Although its heyday as the world’s most advanced civilization has long since passed, Greece once again has the potential to influence the rest of the world. Unfortunately, its most famous export, democracy, has been replaced with a far less desirable commodity—debt. That Greece with a population of a mere 11 million and a GDP of $300 billion (only 2% of the Eurozone economies) can create systemic risk for the world speaks volumes about the downside of global interdependence.
As in previous debt crises, the debate over debt rescheduling revolves around two key concepts: moral hazard and systemic risk. Moral hazard refers to the problem that, if you shield an actor from the consequences of irresponsible decisions, you only encourage more bad behavior by that actor and others and ultimately make things worse. The counter to this view is the “too big to fail” argument: Even though you might find bailing out profligate debtors distasteful, not doing so might bring the system down. You will end up cutting off your nose to spite your face.
What does the history of debt rescheduling over the last two years tell us? A cynic might side with Hegel, who said “We learn from history that we do not learn from history.” In 1982, following years of borrowing, Latin American countries as well as others in Asia and elsewhere found themselves massively in debt. With Ronald Reagan encouraging Fed Chairman Paul Volcker to raise interest rates to kill off U.S. inflation, Mexico in particular found itself in dire straits. It faced a 21% prime rate on its floating debt, falling oil prices, and recession in the developed countries. This confluence of macroeconomic factors proved to be a poisonous cocktail.
By August 1982, Mexico neared complete default. Ironically, Brazil was already attempting to retrench and adjust, but bank retrenchment and “redlining”—treating the whole region as being the same—resulted in over 25 countries falling into arrears by 1983. On August 13, 1982, when Mexican Finance Minister Silva Herzog met with officials of the U.S. government and IMF to tell them that “we have a problem” he was signaling systemic risk.
What came next was a preview of the current Greek “debt game.” Mexico was asked to develop an economic adjustment program in exchange for a “jumbo loan” put together by the banks, the U.S. government (the analog to the Germans in today’s Greek drama), and the IMF. Central banks pitched in with a $1.85 billion credit to be released in three tranches with disbursement hinging on the results between Mexico and the IMF over austerity measures.