All eyes in the financial markets have been focused on Greece for some weeks now. The Greeks borrowed too much money and now international financiers are worried about how they will pay it back. The government must raise €53 billion this year or about 5 percent of GDP. Total Greek sovereign debt is somewhere between $300 and $400 billion. The lack of precision stems from the fact that Greece hid and under-reported their debt for years by availing themselves of complex financial instruments purchased from investment banks including Goldman Sachs. Those guys again?
For comparison purposes, the U.S. needs to raise an additional $1.5 trillion, or about 11 percent of GDP, to cover the 2010 budget deficit. Congress recently increased the permitted debt ceiling by $1.9 trillion to $14.3 trillion, which is about 100 percent of GDP. Before you worry too much about a Greek tragedy in our future, remember that being the issuer of the world's reserve currency does bring some advantages. We take further comfort from the fact that China and Japan still consider the U.S. "too big to fail."
It may seem odd that the debt crisis of a relatively small country should merit such attention but, after all, Greece is part of the Economic and Monetary Union of Europe (EMU). Actually that is a misnomer. While the euro is indeed the currency representing a monetary union with a central bank, it is hardly an economic union. Economic union means coordinated fiscal and economic regulatory policies and, ultimately, foreign and military policies, at least in terms of commerce external to the union. That, of course, leads to politics and we all know for certain that the EU is far from a political union. Let's say monetary union and a sort of open trade zone.
Like any club there are rules for joining and remaining a member. For the EU some of the rules limited public budget deficits to 3 percent of GDP. Those rules were tossed overboard years ago when the two largest founding members, Germany and France, could not abide by them. The core question today is whether the taxpayers in other EU countries are willing to bailout the profligate Greeks. And, by the way, if they save the Greeks, won't the Spaniards, Portuguese and Irish be getting on line for some of the same largesse? The Germans have seen this movie before when they acquired the economic train wreck of communist East Germany. But there was a key difference: the East Germans had the same language and same cultural heritage. It was like taking in a long, lost cousin that you found homeless on the street.
How do the German taxpayers feel about bailing out the Greeks? They might do it if the Greeks will adopt Germanic fiscal discipline. The council of EU finance ministers has also stated that Greece must impose draconian budget austerity by March 16 or the EU will impose a budget under Article 126 of the Lisbon Treaty. They have also suspended Greek voting rights at a key committee meeting. This last was more of a symbolic slap in the face. Under Article 126, Greece would become a ward of the EU. And what are they requiring? The Council is demanding that the deficit be reduced from 12.7 percent of GDP to 3 percent in three years.
Meanwhile the Greek economy is in freefall with retail sales off 9 percent and industrial production falling 7.6 percent. Unemployment is at 10.6 percent and climbing. There are already strikes and riots in Athens to protest the imposition of economic austerity by foreigners. This reaction is no different than the legions of third world countries who were subjected to the IMF's bitter economic medicine over the last 50 years. We're trying to think of a case when the IMF's policy prescription of fiscal austerity and sound currency produced a success. None are coming to mind. The IMF produced mostly social turmoil and political upheaval.
So what happens if the Greeks don't want to act like Germans? Could they get tossed out of the monetary union or withdraw under Article 50? The mechanism there is a little hard to contemplate. We suppose they would lose access to the European central bank, meaning that drachmas would be brought back to life. They would stop servicing their euro-denominated debt and call for a "Paris Club" rescheduling. Inflation would take off as the government printed money and issued drachma-denominated bonds to finance operations and pay government workers. Under Gresham's law the euro would be quickly driven out as the primary currency in circulation. The government would likely begin with a fixed exchange rate, but the market would eventually establish a truer value.
In the U.S. the sort of cross-border support the Europeans are struggling with is common place. Every year taxpayers in California and New York send money to Washington that is used disproportionately to aid the citizens of West Virginia and Mississippi. We've even extended our largesse outside the 50 states. In 1995, using an executive order, President Clinton lent Mexico $20 billion and guaranteed some of their bonds to solve a debt and currency crisis. Mexico stabilized quickly and the money was repaid well ahead of schedule. The last time Europe needed a bailout was after WWII when U.S. taxpayers generously put up 1.4 percent of GDP to rebuild the place between 1945 and 1952.
Every banking crisis eventually begets a sovereign debt crisis. The two are self-reinforcing. One obvious worry is how the banks that hold Greek debt could sustain the financial impact of a default. The other is that lack of support from the union for a Greek restructuring will lead to exits by other weak countries and the collapse of the entire union. For many, ceding their suzerainty is political suicide. So not only might we see pesetas, punts and escudos in the future, but francs and deutschmarks as well.
Odd Juxtaposition
On Thursday, President Obama stepped in front of a national television audience and spoke about the importance of federal fiscal responsibility. He then announced the creation of The National Commission on Fiscal Responsibility and Reform.
On Friday, Tiger Woods stepped in front of a national television audience and spoke about the importance of marital fidelity. He then returned immediately to rehab.
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