Euro country can/will default.

As a result, immediately after Euro introduction, the significant spreads between Greek & German sovereign debt simply vanished due to this ‘guarantee’.

Greece is now crashing since Germany has rightly shown reluctance to honor this guarantee. Honoring this guarantee requires massive money printing (inflation) effectively redistributing wealth from savers (Germany) to borrowers (countries like PIIGS). Germany may choose to do so (effectively become one nation) but there is no compulsion and it will only avoid explicit default. It will NOT make Greece productive.

See why Greece should default and remain within the Euro.

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