Today Greece, tomorrow the world

Greece has been living beyond its means, having borrowed too much during the easy times. Its underlying economy is too weak to support its preferred lifestyle, which is why the Greek government is now being told by its main creditors, the IMF and the Eurozone central banks, that it needs to make more cuts, especially to state pensions.

Is Greece unique in this regard? No, it is not. In fact, Greece is just the current and most obvious case of a problem that affects most developed economies to some degree, and even some developing economies, including the biggest of them all, China. The US Federal Reserve, in recent budget forecasts, has repeatedly warned that the US will not be able to pay future pension and welfare commitments.

The problem is caused by unrealistic expectations brought about by the rise of the financial sector relative to the real economy: banking has grown out of all proportion to its true purpose, which is to fund real industry.

All wealth creation begins with real industry: workers add value to the earth’s natural resources by creating useful products through industry. This is the process of real wealth creation. Financial services do not create wealth, they merely shift around the wealth that’s already been created by real industry, trying to profit in the process.
As the following two charts show, only 20% or so of lending these days goes to productive industry, the rest adds to the kind of unproductive debt that is crippling Greece and will soon cripple many other economies.

Why did Greece borrow too much? Why did the nation adopt a live-now-pay-later mentality? The answer is simple: because it could. Previous Greek governments did what a great many governments, businesses and individuals have been doing ever since the 1980s, when the financial sector was first let loose to pursue its own agenda of trying to make money from money: they borrowed because the banks wanted to lend. They made it easy: easy credit, easy money.
Did the banks ever bother to work out if Greece could afford these loans? No, they didn’t. The good times were rolling along nicely, so who cared.

But even back then, in the late 90s and early 2000s, the good times were becoming illusory, with GDP figures increasingly boosted by debt, as my next chart shows. 

Governments base a lot of their economic decisions on GDP figures, as they give an indication of economic activity and supposedly of economic health. They’re also useful when making international comparisons.
But GDP figures are a very poor indicator of true economic health: they are boosted just as much by unproductive economic activity based on debt as they are by real productive industry (more here).
Because of internationally agreed accounting rules, banks actually add to GDP when they make loans, regardless of where the loan is going. This explains why nations with big banking sectors, such as Britain, have relatively strong GDP figures even though, with 80% of the economy based on services, they don’t produce much anymore. Our prosperity is a debt-based illusion.

Unfortunately there comes a time, as Greece is finding now, when debts have to paid, one way or another. If this wasn’t the case, then we’d have found a way to create wealth out of nothing. But we haven’t found a way to create wealth out of nothing, what we’ve done is borrowed from future earnings. This is why Greece is getting poorer, and it’s also why much of the developed world will get poorer too.

The solution, both for Greece and elsewhere, will not be easy. Firstly we must accept the reality, that debt-based economies are living well beyond their means and that the future growth that repayments depend on is not going to happen. This was the big mistake, to assume that rapid growth would continue forever. How could it?
The oil-powered postwar boom times were bound to fizzle out eventually because they were based on a virtuous cycle of rapid industrialization, job creation and consumer demand following the devastation of war and the previous decades of hardship. China has seen a similar thing in recent decades, but this is already fading. We need to adapt to the reality of low or no growth, and if we’re lucky this might have the added bonus of reducing global warming and saving humanity into the bargain.

In the meantime there will be defaults on loans, both in Greece and elsewhere, because there is no way all these loans can be repaid. And why should they be? Is it the fault of the Greek people that their leaders borrowed far more than the country could afford? No, it isn’t. Is it the fault of the banks? Yes, it is – the banks are as much at fault as were the leaders that took the loans. So perhaps it is only right that wealthy investors should lose out. Why should Greek pensioners bear all the hardship?

Greece may or may not be the trigger for the next global economic crisis, a crisis that could make the last one look fairly mild, but whatever happens with Greece in the coming weeks and months, the global debt problem is only going to get worse. As long as banks, stock markets and property empires are built on the foundations of credit that is itself based on the illusion of future growth, another crash is inevitable.