Title: Lessons from the Greek crisis

Sub-title: Experts argue about the effects of the Greek crisis on Canada. But there are lessons to be learned.

 

Greece efforts to unwind from mounting public debt, which have sparked rioting and several deaths, are all over the news these days. Experienced observers, ranging from Bank of Canada governor Mark Carney to White House economic advisor Paul Volker, have expressed fears that the crisis could slow a global economic recovery and may even lead to a breakup of the Euro Zone.

 

Yet many Canadians remain perplexed about the Greek situation. They wonder how the troubles of a faraway country with such a small economy, with whom Canada trades little, could affect us. Avery Shenfeld, an economist at CIBC World Markets expressed those doubts in a recent note to the bank’s clients. “A recession in tiny Greece (joining Ireland and Spain where budget cuts are also prolonging recessions) can hardly be a similar spark for a global recession,” asks Shenfeld, rhetorically. “Or can it?”

 

The contagion affect

As Shenfeld points out, troubles in small, faraway places can easily have global implications. Shenfeld cites the plunge in the Thai bhat in 1998, which sparked a capital flight from emerging Asian economies, and then “hit global growth enough to see a downswing in resource prices (oil hit $11 a barrel) that affected Canada’s performance.”

 

This spread of small, localized problems into a wider arena is known as the “contagion effect,” and it has a lot of experts worried. The global economy is vulnerable right now. Rich western counties (including Japan) are struggling with mounting debt, ageing populations and spiraling health care and pension costs. As a result, they are less able to react than they might otherwise have been.

 

In recent weeks key European Union countries, backed by the International Monetary Fund set aside a trillion dollars to stabilize the financial system. The worry is that a Greek debt default spreads to other weak economies in the zone. Portugal, Ireland, Greece and Spain, (collectively referred to by the unflattering acronym “PIGS”) are particularly vulnerable.

 

In return for the financial assistance, Greece’s lenders have asked the country to undergo a series of tough austerity measures. These include an across the board 20 percent cut in public sector salaries, a 10 percent cut in pensions and a large hike in its sales tax.

 

However many observers don’t think that this will be enough. Sherry Cooper, an economist with BMO Capital Markets notes that the fact that Greece does not have its own currency, means that it cannot simply inflate its way out of its debt troubles. As a result, the Greek government’s belt tightening will likely “trigger a deflationary spiral that, in itself, will widen the deficit,” which will “inevitably require default, and/or major (debt) restructuring.”

 

How does this effect Canada?

The Greek crisis presents Canada with variety of challenges and opportunities. The most obvious one right now is the 15 percent plunge in the euro’s value relative to the loonie since the start of the year, which considerably hampers the competitiveness of exporters in European markets, at time when many are already reeling from similar challenges in US markets.

 

Others have noted that Greece’s troubles actually benefit us in some ways. For example the stronger currency cuts the costs for Canadians who want to buy European stocks or real estate, and drives down travel costs for visitors there. The falling euro, also indirectly helped keep home ownership costs down. That’s because the fact that many investors are switching their assets back to perceived security offered by the loonie and greenback, pushes down bond yields, which in turn forces down mortgage lending rates.  

 

That said, Canada’s biggest opportunity to profit from the Greek crisis may be to simply learn from it. A fire in your neighbor’s house may indirectly you.  But the paid will be mitigated if it incites you to go out and buy a fire extinguisher.

 

For example one of the things that got Greece into big trouble was when it hired Goldman Sachs, to use sophisticated investment techniques, to hide the severity of its problems from financial markets by understating its debts.

 

Now would be a good time to look into whether a similar situation could occur in Canada.  The Auditor General, which reports to Parliament on financial matters, in theory has the powers and the resources to detect malfeasance of this sort. Whether this is also true in practice remains an open question.

 

The other key lesson to learn from the Greek crisis is what happens when governments live beyond their means. Greece’s baby boomers, like those many western countries, awarded themselves lucrative and cushy public sector jobs, huge pensions and other retirement benefits, without setting aside the funds to pay for them.

 

Now the chickens are coming home to roost.

 

Peter Diekmeyer (peter@peterdiekmeyer.com) is a Montreal-based freelance business writer.

 

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