The headlines are buzzing today with more news about the European crisis and speculation abounds on the fate of Greece within the Eurozone. Just reading this article in the New York Times today highlights just how badly the European leaders have failed so far to contain this crisis and put the peripheral economies on sound footing. This crisis has been going on for over a year now and who would have thought that it would have lasted this long, let alone threaten French banks to the point of downgrade? Yield increases on Italian and Spanish debt were not too surprising but could have been avoided if the Western European leaders, in particular Angela Merkel, had actually dealt with the underlying problems in the Eurozone instead of attempting to muddle through.
Just for clarification, does any actually think Greece can avoid default without some radical transformation of the European Union into some sort of transfer union designed to tax the Germans to pay for the Greeks? This issue has bothered me for quite a while now: The Germans refuse to allow either the Greeks to default/leave the Eurozone, while simultaneously refusing to turn the EU into something closer to a transfer union that might help peripheral economies to overcome their deficits. It shouldn’t take much macro thinking to see that this is a complete contradiction.
Usually in a recession or debt crisis, the affected country has a few tools available. One process, which might happen automatically, is that the currency should weaken relative to trading partners due to the weakness in the economy and the heavy debt burden. This should allow the affected country, Greece in this case, to improve its trade balance with its partners, providing extra growth. This essentially means exports should increase creating jobs and income. Of all the ways of paying down debt, growth is by far the best solution. If the currency, however; doesn’t weaken on its own, the government always has the option to print currency to pay debt, which causes a real decrease in the value of the debt and shortens the pay down time. Another, more controversial for a heavily indebted (>60% debt/GDP) country, is to undergo Keynesian stimulus to try and spur growth. Right now, Greece should be experiencing one of these three options for dealing with debt, but there is one huge obstacle: Germany and the Eurozone.
Since Greece is a part of the Eurozone, it has relinquished independent control of its monetary policy to institutions more heavily influenced by Germany and France than they are by Portugal, Ireland, and Greece. So instead of being more liberal with interest rates to encourage lending and consumption to revive growth, the ECB raised rates only just this summer! Meanwhile, as lending conditions become tighter in Europe, Greece’s lenders (Germany, France for instance) are asking for greater cuts in government spending to close the budget gap. For those of you with less macroeconomic knowledge GDP = consumption + investment + gov’t spending + net exports. Of course, in a time of low investment and consumption, government spending is the only other actor (besides exports, which we already mentioned) that could create growth. So the European leaders deny Greece the option of increasing its exports (lack of independent monetary authority) while simultaneously asking for Greece to cut government spending! This is completely absurd.
And now the real point: Greece needs to leave the Eurozone today and default on its debt. period. This would of course cause a sharp decrease in output initially, but would allow Greece the option of competing on the world market with its own prices (as opposed to German prices). This may seem ridiculous to some of you, but I provide you with a little recent historical example of how defaulting and floating the currency in an indebted country without independent monetary policy can really help. In Argentina pre-2002, the leaders pegged the peso at an extremely rigid exchange rate to the U.S. dollar eventually reaching 1:1. This of course hurt exports and growth, similar to how the strong Euro hurts Greek products and services. Argentina also had a debt problem at the time. However, the Argentine government didn’t have rich partners to bail it out like the Greeks do, so eventually they had to default and negotiate for debt restructuring. The got rid of the 1:1 peso to dollar peg and the results are apparent in this graph:
You clearly see a moderate recession lingering until the Argentine default in 2001 which led to a deep, but short v-shaped recession. Immediately after this deep recession, growth rebounded strongly and continued at levels equal to and high than before the crisis. compare this to the Greek situation and you will immediately notice the differences. The Greek crisis remains precisely because of the inability of the European leaders to recognize or admit to the inconsistencies in their demands on the weakened Greek economy. I doubt Greece will recover at all until something gives one way or the other in favor of default or the creation of a transfer union. Though it may be tempting to attempt at preserving the current make up of the Eurozone, the Germans must realize that it will be increasingly difficult for Greece to avoid default unless it finds someway to create growth. Let the Greeks go, let them retake control of their own currency, let them restructure their debt and maybe this financial crisis will finally end!
