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Posts Tagged ‘greece’

Greece Update

My go-to guy on Greece these days is Harris Mylonas, a fellow Yalie from a few years back, now teaching at GW. Here’s his latest take on coalition negotiations in Greece. Bottom line: new elections in a few weeks are looking increasingly likely, and the result might yield something more stable. Also check out his book.

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More Evidence for Greek Default

The Economist has a chart up today comparing growth rates pre- and post-default in recent years. Interestingly, countries have typically grown faster after default than before. There are reasons to be skeptical of a causal relationship, but it still shows that default is no disaster.

Scholarly work by John Ahlquist also has shown that default tends to attract more rather than less private investment. I have found a similar relationship in the data I have worked with.

More reasons to think that the catastrophic scenarios entertained to get European taxpayers to go along with bailouts are just not realistic.

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For those who followed the neo-Marxist debates on state theory in the 1970s (or were forced to learn about them by one’s professors), one of the more interesting contributions came from James O’Connor’s book, The Fiscal Crisis of the State. In essence, O’Connor argued that the state must simultaneously execute two conflicting functions: an accumulation function (creating the conditions for capital accumulation or corporate profitability) and a legitimation function (responding to the demands of voters and mobilized groups).  As elected officials meet the demands for social provision, they embrace higher levels of taxation, ultimately reaching a point where capital accumulation collapses. They can try to put off the day of reckoning (e.g., through incurring debt) but ultimately, the crisis would occur, perhaps as a result of an exogenous shock. Of course, some of what O’Connor argued could also be extracted from public choice arguments that were emerging at the same time (see Buchanan) and the work of Mancur Olson (see The Rise and Decline of Nations).

With this in mind, the press is increasingly full of pieces detailing the fiscal crisis of in Europe, which has come to a head as a result of the sovereign debt crisis.  I find these pieces interesting, in part, because they may foreshadow what will be occurring in the US in the next few decades.

As Michael Weissenstein reports, “the welfare state—cherished by many Europeans as an alternative to what they see as dog-eat-dog American capitalism—is coming under its most serious threat in decades.”

Peggy Hollinger (Financial Times) reports that France is seriously contemplating an increase in the retirement age, “as it embarks on a contentious reform of its debt-laden pension system and brings public finances back into line.”  The unions are (insert shocked expression here) strongly opposed to any cuts and are planning a national strike on Thursday.

There was an interesting “debate” at the New York Times on whether we are witnessing the twilight of the welfare state and whether the sovereign debt crisis holds any important lessons for the United States.

It is my take (corrections are welcome) that the extent of the crisis in Europe is a bit overstated. First, the coverage of the crisis seems to suffer at times from what logicians call the fallacy of false dilemma (dismantle the welfare state or suffer collapse). There is often a failure to acknowledge that there is much room for reform and viable models within Europe (e.g., , flexicurity in Denmark).  Second, the European welfare states have been far more generous than the US welfare state. In France, for example, the debate focuses on whether to increase the retirement age from 60. And as one 92 year old Spanish pensioner said (in the Weissenstein piece above) “he was unlikely to live long enough to see the worst of the pension freeze, but had no doubts he would have to start relying on savings to maintain his lifestyle.” My guess is very few 92 year old retired civil servants in the US are starting to contemplate dipping into savings.

Yet, one must ask: to what extent is the current crisis in Europe a harbinger of what will occur in the United States (2030, or 2040)?  We are incurring ever-greater debt (and I know this may not strike a chord with Sven, but it certainly does with me) and this is only the beginning given the problem of long-term unfunded liabilities. Our demographic profile, while not nearly as bad as Europe’s, is nonetheless going to place ever-greater stress on a smaller proportion of the population, mandating levels of taxation that will have negative implications for growth and social cohesion.

The end result may not take the form of crisis, but a painful state of sclerosis and a moribund economy.  O’Connor may have gotten the basic story right, but in the end, Mancur Olson may have been far better in teasing out the implications.

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Here is the reason why a subscription to the WSJ is worth the money: because they run pieces by people like John Cochrane.   I’ve been trying to make sense of the Greece mess, but I was missing the key.  Here it is:

Letting someone lose money on sovereign debt is the acid test for the euro. If not now, when? It won’t happen in good times, nor to a smaller country. The sooner the EU commits, and other countries and their lenders come to terms with the fact that they will not be bailed out, the better.

