Greece

The End Game?

Yesterday, Walter Russell Mead wrote about and quoted George Soros on the subject of Europe and its economic fate:

Regular readers know that while I disagree with George Soros on a number of points, I find him to be one of the keenest observers of world events. And of all the subjects on which George is brilliant, Europe is perhaps his best….

In a speech recently given in Trento, Italy, George lays out his vision of the crisis of the European Union and the prospects for its recovery….

The first third is a rehash of some basic concepts that George uses to distinguish between the social sciences and the natural sciences….

Once he’s worked through this concept, George turns his attention to what went wrong in Europe — and to what could be done about it. In a nutshell, he says that the Europe of the last twenty years was a kind of bubble: it was a “fantastic object” — something that was so alluring and attractive that people behaved as if it existed even though in fact it did not.

Now that the financial crisis (which George diagnoses as both a sovereign debt crisis like the third world debt crisis of 1982 and a banking crisis) is upon us….

And what does the world’s most successful financial investor thinks will actually happen?

But the likelihood is that the euro will survive because a breakup would be devastating not only for the periphery but also for Germany…  So Germany is likely to do what is necessary to preserve the euro – but nothing more. That would result in a eurozone dominated by Germany in which the divergence between the creditor and debtor countries would continue to widen and the periphery would turn into permanently depressed areas in need of constant transfer of payments. That would turn the European Union into something very different from what it was when it was a “fantastic object” that fired peoples imagination. It would be a German empire with the periphery as the hinterland.

Today, Mead writes:

After months upon months of fruitless back-and-forth over the Eurozone crisis, as Greece and then Spain brought the continent ever-closer to the brink of catastrophe, the signs of a coherent German policy are beginning to emerge. The Wall Street Journal reports:

Germany is sending strong signals that it would eventually be willing to lift its objections to ideas such as common euro-zone bonds or mutual support for European banks if other European governments were to agree to transfer further powers to Europe….

Unfortunately, the end result is still anything but foreordained. The French, for their part, have balked at the kind of loss of sovereignty over fiscal matters that the Germans are demanding here. And the fact that this kind of sweeping change would require the rewriting and re-ratification of scores of EU treaties means that no solution is immediately at hand, even if all of Europe’s leaders agree to a solution. It’s not at all clear that markets will give Europe the time its sclerotic political process needs to work through — and it’s even less clear that all the other EU countries will sign up for Germany’s new plan.

But a step forward is a step forward, and given the stakes, any sign of life from Europe’s political leadership is to be welcomed.

All may be for naught, however, because of the huge pile of indebtedness and obligations that the industrialized nations have accumulated. One financial expert, Raoul Pal, sees it this way:

…Pal expects a series of sovereign defaults, the “biggest banking crisis in world history”, and asserts that we don’t have many options to stop it.

Pal previously co-managed the GLG Global Macro Fund. He is also a Goldman Sachs alum. He currently writes for The Global Macro Investor, a research publication for large and institutional investors.

A note on the presentation; the last slide is not meant to suggest that we’re going back to the economic activity of 3000 years ago. It refers to the 3000 year old trade links between the nations along the Indian Ocean, which Mr. Pal believes will be the center of world’s opportunities. Just like the West 50 years ago, they have “…low debts, high savings and a young population”….

Read it and … panic? I link, you decide.

Related posts:
The Causes of Economic Growth
In the Long Run We Are All Poorer
Mr. Greenspan Doth Protest Too Much
A Short Course in Economics
Addendum to a Short Course in Economics
The Price of Government
The Price of Government Redux
The Mega-Depression
As Goes Greece
Ricardian Equivalence Reconsidered
The Real Burden of Government
The Illusion of Prosperity and Stability
Estimating the Rahn Curve: Or, How Government Inhibits Economic Growth
The Deficit Commission’s Deficit of Understanding
The Bowles-Simpson Report
The Bowles-Simpson Band-Aid
The Stagnation Thesis
Taxing the Rich
More about Taxing the Rich
America’s Financial Crisis Is Now
Money, Credit, and Economic Fluctuations
A Keynesian Fantasy Land
The Keynesian Fallacy and Regime Uncertainty
Why the “Stimulus” Failed to Stimulate
The “Jobs Speech” That Obama Should Have Given
Regime Uncertainty and the Great Recession
The Real Multiplier
Vulgar Keynesianism and Capitalism
Why Are Interest Rates So Low?
The Commandeered Economy
Stocks for the Long Run?
We Owe It to Ourselves
Stocks for the Long Run? (Part II)
Estimating the Rahn Curve: A Sequel
In Defense of the 1%
Bonds for the Long Run?
The Real Multiplier (II)
Lay My (Regulatory) Burden Down
The Burden of Government
Economic Growth Since World War II
More Evidence for the Rahn Curve

As Goes Greece . . .