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Hmm, interesting point on Argentina. A lot of food for thought here that I need to look into.
I’m interested to hear your opinion on something a finance guy told me recently: that the EU has something akin to The Articles of Confederation. what’s your opinion?
What about the perspective of the German taxpayer who in the end will have to pay for a Greece bailout? Should they support Greece’s departure as well?
@OFM
At face value is it unfair to ask the German taxpayer to pay for the problems of another European country since the EU and the eurozone are not designed to be transfer unions (yet) like the federal government of the United States. However, you have to look one level deeper. It’s true the Germans were “responsible” and the Greeks seemingly “irresponsible” and therefore why should German money go to Greece? However, the source of Greece’s problems come partially from the euro and the monetary policy of the ECB. These are two institutions undoubtedly controlled by the French and Germans. They chose certain monetary policies to benefit themselves (raising rates in the middle of a Greek recession), maybe without even understanding the consequences for their peripheral partners.
It is therefore reasonable to conclude that if the French and Germans wish to hold a disproportionate power over the EU institutions, then they should also accept a certain level of responsibility for dealing with the consequences. So if the German taxpayer should support a controlled Greek exit from the eurozone to simultaneously avoiding banking “irresponsibility” while helping Greece become competitive.
@padmalin
I personally am in support of a more unified Europe- although I think the path to getting there will be long and hard. The above article outlines many of the problems inherent in the current euro system, all of which have been revealed before- the early nineties were particularly problematic. The solution possibilities are either a slow disintegration of the euro zone, or further unification that will eliminate such problems. An Articles of Confederation-type document is exactly what needs to be revised to a Constitution-type document to improve the euro zone. Whether or not this will happen in the near future is up for debate.
Thank you Marshall.
@OFM – Absolutely NOT!! If I were a German or French taxpayer, I’d be making some noise. Assistance when it’s needed is one thing; absolute bailout for irresponsible behavior is quite another and doesn’t serve Greece in the long run at all. All it does is appease the world market balance for a little while, while encouraging said irresponsible behavior in the rest of the struggling countries of the Union. Doesn’t this just delay the inevitable a little further down the line?
At the risk of being labelled the commentator who’s a little ‘out there’, I’d like to point out something just recently learned. Quakewatch has shown that earthquakes in Greece, which happen frequently on a daily basis, have risen lately in intensity if not in number. I’ve noticed the magnitudes climbing from the 1′s into the 3′s in the past couple days. Coincidence? Hmmm….
@padmalin @OFM
The issue with bailing out Greece is that the seemingly “irresponsible” behavior undertaken by the Greeks may not be caused by any fault in Greek society, but more by mixed incentives created by the euro system. Since the Greeks lose productivity against the Germans by competing with a currency of the same strength, the Greek economy will have to face an increase in unemployment and a slowing of growth unless some other factor picks up the slack. Since the euro provided low interest rates, this made it easiest for investment and government spending to take up the slack in growth to preserve employment. The ballooning of government debt corresponds with this idea.
The Greek disease of taking on too much debt may more reflect on the current world economy whereby certain economies undertake measures to create very large trade surpluses (china, japan, germany). Since all world trade balance must net to zero, this means there must be some countries that run very large trade deficits. Since surpluses boost growth, the surplus countries do not need as much debt to provide growth, whereas the deficit countries must increase debt to maintain employment. One could say the United States faces a similar version vis-a-vis China as Greece does with Germany.
The best thing for the surplus countries to do is to decrease their large trade surpluses or even become deficit countries. This will provide extra demand for the exports of the debt ridden economies, allowing them to grow without having to take on more debt. This would simultaneously give Japan, China, and Germany a chance to balance their economies towards more consumption (almost universally agreed to be necessary before the world can grow stably again).
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