The current course—ever-larger and less-credible bailout promises, angry German voters who may vitiate those promises, vague additional fiscal supervision (i.e. more of what just failed miserably)—is not the answer.

The only way to solve the underlying euro-zone fiscal mess (and our own) is to slash government spending and to focus on growth. Countries only pay off debts by growing out of them. And no, growth does not come from spending, especially on generous pensions and padded government payrolls. Greece’s spending over 50% of GDP did not result in robust growth and full coffers. At least the looming worldwide sovereign debt crisis is heaving “fiscal stimulus” on the ash heap of bad ideas.

I’m pre-disposed to like Cochrane because he was a terrific teacher of mine (though I was a terrible student) and a super nice guy, but mostly I like him because he nits the nail on the head: as a currency the Euro is a great idea,  but the problem is that the EU can’t decide whether it is going to be a fiscal union in addition to a monetary union, so the bond holders aren’t being required to take the hit they legitimately deserve (and need) to take for investing in Greece in the first place.

A comparison between Cochrane’s arguments and those of Paul Krugman would be interesting.  But getting past the “Republicans are soooo evil” nonsense to find the actual economics is too annoying for a late night.

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About a month ago, Jonathan Capehart asked, “Hey, Tea Party, why all the fuss?” He cites some evidence—rather thin evidence, but evidence all the same—that many self-identified Tea Partiers are at the moment in decent financial shape. So what are they upset about?

That is a bit of a disingenuous question, since much of the Tea Party complaint, as I understand it, is about the future consequences of our current fiscal trajectories. But if you want an answer to the “What’s all the fuss about?” question, you might start with “The Mother of All Bubbles,” published last week by Der Spiegel. It explains in some detail—in horrifying detail—just how close to the fiscal precipice we are.

The Euro Zone economies are not just interdependent: they are deeply interindebted. They are all massively in debt to each other, so much so, in fact, that if the bailout to Greece does not stanch the bleeding, an all-too-real possibility is that Greece will fail, followed quickly by Portugal, Ireland, Italy, and Spain, whereupon the stress on Germany, the economically strongest economy in the EU right now (though itself with enormous and rising debt), will find itself pulled into the abyss by the other European Union countries. If that happens, as Der Spiegel, puts it, “the euro would fall apart.” No one really knows what would happen then—but everyone agrees that it would be bad; very bad.

The even larger problem, however, is that “All of the major industrialized countries have lived beyond their means for decades. Even in good times, government budget deficits continued to expand.” This puts the lie to the “principle of hope” on which Der Spiegel argues Greece’s bailout rests: “hope that it will be possible to repay the debt that has accumulated in past years, that governments will manage to clean up their ailing budgets, thereby averting the worst, and that life will go on, just as life has always gone on, somehow, after earlier crises.” One is reminded of the string quartet continuing to play as the Titanic took on water: just pretend nothing is wrong; that will make it all go away.

But of course it will not go away. Without immediate and dramatic changes in fiscal policy, not only will the catastrophe come, but, to paraphrase Mencken, it will come good and hard. And I would not recommend putting much stock in the chances of “immediate and dramatic changes.” The only way these bailouts will work is if everything goes according to plan in the best way it could. All the dice have to come up sixes, and there are dozens, even scores, of dice. What are the odds of that?

If you are still inclined to let your hope spring eternal, consider these sobering facts: “The national deficits of the 30 members of the [OECD] have grown almost sevenfold since 2007, to about $3.4 trillion today. Their total debt burden has also grown dramatically, to a record-setting $43 trillion. In the euro zone, national deficits have even grown 12-fold in the same time period, with the euro-zone countries accumulating $7.7 trillion in debt.” All the “austerity” measures imposed on Greece thus won’t make any difference, because all of the much bigger countries are accelerating their assumption of debt.

So, when Greece, then the other PIIGS countries, then the entire euro zone all fail, will the United States federal government bail them out too? Der Spiegel writes: “The United States is still capable of fulfilling all of its obligations [according to "a strictly confidential IMF document, referred to internally as an early warning device"], but [the document] also points out the worrisome rate at which the national debt is growing.” Right.

University of Chicago economist Liugi Zingales has written recently about the “menace of strategic default,” in which homeowners in the United States realize that their home is worth substantially less than their mortgage, and they simply walk away. Zingales correctly argues that if this practice continues to grow, the repercussions would be far and wide. But two thoughts are apposite here. First, these homeowners’ situations bears striking, and startling, similarities to the situations of some countries. So how bad will it be once countries realize that they might just be better off walking away from all the debt?

