Contemporary Issues in Finance.

Contents
1. Introduction 2
2. Debate 3
2.1 Falsification of debt levels 3
EMU debt requirements 3
Non-compliance prior to ascension 3
Linkage to the financial system of the Eurozone 4
2.2 Excessive public expenditure 4
Common conception of public deficit 4
Usage of funds for unproductive sectors 5
Linkage to the financial system 5
3. The role of debt monetisation 5
Debt monetisation 5
EMU framework 6
Preclusion to debt monetisation as the key factor 6
4. Conclusion 7
References 7



1. Introduction

This paper is a review of an article on the causes of the Greek sovereign debt crisis by Armitstead (2012) which was featured on the website of Telegraph. An article on the Greek sovereign debt crisis was chosen due to the lasting and widespread implications it brought to the financial system of the Eurozone (Reinhart et al., 2012).

The sovereign debt crisis was trigger in the late 2009 when Greece announced a larger than expected deficit, sparking concerns over Greece's fiscal solvency and the subsequent downgrade of their credit rating (Lane, 2012). Critical implications to the Eurozone's financial system is evident where peripheral European Monetary Union (EMU) members' with similar debt fundamentals as Greece experienced a spike in sovereign debt yields evident in Figure 1. Consequently, the high cost of debt served as an obstacle to sovereigns as borrowers to access much needed funds, to rollover their existing debts (Afonso et al., 2012).



This paper is structured as follows: (i) debate on key causes of the crisis as presented by the article; (ii) the role of debt monetisation; and (iii) conclusion.



2. Debate

Armitstead (2012) presents two key causes to the debt crisis in the background of her article, namely (i) the falsification of debt levels; and (ii) excessive public expenditure. The objective of this section is to discuss the purported factors using a combination of empirical evidence and a literature review.

2.1 Falsification of debt levels



EMU debt requirements
The EMU's Stability and Growth Pact stipulates that members should limit government debt to 60% of gross domestic product (GDP) and annual deficits shall be capped at 3% of GDP (Gianviti et al., 2010). The quote above by Armitstead suggests that Greece ascended the EMU by doctoring their debt levels to meet EMU membership requirements of the Stability and Growth Pact.

Non-compliance prior to ascension
While Greece became an EMU member in 2001, its debt-to-gdp levels from publicly available sources (OECD) indicates that they have never met the EMU debt requirements even prior to ascension. Interestingly, OECD statistics indicates that Greece was not the only culprit in breech, with Italy being non-compliant as well.



Linkage to the financial system of the Eurozone
The implication of the Greece debt crisis to the EMU have been demonstrated in Figure 1, where it triggered a spike in borrowing cost of several EMU members. Hence, preventing sovereign borrowers to access funds from savers, which sparked the destabilisation of the Eurozone financial system as a whole.

While it have been suggested in Armitstead's article that Greece's dishonesty was the culprit in this destabilization, statistics in Figure 2 indicate that it was the failure of the European Central Bank's (ECB) oversight to execute its duties in exercising due diligence and punishing non-compliance to have caused the destabilization of the Eurozone financial system from this episode (Arghyrou and Kontonikas, 2012).

2.2 Excessive public expenditure



Common conception of public deficit
Public deficit occurs when a sovereign disburses more than receipts from its income streams such as taxation, sovereign investments and businesses (Ferré, 2005). The application of layman logic often result in the suggestion that excessive spending leads to excessive debt levels, which leads to sovereign debt servicing problems. Armistead have applied the same in suggesting in the quote above that excessive public spending caused Greek's debt problems.

Usage of funds for unproductive sectors
Giavazzi and Spaventa (2011) provides an interesting perspective to the debt crisis, in which they argue that the sheer amount of public spending to not be a cause of sovereign debt problems, but rather the unproductive uses in which public funds have gone to. Stated differently, Greece have employed funds from external financing for purposes that do not contribute to generation of future debt repayments, namely private consumption and domestic demand by way of public wages (Giavazzi and Spaventa, 2011; Higgins and Klitgaard, 2011).

