Peer reviewed analysis from world leading experts

The Greek tragedy: Global debt crisis and balance sheets

Reading Time: 5 mins

In Brief

If a pack of wolves stalk a herd of buffalo, the herd can guard the weaker buffaloes. But if the wolves stampede the herd, they are able to take down the weakest buffaloes.

Financial crises behave similarly. The market speculators are like wolves that attack the weakest or most vulnerable economy. During the Asian crisis, the markets attacked Thailand first, because it had the highest external debt. This time, the markets attacked Greece, the most vulnerable economy in the EU. Greece may be the 27th largest economy in the world, but with a GDP of US$352 billion, it is only 3.1 per cent of the size of the EU.


  • A
  • A
  • A


  • A
  • A
  • A

In 2009, the IMF noted Greece’s challenges of high fiscal and external imbalances and weakened competitiveness. The problem of Greece was clearly one of over-spending. Greece has run fiscal deficits averaging 7.8 per cent of GDP since 1988. Greece’s external debt is nearly 150 per cent of GDP, with two-thirds public sector debt.

The credibility of the Greek government was shaken when its credit rating was downgraded to junk status in April, the same level as Pakistan. On May 9, the IMF, whose voting power is largely in European hands, approved a €30 billion three-year loan to Greece as part of a joint EU-IMF €110 billion financing package. This package is unprecedented in size.

The reason for such a large package is that contagion had already spread to other EU markets and the future of the Euro as a reserve currency was under threat. If Greece or the PIIGS countries default, the banking system of the larger countries will also fail.

The question now is, can the euro survive?

Having a large economy to back a unified exchange rate is not enough. The basic strength and the weakness of a fixed exchange regime is that the real economy must adjust to the exchange rate. Greece’s EU membership means it cannot devalue and therefore it must suffer severe deflation. Estimates suggest that in order to balance its fiscal books, Greece must cut expenditure by 25 per cent or increase taxes by 28 per cent. The real threat to the Euro area is the fact that it is first a political union and second a currency area. The concept of the euro was that a single currency would force economic convergence and integration. But that is also a flaw.

The euro’s flaw is that there is no mechanism to enforce fiscal discipline amongst members. The Eurozone is now caught because the EU was not politically able to enforce the fiscal discipline agreed to under the Maastricht Treaty.

If member countries are not willing to enforce fiscal discipline themselves, ultimately the market enforces that discipline through withdrawal of credit [following downgrading of the credit rating] or increase in the interest rate. But there is a structural political problem that is also fundamentally an economic one.

In Asian to Global Financial Crisis, my research shows that the net foreign asset position (NFA) is an excellent indicator of financial crises. Every Asian country except Korea that went into crisis in 1997 had a NFA deficit of more than 50 per cent of GDP.

The ratios of the PIIGS countries for 2008 are: Portugal (-101 per cent), Ireland (-55.3 per cent), Italy (-23.2 per cent), Greece (-103.7 per cent) and Spain (-76.1 per cent). The question is why no rating agency or the IMF used these NFA numbers to warn everyone of the problems before we reached the crisis stage?

There are serious implications for the world and for China. There are two surplus zones – East Asia and others, mostly oil producers, which account for $7.9 trillion of surpluses, with an average NFA/GDP ratio of 49.1 per cent of GDP.

The deficit zones – the US, Eurozone, and Australia, amount to $6.8 trillion deficit with a NFA/GDP ratio of 23.3 per cent of GDP. The imbalance is actually very concentrated, with a small number of surplus countries financing two large deficit zones of nearly double their size.

The deficit countries are now asking the surplus countries to revalue. What is the economic impact of such revaluation? The Asian crisis experience suggested that sometimes the balance sheet effect could be larger than the trade effect.

The policy implication is that the larger NFA surplus a country accumulates, the more vulnerable the country is to exchange rate revaluation pressure. In terms of size, Japan and China would suffer losses of US$247 billion and US$142 billion respectively (7.6 per cent of GDP and 4.7 per cent of GDP respectively).

Even though most economists claim that the world must deleverage, what the financial crisis is telling us is that the markets will not accept too much consumption and debt. In reality, the deficit countries have not begun to deleverage; they have replaced private sector debt with government debt, trying to reduce their pain by pressuring the surplus countries to revalue.

The few surplus countries will have to bear very large balance sheet losses in order to accommodate the deficit countries, but the relative benefits to the deficit countries are not too large. This is the political economy of unequal burden sharing.

The second policy implication is that even without revaluation against the US dollar, if the euro devalues, the surplus countries are in effect revaluing.

The true implication of the ‘Greek Tragedy’ is that no country can live beyond its means without someone paying for it. The global imbalances have been financed by printing too much money, with zero or negative real interest rates that are distorting markets through encouraging speculation in all real assets.

Instead of allowing markets to adjust, governments are escalating the size of the interventions.

Europe is large and strong enough for the euro to survive but it has turned out to be weaker than expected.

The surplus countries will be forced to share the burden of adjustment, either through exchange rate pressure, losses on holdings of the debt of deficit countries or through the trade channel. No country is an island.

So far the Euro group has kept the market wolves at bay. But the market wolves are still circling. The second phase of the crisis has begun.

Andrew Sheng is the author of From Asian to Global Financial Crisis, published by Cambridge University Press, and Adjunct Professor at University of Tsinghua, Beijing and University of Malaya, Kuala Lumpur.

Comments are closed.

Support Quality Analysis

The East Asia Forum office is based in Australia and EAF acknowledges the First Peoples of this land — in Canberra the Ngunnawal and Ngambri people — and recognises their continuous connection to culture, community and Country.

Article printed from East Asia Forum (

Copyright ©2024 East Asia Forum. All rights reserved.