Second, consider the interesting “tragedy of the commons” dynamic this introduces. There will be bailout money available from the EU, then from the US, for a short time. No one knows how long, but if a country in as bad a shape, and as bad a risk as Greece can get a $150 billion bailout, then why wouldn’t some of the other precariously perched countries, who know they’re going to fail sooner or later anyway, not decide to crash now so that they can get their bailout while there are still bailouts to be had?

The interdependency, and interindebtedness, of the world’s countries make this we’d-better-get-ours-quick mindset—which will increasingly make rational fiscal sense for more and more countries—a threat of catastrophic proportions to the global economy and to every citizen in it.

That is what all the fuss is about.

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Just about everything Paul Krugman writes nowadays is in some way related to rationalizing the Obama deficits. Now, Krugman’s a smarter man than I, but I think it’s pretty clear that his partisanship drives his economic analysis these days, rather than the other way around.

Yesterday Krugman turned a case against the euro into a mind-boggling attempt to justify Greece’s fiscal shenanigans over the past few years:

Right now everyone is focused on public debt, which can make it seem as if this is a simple story of governments that couldn’t control their spending. But that’s only part of the story for Greece, much less for Portugal, and not at all the story for Spain.The fact is that three years ago none of the countries now in or near crisis seemed to be in deep fiscal trouble. Even Greece’s 2007 budget deficit was no higher, as a share of G.D.P., than the deficits the United States ran in the mid-1980s (morning in America!), while Spain actually ran a surplus.

So because the U.S. ran a budget deficit of about 5% of GDP when existing public debt was about 50% of GDP, that makes it OK for Greece to run a deficit of just under 5% of GDP when existing public debt was about 100% of GDP? As for Spain and Portugal, the rigidity of their labor markets contributes to unemployment – and in Spain the popping of an enormous housing bubble has intensified the effect. He continues:

The problem is that deflation — falling wages and prices — is always and everywhere a deeply painful process. It invariably involves a prolonged slump with high unemployment.

Oh really? Tell that to economists who study the classical gold standard. From about 1880 to 1914, prices dropped on average 2% per year, even as the Second Industrial Revolution motored on. And here comes the inevitable payoff:

The deficit hawks are already trying to appropriate the European crisis, presenting it as an object lesson in the evils of government red ink. What the crisis really demonstrates, however, is the dangers of putting yourself in a policy straitjacket. When they joined the euro, the governments of Greece, Portugal and Spain denied themselves the ability to do some bad things, like printing too much money; but they also denied themselves the ability to respond flexibly to events.

Because everything has to relate back to defending the U.S. government’s unconscionable fiscal excesses. If Krugman really thought monetary pump-priming is always necessary to get a local economy back on track, he would favor abolishing the dollar and breaking the U.S. up into optimal currency areas.

More to the point, Krugman’s (lack of) concern about budget deficits is strangely selective. Back in 2004, he castigated the Bush Administration for “enormous” budget deficits and “irresponsible” tax cuts. So much for the objectivity of the scholar.

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The transatlantic political class has taken up the cudgels on behalf of a Greek bailout. Even the Economist has joined the parade, warning of “contagion” to other European economies if a rescue package is not approved. Megan McArdle, while skeptical of a bailout, also resorts to the contagion meme and compares Greece’s current difficulties to the origins of the Great Depression.

The problem with the contagion forecast is that it implicitly assumes greater rationality and forethought among economic commentators than among international investors risking their own money. If contagion could be predicted, it wouldn’t happen.

The risk here isn’t contagion, but an entirely rational market response to poor fundamentals in highly indebted countries. Let’s take the three options available to the EU: allowing Greece to default, allowing Greece to leave the euro and default through inflation, and giving Greece a massive bailout. All of these options entail depreciation in the euro and a rise in the cost of sovereign borrowing for Eurozone governments. The putative advantage of bailout is that it redistributes these costs from the PIIGS governments teetering on the brink to relatively healthy states like Germany and France. The putative disadvantage is a long-term rise in moral hazard. Granted that the efficient-market hypothesis is wrong, we still cannot know whether any of these options might foreshadow or forestall widespread financial panic, but each has its costs and benefits.

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