The global economic crisis is now moving into a new phase. The first wave saw a series of bankruptcies as a financial panic wreaked havoc across the world’s major financial centers. The panic was stemmed more or less by central bankers intervening to save some institutions, provide for the orderly or quasi-orderly break-up of others and flooding the world’s markets with cheap and abundant credit. The second stage saw national governments around the world attempting to prevent the financial panic from turning into a major depression in the real economy. Governments opened the floodgates to spend lavishly on public works and support endangered industries (especially the automotive industry) in order to keep as many people working and spending as possible. This fall we saw pretty promising signs that these efforts have been moderately successful; while they didn’t prevent a severe recession, in Europe, North America and Asia most of the world’s major economies have stabilized and started to grow.
The new phase we now seem to be entering will test the health of the world’s financial system as smaller, more exposed economies and governments stagger under loads of unsustainable debt. The Thanksgiving announcement that Dubai’s economic development agency could not pay its debts was the first sign of trouble. Dubai was billing itself as a financial center and tourism destination in the Gulf; high profile real estate developments like artificial islands set up to resemble a map of the world and resorts featuring attractions like artificial indoor ski slopes were supposed to attract tourists and investors. The world’s tallest building would be filled with financial firms paying high rents for spectacular views at a prestigious address. The fragile and delicate financial infrastructure supporting this exuberant extravagance was no match for the rough economic conditions we have seen since 2008; Dubai’s problems have led investors to re-evaluate other emerging market economies.
Attention has now turned to Greece, where the situation is even more complicated. With the budget deficit out of control and investors demanding high risk premiums to buy Greek bonds, the country may soon force its EU partners to choose between bailing it out or seeing one of the euro-economies melt down.
For the new Socialist government, the situation is genuinely nightmarish. Greece has one of Europe’s most bloated and corrupt bureaucracies and its sullen civil service workers are more likely to riot and strike than to peacefully accept the kinds of cutbacks that will be required.
The Greek civil service isn’t just a little bit corrupt and incompetent. It is such a vile and stinking sewer of corruption and rampant incompetence that Greece’s new prime minister was forced to confess the mess at an EU summit last week. (Confession: I was once stuck in what was then Yugoslavia for 36 hours when Greek customs workers went on strike and no one could cross the border. It’s hard to know which is worse: the arrogance and selfishness of public officials who would behave in that way or the ineptness and weakness of a government that would allow it.) Greece cooked the books to get into the euro, and has been cooking them busily ever since. No one, not even Greece’s own Minister of Finance, really knows by this time what the actual condition of the country really is.
It’s not clear that even the specter of oncoming bankruptcy will enable the Greek government to take the steps that are required. The high levels of debt, warned Prime Minister George Papandreou, “could eliminate the country,” but it won’t be easy selling that to the Greek customs service and their colleagues across a bloated state. Other euro member countries — Spain, Ireland and Portugal — are also in trouble. Italy is not quite in this class, but its public finances are in a state of long term decline that will sooner or later cause trouble.
How all this will work out we don’t know. The possibility still exists that another chain reaction of crises and defaults could plunge us back into the horrifying panic that seized up world markets a year ago; if so, it would be much harder for the central banks to limit the damage. I’m inclined to be modestly hopeful, though. Greece’s problems are large but the economy itself is small, and the Europeans are financially well organized and very much aware of what is at stake. And while the socialist party now ruling Greece has in the past been associated with some of its worst corruption, Papandreou is a serious politician who seems to understand that Greece needs to clean up its act.
We shall see. If this latest string of crises sputters out, then it looks as if the global recovery could continue for a while. The most serious problems behind it have yet to be addressed — in particular the imbalances between export-oriented economies and their customers. Sooner or later these are likely to cause new problems, but we may still have some time for countries like China and the United States to make some adjustments. With a little bit of luck and a lot of tricky footwork, the Greek crisis could be the last real nail-biting moment of the current crisis.