Linkage to the financial system
Giavazzi and Spaventa's argument suggest that Armistead's quote is rather inaccurate. While it is true that public sector wages did not contribute to future debt repayment capabilities, investments in infrastructure in general provide a positive contribution to future debt repayments by way of making the country more investment and business friendly.

Therefore, it can be concluded that Greece's debt crisis and the subsequent destabilisation of the Eurozone financial system, was more a function of ineffective fiscal expenditures rather than excessive fiscal expenditures.

3. The role of debt monetisation

Debt monetisation
Quantitative easing refers to funds being created artificially by relevant central banks, which are typically used to buy back outstanding debts to pump additional funds into a nation's financial system (Krishnamurthy and Vissing-Jorgensen, 2011). Debt monetisation is a function of quantitative easing, where relevant central banks artificially create money to reduce debt levels or service debts repayments, or a combination of both (Jeanne, 2012).

EMU framework
The EMU framework precludes individual sovereigns from conducting quantitative easing, with all quantitative easing to be conducted through the European Central Bank (Pisani-Ferry et al., 2013). As quantitative easing spurs currency devaluation and inflation amongst many other side effects, the reason for such a ruling is to ensure the stability of the Eurozone financial system as a whole (Jeanne, 2012).

Preclusion to debt monetisation as the key factor


The purpose of Figure 3 is two-fold: (i) it puts into perspective the debt levels of various nations via its debt-to-gdp ratio; and (ii) it puts into perspective the borrowing cost of various nations by way of using their 10-year sovereign bond yield as a benchmark.

Drawing focus to Greece, Japan and United Kingdom, it is evident that while Japan and United Kingdom have debt levels which are similar or higher as compared to Greece, their sovereign debt yields remain stable and low. A common relationship between Japan and United Kingdom that differs from Greece is where their central banks have the ability to employ quantitative easing to monetise their sovereign debts (Joyce et al., 2011). Notwithstanding the other potential problems arising from employing quantitative easing to monetise debt such as hyperinflation, Japan and United Kingdom are technically protected from a sovereign debt default despite their high debt levels, as they can create artificial funds to service their debt obligations.

Hence, the statistics in Figure 3 suggest that the preclusion of EMU members from debt monetisation to be a fundamental factor behind Greece's sovereign debt crisis and the subsequent destabilisation of the Eurozone financial system.

4. Conclusion

This paper set out to critically review the article on the Greek sovereign debt crisis by Armitstead. The analysis of this paper yielded three findings. (i) The suggestion that Greece's falsification of debt levels in their ascension to the Eurozone is untrue, where their debt levels prior to and after have always been in significant breech of EMU stipulations. Instead, it was the failure of the European Central Bank to exercise due diligence and disciplinary actions on non-compliant members. (ii) Rather than excessive public expenditures as suggested, it was instead the non-productive nature of these expenditures which underpinned the crisis. (iii) The article missed an important piece within the debt crisis puzzle, where the inability of Greek to monetise its debt due to inherent limitations of the EMU framework was the fundamental factor to the crisis.
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References
Armitstead, L. (2012). "What's the Greek debt crisis all about?" The Telegraph. http://www.telegraph.co.uk/finance/financialcrisis/9098559/Whats-the-Greek-debt-crisis-all-about.html
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Giavazzi, F., Spaventa, L., 2010. Why the Current Account May Matter in a Monetary Union: Lessons from the Financial Crisis in the Euro Area. Discussion Paper 8008, Centre for Economic Policy Research.
Higgins, M., Klitgaard, T., 2011. Saving imbalances and the euro area sovereign debt crisis. Current Issues in Economics and Finance 17.
Jeanne, O. (2012). Fiscal challenges to monetary dominance in the euro area: a theoretical perspective. Banque de France Financial Stability Review, 16, 143-150.
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