By Professor Dipak Basu, Professor in International Economics, Nagasaki University, Nagasaki, Japan

Thousands of demonstrators who are gathering in front of the famous Wall Street, the financial centre of the USA and the world in New York are demanding a serious change in the world financial system that does not care about the people but only about the profit of the investment banks. Initially it was the debt problem of some smaller European countries like Greece, Italy, Ireland, Spain, Portugal, Iceland and the Baltic States. Now it has spread to the banking system of both USA and UK creating panic in the world economy.

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Greek crisis, resulting into Greece’s submission to the IMF and the forthcoming social unrest is related to the Global crisis of finance both in Europe and in USA. The result can very well be a global recession, from which the merging countries like India cannot escape. Globalization has massively increased the vulnerability of the world’s financial and economic system. Every day trillions of dollars is transacted at the speed of light, much of it unregulated. The derivative products or gambling of various kinds on every financial future market have accrued to the level of hundreds of trillions of dollars, unmonitored by any governmental authority. In essence, a vast global financial superstructure has been erected on a fragile foundation by arranging massive loans by some investment banks to countries who cannot afford to pay back. This is just as worst as the sub-prime securities or loans to poor American to buy houses knowing their inability to repay but then selling these loans as assets to the rest of the world.

The situation has already created a fear psychosis all over the world of an impending recession of the world economy. European governments decided to fund a bailout largely out of fear that a Greek default might lead to a new financial crisis and the bankruptcy of other countries, such as Ireland, Portugal and Spain. Credit rating agencies recently downgraded both countries' debt. If Greece will collapse, others will follow.

Greek Debts:

Greek government of Prime Minister Giorgios Papandreou announced massive social cuts worked out in negotiations with European and International Monetary Fund (IMF) officials to pay off the Greek debt to its international creditors. In exchange for these austerity measures, the European financial ministers decided earlier to implement a €110 billion bailout package for Greece so that Greece will not default, which would ruin the European monetary system and its currency Euro. It's more than likely that austerity package will be rejected by the Greek people who would prefer to default on the debt. If Greece can get away with a default, that will make the prospect of default for Ireland, Portugal and even Spain a much more realistic possibility. Greece has a national debt of 330 billion Euro out of that about half are due to international banks mainly American, other half are from German and French banks. French banks hold $75.4 billion worth of Greek debt, followed by Swiss institutions, at $64 billion, according to the Bank for International Settlements. German banks’ exposure stands at $43.2 billion. That gives the Greek debt crisis an international dimension with worldwide impacts. One possible way out for Greece is to default on its debts and quit the European Monetary system. This would allow Greece to devalue, to improve its balance of payments with cheaper exports. However, in that case Greece will be unable to borrow in future from the European Central Bank and people will get rid of their own currency to have more Euro to survive the uncertainly. That will exhaust its foreign exchange reserve. A default would hurt French and German banks in particular. They were some of the biggest lenders, holding more than two-thirds of the Greek government bonds in international lenders' hands at the end of last year.

How Greece fell into the Debt Trap:

Greeks are some of the world's richest people. The National Bank of Greece, Eurobank, Alphabank and Piraeus bank, have 164 billion Euros in deposits alone. The estimated loans taken from the foreigners are about 216 Billion Euros. Greece has extremely low household debt / GDP ratio; low corporate debt/ GDP ratio; low bank debt/ GDP ratio; a manageable total debt / GDP ratio, but a very poor Government debt / GDP ratio, above 100% of GDP.

In 1980, when Greece has joined the European Union, Government Debt/GDP ratio was 30% and it would have been much lower were it not for the high costs of defense. When Greece joined the EU in 1980, it became a party time. A small oligarchy then was the only source of capital and had the acumen, education and experience to deploy it as the country developed. Old families controlled the steel, cement, foodstuffs and construction companies that rebuilt Greece after the war.

Money that was sent from the European Commission to build the Greek infrastructure, about 6% of Greek GDP for the last 30 years, was funneled directly into the pockets of the oligarchy due to high level of corruption in Greece. Most part of that money could be used in socially desirable projects, but instead the bulk ended up in the pockets of the twenty families who run Greek business and own all the banks. Low rate of interest from the European banks, have allowed the Government of Greece to be borrow more and more but the people on the street never saw the benefit of the 300 billion the government has borrowed. Even then, Greece should not have any difficulty given the deposits and assets of the Greek banks.

Greece then fell into the trap of debt due mainly to a financial derivative called Credit-Default Swap. The contract, known as credit-default swaps, means if a company or, in this case Greece, an entire country, fails to pay its debts, Banks and financial institutions who own these swaps stand to profit. It’s like buying fire insurance on your neighbour’s house — you will be motivated to burn down the house of your neighbour so that you can receive a huge insurance payment subsequently. Similar conditions were created for Greece by a number of Banks, some of which are Greek. Greece was encouraged to borrow heavily by these banks to finance its budget deficit. At the same time, Goldman Sachs, JP Morgan Chase and about a dozen other banks had created an index that enabled market players to bet on whether Greece and other European nations would go bust.

As banks and others rush into these swaps, the cost of insuring Greece’s debt rises. Alarmed by that signal, bond investors then started rejecting Greek bonds, making it harder for the Greece to borrow. That, in turn, adds to the anxiety that Greece cannot repay its existing debts by borrowing more. Anxiety now covers other troubled economies like Ireland, the Baltic States of the former Soviet Union, Portugal and Spain.

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