Whistling past the graveyard?

Simon Nixon holds that in the years before the financial crisis broke, Greece was flush with money. The Greek governments of the time did the popular thing by increasing pensions and wages for public employees well beyond the level that the feeble Greek economy could sustain in normal times. Then the slump dried up the river of money. Greece faced a crisis; a Greek financial collapse could spread to the rest of the Eurozone; and the European Central Bank, the Eurozone countries, and the International Monetary Fund stepped in with a bailout.[1]

In return for this bail-out, the creditors demanded that Greece make reforms of its unsustainable public-sector and pension systems to reduce spending to a level that the Greek economy could support in normal times. Instead of pursuing this politically unpopular course, Greece laid its main effort on enhanced tax collection and on a reform of the pension system that did not address the real problem. Thus, the number of bureaucrats fell as they were transferred to early retirement. This increased the burden of pensions in the budget rather than reducing it.

The Syriza government argues that budget cuts will just push Greece deeper into recession. They have been asking for an expansionary budget policy combined with more money from the European Union for “investment.”

There is a consensus on the need to “restructure” (greatly reduce) Greece’s debt. There is a consensus among the creditors on the need for serious reforms of Greece’s public sector and pension systems. A deal should be easy to reach. However, the Greeks want the debt reduction to come at the same time as the promise to implement reforms in the future.[2] The creditors don’t trust the Greeks to implement the reforms once they have the money in hand. As a result, they insist that the reforms have to precede any debt restructuring.

Anatole Kaletsky argues that, between the outbreak of the Greek financial crisis in 2009 and the end of 2014, there existed a real danger that a Greek default would be the first domino in a chain that ran through Portugal, Spain, and Italy before crashing down on Germany.[3] In January 2015, however, Mario Draghi, the head of the European Central Bank, won approval for a massive program of bond-buying on the part of the ECB. In essence, the ECB now can print all the money it needs to drown the fires of a financial crisis. Euro-zone countries agreed to this measure in order to build a fire-wall between Greece and the rest of the Eurozone. Now, the dangers of a Greek default are chiefly to the Greeks themselves: default will block access to foreign credits, end ECB support for the Greek banking system, lead to a run on the banks that will leave many people empty handed, and the government will be unable to pay the pensioners and public employees on whose behalf it has been engaged in this game of chicken.

Then there is the collateral damage. A “Grexit” may not do serious damage to the European economy. It will harm the reputation of the IMF. IMF rules bar it from lending to countries that are unlikely to be able to sustain the debt. The Eurozone lured the IMF into participating in the Greek bail-out by warnings of a “financial contagion.” Well, the current level of Greek debt is not sustainable. A Greek default will gore the IMF, which prime minister Tsipras has just denounced as ‘criminal.” That will affect IMF lending programs in several ways for the foreseeable future.

The level of emotional engagement here reminds us that politics isn’t always rational.

[1] Simon Nixon, “Athens and Its Creditors Head for the Brink,” WSJ, 8 June 2015.

[2] See: “I’ll gladly pay you Tuesday for a hamburger today.”

[3] Anatole Kaletsky, “Greek crisis: Europe has nothing to fear from Greek belligerence,” The Guardian, 16 June 2015.

Playing Chicken.

Architects of the Euro-zone sought a stronger, more prosperous, and more harmonious union.[1] The inauguration of the Euro in 1999 began a period of low interest rates for member countries. Low interest rate led to heavy borrowing by both public (Greece) and private (Spain, Ireland) sectors. When the world economy slowed down after the American financial crisis, debt-service became a problem.

The architects had not then—and have not yet—resolved all of the problems. One worm in the apple is that the single currency serves 19 sovereign states. Those states do not pursue uniform economic policies. Nor do all national cultures celebrate the same values.[2] German hostility to budget deficits closed off large-scale counter-cyclical spending as a policy tool. Instead, states were to pursue limiting deficits as a share of Gross Domestic Product (GDP).

The pursuit of austerity policies has had different effects in different countries.[3] The GDP of Germany has risen about 10 percent from 2009. The GDP of Portugal, Spain, and Italy are all down about 10 percent. The GDP of Greece is down more than 20 percent. The decline in GDP has increased the burden of the government debt financed by taxation. Government debt as a share of GDP has risen from about 30 percent to about 70 percent in Spain; from 90 percent to about 110 percent in Italy; and from 60 percent to about 120 percent in Portugal. Greek government debt as a share of GDP has risen from about 110 percent to about 170 percent. (Thus, austerity has pushed Italy and Portugal into the same territory from which Greece began.) This raises the danger that bigger, more severe crises lie over the horizon.

The the creditor countries could pursue expansionary policies that might fuel demand for goods from the debtor countries. Once again, different national politics and cultures come into play. The northern creditor countries don’t want to abandon the policies that they associate with their own success, least of all to bail out the improvident.[4]

The concept of the Euro-zone was that—like Mr. Lincoln’s theory of the Union—the members had formed an indissoluble bond.[5] The Greek crisis threatens that idea. If Greece was to be forced out, then any other country that got into serious financial difficulty in the future might suffer the same fate. Countries at risk would have to pay extremely high risk premiums for financing public debt. The whole Euro-zone could unravel from the bottom like a sweater. Crisis after crisis would gnaw at a union that seeks the benefits of stability.

Hard-liners have not said so, but it might turn out to be a way of finally enforcing the economic doctrines of the northern creditor countries on the southern debtor countries.[6] Any country that did not wish to pay high risk premiums to lenders would have to pursue “sound” finances. That, in turn, could force a reform of social and economic policies.

The Greek “Syritza” and Spanish “Podemos” parties have drawn strong support for demands to end austerity and for debt repudiation. Many American observers seem to think that the Germans and other creditors should be happy to get robbed by the Greeks and other debtors for the greater good. The long Republican counter-attack against high taxes since the Reagan Administration shows something different. People who feel victimized will fight back. Right now, the focus is on angry Greeks and Spaniards. In the future it’s likely to be angry Germans.

[1] Eduardo Porter, “Local Politics Are Fracturing European Unity,” NYT, 3 February 2015.

[2] Flexibility, thrift, and probity, for example.

[3] See the charts in Porter, “Local Politics.”

[4] The limited historical knowledge of many economic commentators leads them to make frequent references to the post-First World War inflation as a formative experience. They ignore the “cigarette economy” that flourished after the Second World War and the heavy burdens carried by West Germans after absorption of the defunct German Democratic Republic in 1989. Germans today have a far more vivid set of memories shaping their behavior.

[5] Stephen Fidler, “Europe Weights Costs of Casting Greece Aside,” WSJ, 6 February 2015.

[6] As Voltaire quipped after the Royal Navy executed Admiral John Byng, “They shoot one to encourage the others.”