Friday 2 September 2011, 14:00
"...Like the blind cyclops casually touching the backs of his sheep, bondholders didn't pay close enough attention to the fact that the risks of default had not gone away."
On More or Less, we're always looking for the perfect analogy to help clarify complicated things. And the European debt crisis is certainly complicated. We think we've come up with exactly the right way to describe the whole sorry business: as Homer's Odyssey.
Let's start with the Trojan Horse. The original horse was a big hollow wooden statue, inside which a Greek attack squad was smuggled into the city of Troy.
What has that got to do with the debt crisis? It all goes back the late 1990s and the creation of the Eurozone, which the Greeks wanted to join. To get inside the walls of the Eurozone, the Greeks needed to convince the European Union that they had met various irksome rules about inflation, government deficit, and government debt.
Instead of calling Odysseus, the modern Greek's called Goldman Sachs and asked them to structure a clever financial deal that put a lot of Greek borrowing off the books. And it wasn't just Goldman Sachs - it's been reported that there were all kinds of ways in which the Greek government of 11 years ago managed to make their macroeconomic statistics look trim and healthy.
In late 2009, George Papandreou came to power in Greece and announced some bad news: the Greek deficit wasn't the manageable 3.7 per cent of GDP which his predecessors had reported. It was almost four times bigger. And that made Greece's debt look completely unsustainable.
Time to introduce our next character to the story: the cyclops, the one-eyed giant who trapped Odysseus's men in a cave, planning to eat them for breakfast. Odysseus then stabbed the cyclops in the eye with a red hot sharpened stake - which has to hurt.
What have I got in mind for the modern-day equivalent of a blind, enraged colossus? Easy: the international bond markets. Think about how Odysseus escaped. The Cyclops, unable to see, stood by the entrance to his cave and touched each of his giant sheep as they trotted out to graze. Odysseus -cunningly - told his men to cling to the underside of the sheep, and the Cyclops was unable to tell that the Greeks were sheltering under his livestock.
When different European countries had different currencies, investors - that is, the international bond markets - charged much higher interest rates to the likes of Greece than to Germany, simply because of the risk they were taking in lending money to the Greeks rather than the Germans.
But the Euro acted like the giant sheep. Clinging on beneath it were all these national governments, some of which were creditworthy and some of which were not. But the bond markets acted as though they were all pretty much the same.
And obviously they weren't all the same. Like the blind cyclops casually touching the backs of his sheep, bondholders didn't pay close enough attention to the fact that the risks of default had not gone away. They treated all Eurozone countries very similarly - at least until a couple of years ago - and lent money to Greece almost as cheaply as they had done to Germany.
Now. Remember Circe? Circe invited Odysseus and the Greek sailors to a banquet on her island, and as they gorged themselves on the food and drink, she transformed them into pigs. It's evocative of what a lot of people think happened to Portugal, Ireland, Greece and Spain - often collectively, and rather impertinently, called the PIGS.
Many people think those countries gorged themselves on cheap money which they had access to courtesy of the blind bond markets. And they used the money to get on with whatever they fancied getting on with. In the case of Ireland, it was a property boom. But in the case of Greece, it was the Greek state running a large, unacknowledged deficit.
Different things have happened to different countries. In Ireland, the national debt suddenly ballooned because Irish banks had lost an inconceivable amount of money. In Spain, the problem was that growth collapsed. The debt was low - and in fact it's still not that high - but with low growth investors are getting nervous. And then in Greece there was that long-run off-the-books accumulation of debt. Each case is different.
And we Brits shouldn't be too smug. Last year, our budget deficit was higher than that of Portugal, Ireland, Greece or Spain. We out-pigged the lot of them. But, like Odysseus, we escaped unscathed.
Why? Well, like him or loathe him, nobody doubts that George Osborne plans to get the deficit down quickly, and that reassures investors. But before Osborne pats himself on the back, there are other reasons. George Osborne's arch enemies, Gordon Brown and Ed Balls, kept the UK out of the Eurozone.
That means austerity measures in the UK don't hurt growth as much as they do in Eurozone countries. Our flexible currency allows to export some of the pain to others.
Time for another tale from the Odyssey: the Sirens. The Sirens had beautiful, tempting songs but would rip sailors to pieces. Odysseus told his sailors to block their ears with wax but had himself tied to the mast so that he could hear the Siren song and yet couldn't leap overboard to his death, no matter how hard he tried.
It turns out that the story of the Sirens is a classic in economic theory. It represents the idea that sometimes you can gain an advantage from tying your own hands. It's called a commitment strategy. And this is one of things investors liked about the Euro: being a part of it means Greece, for example, can't devalue its debt by printing money, no matter how tempting that option becomes.
But there is a downside. These commitment strategies are great until you reach a situation where you really, really need to break your commitment. At that point, you're stuffed.
Later in the Odyssey, Odysseus is sucked into the gigantic whirlpool of Charybdis. He saved himself by leaping off a raft and grabbing hold of a fig tree. The point is: it is a good job he wasn't tied to any masts at the time.
The Odyssey ends with a bloody massacre of a bunch of greedy ne'er do wells. Let's hope that this story ends better.
Tim Harford is the presenter of More or Less on Radio 4
Join the discussion...