Greece, EU, Governments, Defaults, Banks and Lessons for the U.S.

Greece is broke. So is much of the rest of Europe.

What does this mean? In other words, what difference does it make to America?

And how does a country, continent, city or state differ from a private company when we refer to going broke?

Let's begin with the public government versus private company comparison. One very important difference is the presence or absence of taxpayer support.

Governments have taxing power and therefore don't cease to exist when they default on their debt obligations. Neither do they generate income or wealth in order to service their debts. Their money comes from taxes, borrowings and printing money, aka inflation or currency depreciation.

In private company bankruptcies, however, the companies often cease to exist, and their shareholders as well as creditors lose most or all of their invested funds as a result. That's due to the companies' failure to generate income or profit sufficient to stay in business, continue to pay taxes, employees and suppliers.

The real difference when the bills can't be paid? Game over for private companies but the game goes on for governments. Taxes and money creation by printing make the difference.

Thus, Greece won't cease to exist. Its citizens will suffer great financial hardship for years to come, however, no matter what else it does. And the currency may change if Greece withdraws from the EU and euro. Before the euro currency, there was the drachma. That change in currency could happen again.

But let's begin with the euro and the contemplated European Greek bailout, along with what Greece must do to remain a euro currency.

Why We Can't Escape the Eurocrisis is about the potential worldwide effects of the Greek bailout and crisis. It begins this way:

"When is a bailout not a bailout? When the bailor is short of funds. The recently announced debt plan in the European Union comes up short in almost all respects.

The debt crisis is not just an EU problem, but a trans-Atlantic financial crisis. The overwhelming debt problems on either side of the pond are interlinked through the banking system.

First to the EU. The underlying dilemma is that governments have promised their citizens more social programs than can be financed with the tax revenue generated by the private sector. High tax rates choke off the economic growth needed to finance the promises. Economic activity gets driven into the underground economy, where it often escapes taxation.

Nowhere is this truer than in Greece, which has a long history of sovereign defaults in the 19th and 20th centuries. There is a bloated public sector, and competitive private enterprise is hobbled by regulation and government barriers to entry. Successive Greek governments ran chronic budget deficits, and the Greek banks lent to the government. Banks in other EU countries, such as France, lent to the Greek banks.

In Greece and elsewhere in the EU, the banks support the government by purchasing its bonds, and the government guarantees the banks. It is a Ponzi scheme not even Bernie Madoff could have concocted. The banks can no longer afford to fund budget deficits, yet they cannot afford to see governments default. Governments cannot make good on their guarantees of the banks."

Next it delivers a message of warning to the American government and its taxpayers:

"Americans must not be smug about the suffering of Europeans—our financial system is thoroughly integrated with theirs. Moreover, the International Monetary Fund will most likely be involved in the event of future bailouts and will likely need large funds from its members, which ultimately means the taxpayers.

And, of course, the U.S. has its own large and growing public debt burden. We have not gone as far down the road to entitlements, but we are catching up. If you want to know how the debt crisis will play out here, watch the downward spiral in the EU."

Whispers of Return to Drachma Grow Louder in Greek Crisis talks about the growing sentiment among Greeks to return to the drachma and withdraw from the Euro currency. It says this about the rock and a hard place in which the Greeks find themselves between:

"The political upheaval in Athens has suddenly made the once unspeakable — Greek debt default — a distinct possibility.

So now it is time to ponder the once unthinkable: that Greece might end its 10-year use of the euro and return to its former currency, the drachma."

There is an enormous difference between Greece staying with the euro and opting to return to the drachma as its currency:

"Under the latest bailout plan from Europe, Greek debt held by private institutions would be written down by 50 percent. In return, as long as Greece stayed on track carrying out painful austerity measures through 2015, Athens would continue to receive more bailout money to finance its remaining debt.

When Mr. Papandreou brought that tentative deal back from Brussels last week, the escalated protests and rioting on Greek streets were a sign that it was not something his people would easily stand for.

Supporters of a return to the drachma note that the severe budget cuts of the last two years had resulted in almost closing the budget deficit — as long as interest payments on its debt are not counted.

Stripping out interest payments, Greece is expected to register a budget surplus next year of 1.5 percent of its gross domestic product (compared with a budget deficit of 8 percent of G.D.P., when interest is counted), and that, in effect, would give it the freedom to stop paying its debts."

So here's the deal. Greece has two choices.

(1) It can elect to default and not make its interest and principal payments on Euro debt. If it chooses to default and return to the drachma, it can in essence start over. Of course, its credit will be ruined for many years and the resulting inflation may be ruinous. That said, it may not need much "external" credit if it in fact runs a budget surplus and reneges on its current debt obligations.

(2) But even if Greece doesn't renege and instead stays with the euro, it very well may not be able to repay its debt obligations over time. In that case, it would have embarked on a deep and severe austerity program with no assurance that it will emerge down the road as a healthy and financially viable country.

In sum, because of the required severe austerity measures and required debt repayments, remaining as a euro currency is a most difficult choice for Greek citizens to make. In my view, however, opting out of the euro and returning to the drachma would be an even worse choice.

The Greeks simply have no good options.

The lesson for America? Well, we need to get our act together before we are faced with the choices now facing the Greeks.

So when we look carefully at the situation in Greece and several other European countries, living within our means doesn't sound so bad, does it?

All we have to do is limit the size of government growth to less than private sector growth. That's the only way out of this current financial mess.

It will take a few years, for sure, but it has to be done. Thus, the sooner we start, the better.

Thanks. Bob.