As Greece has found, foreign investors are no cure

"We are in a position to achieve an economic miracle in our region." - George Alogoskoufis, Finance Minister of Greece, February, 2006.

Yes, it's a miracle all right. Somehow, Greece, a nation of tax evaders, kleptomaniac civil servants and soccer fanatics, whose financial muscle is dwarfed by that of Belgium - Belgium, for crying out loud - has sent the world's investors into fits of anxiety. Somehow, a country whose role in the global economy is of such insignificance that the place could have sunk into the Aegean Sea and no economist would have noticed, is now being noticed.

Somehow, Greece matters. And it's all because of the stellar work of Mr. Alogoskoufis and those who preceded and followed him. Miraculous, indeed.

On Thursday afternoon, just before North American equity markets went into a sickening nosedive, CNBC, Wall Street's official station, was airing live footage of the violence in the streets of the Greek capital. Not the floor of the New York Stock Exchange. Not Jim Cramer ranting and yelling on screen (now there's a situation for employing tear gas).

Why do we care so much if Athens is in flames? The first explanation is that Greece is the first domino. If it defaults on its debt, so begins an ugly game of financial Old Maid, as everyone tries to guess who's stuck with a stinking pile of Greek government bonds. At the extreme, you have a reprise of what happened after the Lehman Brothers collapse in 2008. No bank knows which of its competitors is solvent, therefore each gets skittish about lending to the other banks, and the credit market seizes up.

But that's a worst-case scenario. There are alternative explanations for the financial world's current obsession with Greece, one of which is the dawning realization that developed countries everywhere - even smug, fiscally virtuous Canada - will ultimately be forced to confront one of the key problems that has shoved Greece to the brink. That problem is the curse of excessive public expectations about what government can provide.

Why did Greece capsize into near-bankruptcy? If you said, "because of the Great Recession," give yourself zero points. The real cause was not the massive government deficits of the past two years, but the large ones that persisted before that, year after year, during an economic boom.

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In the late 1990s and early 2000s, Greece's economy outperformed its European neighbours. In 2003, to take one year as an example, countries like Portugal and Germany were shrinking, but Greece roared ahead with 6 per cent growth (that's after inflation). In typical fashion, it also ran a deficit equal to nearly 6 per cent of GDP. And wages in the civil service rose about 6 per cent, continuing a long tradition of largesse. Soon after, a group of OECD economists warned of the insanity of Greek fiscal policy: "Greece ... passed up an even more favourable opportunity to put public finances on a sound and sustainable footing ... much public spending is inefficient ... a largely unreformed and comparatively generous public pension system ... spending pressures will start to rise ..." Et cetera.

There was ample warning. But Greece had plenty of company. Britain boomed until 2008, yet hasn't had a balanced budget since 2001, according to Eurostat. Gordon Brown tried to spend his way to being liked by voters. With similar motivation, George W. Bush tried tax cuts. The U.S. federal debt increased by about 75 per cent, or more than $4.5-trillion, during the Bush years, most of which were characterized by a good economy. Didn't Keynes warn that if you're going to spend like mad during recessions, you've also got to run surpluses during growth periods? Canada did, as did Finland and Sweden and a few others. You never hear about them hitting a debt wall.

But there is another crucial aspect to this, too, one that explains why Greece is in crisis while Japan, which has awful demographics and a much higher debt-to-GDP level, is not. In Japan, the people save like mad. They stuff their money under their mattresses or in deposit accounts at the post office and in banks. So the Japanese government runs enormous deficits, but it can fund those deficits internally. Same with Germany, which also has plenty of debt and rarely balances its budget. Same with France, which hasn't had one government surplus in a decade.

In other words, it's not just the government's balance sheet that matters. It's the entire country's balance sheet - private and public. (This insight comes from Craig Alexander, chief economist at Toronto-Dominion Bank, whose superlative new report on the European debt crisis is a must-read.) What makes the PIGS (Portugal, Ireland, Greece and Spain) so vulnerable is that their people don't save enough to make up for their politicians' profligacy. They spend their own money, then pressure their leaders to spend all the tax receipts and then some. Where does the money come from to fill the gap? Foreign investors. Fickle foreign investors, Greece is discovering.

The citizens of aging rich countries with low savings rates, including the United States, have a choice. They can go along with higher taxes, spending cuts, reduced pensions and the like, to put government finances on solid ground. Or they can cut their own spending and save more - quite a bit more - themselves. What they can't do is expect foreigners to pay for them to live beyond their means forever. That is the clear lesson of Greece.