What the Heck is up with Greece and Why Should I Care?

What's up with Greece? It's in the news a lot these days and keeps getting blamed for every dip in the Dow or drop in the Euro.  Why is Greece such a big deal?

The easy answer is Greece really isn't that important. It has a population of just over 11 million which is a bit smaller than Pennsylvania.  It has GDP of 242 billion making it a little smaller than Louisiana.  Greece's biggest exports are refined petroleum, aluminum, electronic equipment, pharmaceutical products, plastics, vegetables, fruits, iron and steel products.  None of this makes Greece indispensable to the world economy.

The real answer is harder and will require you to learn a little about history and a little about how currencies work.

First let's look at a map of Europe pre 1999.  It was filled with different currencies including the Franc, the Peso, the Deutschmark, and of course, the Greek Drachma. Back then Greece was one of the poorer Euro countries and had one of the weakest currencies in the region.

So currencies act a bit like a governor on a motor, they can slow down or speed up of the economic engine.  Take Greece--if the Greeks spend too much money or print too much money, markets would make the Drachma worth less, so to Greeks foreign goods become more expensive.  This would naturally cause the Greeks to spend less on imports because they became more expensive, and in turn encouraged Greeks to spend more money at home which created more domestic demand. 

Now if you were, say, a German, your Deutschmark could buy more stuff made by the Greeks.  To a German it was cheaper to buy Greek goods, so they would.  This would lead to still higher demand.  This flexibility would cause the Greek economy to grow and currencies would then readjust to fit the new situation.

But fast forward to 1999, when the Euro is issued as a single continental currency.  At first this is great for the Greeks. It artificially gave their 'currency' more buying power.  Suddenly those BMWs and Mercedes the Germans made were a little cheaper.  So instead of spending money at home, the Greeks sent all their Euros to Germany in exchange for shiny new cars and maybe some beer.

It worked well for the Germans too.  By making their currency artificially cheap they sold more stuff to the rest of Europe.   The German economy picked up steam and German citizens enjoyed low unemployment and rising incomes.

But the global credit crunch that began in 2007 exposed chinks in the European currency armor. Because Europe used a single currency, bond investors had considered all bond issuers to be equal. The credit crunch made them reassess this assumption.  Well, guess what, the credit quality of Greece wasn't as strong as the credit quality of Germany.  Now what? You can't devalue just the Euros in Greece- so how do you rebalance the system?

That is the problem with Greece. The single currency nullifies the usual check and balances of free markets.  That is why it is such a big deal. Because no one knows the answer.

The European Central Bank has made Greece swallow a crapburger of austerity measures meant to keep Greece from spending, just like a currency devaluation would. However, this does nothing to encourage domestic growth or to stimulate exports.  The effect is just more pain for the Greek people.  With no other answers, the European Central Bank calls for ever more austerity--that won't work.

From a Greek perspective leaving the EU, while bad, is no worse than more austerity.  If they leave, the Drachma is reborn, and foreign goods are immediately more expensive and domestic goods are more attractive.  Market forces take over and eventually things get better for the Greeks.  Problem solved.  Or is it?

If Greece leaves the Euro, that opens the door for others in a similar situation to follow suit.  Portugal, Spain, and Italy are all caught in the same sink hole.  Will they leave too? Can they afford to stay?  If they leave, how long can the Euro last?  This could be a huge drag on all the European economies as trade dries up and recessions follow.  Even Germany, who has been the primary beneficiary of all this currency wrangling will see its economy shrink as their products quickly become too expensive for others in the region.

Politics comes into play too. Greece is already being courted by Russia.  Russia has oil production capability while Greece has refining capacity. Putin would love to spread his influence.   Can Europe and NATO not be concerned about spreading Russian influence?

The only real answer I can see is that Greece defaults in some shape or form. Either they exit the Euro and pay back creditors in devalued currency, while opening the door for future defections, or they stay in the Euro and the other countries bail them out, opening the door for future bailouts of other weak members. Either way, it is not good for Europe or European trading partners.

And this is what the heck is going on with Greece and why it matters.