. . . so goes the United States? Well, maybe the dependents of our welfare state won’t riot. But, riots aside, the U.S. has much in common with Greece: a huge and rising burden of government (accompanied by a huge and rising burden of government debt), leading to economic stagnation.

As for how the burden of government stagnates an economy, I’ve said plenty. See especially this and this. For more evidence, I turn to statistics and projections available from the Organization for Economic Cooperation and Development (OECD), which has 31 (mostly Western) member nations:

Derived from tables 1 and 32, available at OECD Economic Outlook No. 86 Annex Tables — Table of Contents. The debt-burden statistics represent gross government debt for 1995-2010. The changes in GDP are for 1996-2011.

How fares the debt burden of the United States? Not well:

Derived from OECD annex table 32. I use gross debt because net debt understates the debt burden. For example, it treats the federal government’s IOUs to the Social Security Trust Fund as if they were legitimate assets, which they are not.

All Euro zone countries are represented by the wide, gold line. Greece is a Euro zone country, but I have plotted its debt burden separately to highlight its plight. Japan, the most burdened OECD country, is infamous for its economic stagnation. And there’s the U.S. (wide, blue line) moving ahead of the Euro zone, and not far behind Greece. What’s worse is that the outlook for the U.S. beyond 2011 is deeper debt.

Here’s Robert J. Samuelson’s (correct) analysis of the situation:

What we’re seeing in Greece is the death spiral of the welfare state. This isn’t Greece’s problem alone, and that’s why its crisis has rattled global stock markets and threatens economic recovery. Virtually every advanced nation, including the United States, faces the same prospect. Aging populations have been promised huge health and retirement benefits, which countries haven’t fully covered with taxes. The reckoning has arrived in Greece, but it awaits most wealthy societies. . . .

The welfare state’s death spiral is this: Almost anything governments might do with their budgets threatens to make matters worse by slowing the economy or triggering a recession. By allowing deficits to balloon, they risk a financial crisis as investors one day — no one knows when — doubt governments’ ability to service their debts and, as with Greece, refuse to lend except at exorbitant rates. Cutting welfare benefits or raising taxes all would, at least temporarily, weaken the economy. Perversely, that would make paying the remaining benefits harder.

Greece illustrates the bind. To gain loans from other European countries and the International Monetary Fund, it embraced budget austerity. Average pension benefits will be cut 11 percent; wages for government workers will be cut 14 percent; the basic rate for the value added tax will rise from 21 percent to 23 percent. These measures will plunge Greece into a deep recession. In 2009, unemployment was about 9 percent; some economists expect it to peak near 19 percent.

If only a few countries faced these problems, the solution would be easy. Unlucky countries would trim budgets and resume growth by exporting to healthier nations. But developed countries represent about half the world economy; most have overcommitted welfare states. They might defuse the dangers by gradually trimming future benefits in a way that reassured financial markets. In practice, they haven’t done that; indeed, President Obama’s health program expands benefits. What happens if all these countries are thrust into Greece’s situation? One answer — another worldwide economic collapse — explains why dawdling is so risky.

Can Markets Force Fiscal Discipline?

Today’s market meltdown was triggered by the fear that Greece’s financial problems will spread to other European governments, and then to the United States. Greece’s problems can be described simply: The government cannot afford to pay the debts it owes because it has expanded the welfare state at the behest of its ignorant, greedy citizens. Moreover, the problems of Greece will spread to other Euro-zone nations if and as they incur debt in order to bail out Greece. (Recommended reading: “The Mother of All Bubbles.”)

Now, change “Greece” to the “United States” and you have a perfect description of what is likely to happen in this country if “our” government continues to drive us along the road to Europeanism.

The question of the day is whether the strongly negative response of financial markets to the situation in Europe will cause Europe’s “leaders” — and our own — to re-think their commitment to fiscal profligacy. Or, as seems more likely, will those “leaders” be so fearful of reneging on their irredeemable promises to their political constituents that they fall back on the time-honored “remedy” known as hyperinflation?

Hyperinflation — which is easy enough for central bankers to engineer — “solves” the problem of debt by smothering it under a mountain of new money. The problem with that “solution,” of course, is that it affects not just a government’s creditors but every economic actor. Real economic activity grinds to a near-standstill as vendors raise their prices to unaffordable levels in anticipation of facing even higher prices for their factors of production. Entrepreneurs give up on business formation for the same reason. In the end, a vibrant economy based on money and credit is reduced to a stagnant, near-subsistence economy based on personal relationships and barter.

Which way will Europe and the United States go? I have little confidence that our “leaders” will choose the path of fiscal discipline. They are especially unlikely to choose the path that encourages economic growth by shrinking the welfare state.