Kori Schake at Foreign Policy:
Watching Greeks fire-bomb their banks, shut down their airports and ruin the tourist trade that is their economy’s main prospect, I can’t help but hear Virgil reprised. In that Roman poet’s great narrative The Aeneid, survivors of the Trojan War seek a place to start anew, after much difficulty founding what will become the Roman Empire. It’s rough going, and after much hard luck and stormy seas, the Trojan women burn the ships in order to prevent the men returning them all to sea.
They knew the Sybil (a rough approximation to an oracle for the Greeks) had prophesied that when they “quit at last of the sea’s dangers / for whom still greater are in store on land… wars, vicious wars / I see ahead, and Tiber foaming in blood.” Seeing the fleet in flames, Ascanius’ reaction is “but your own hopes are what you burn!” And so it is with the Greeks — they burn their own hopes by such unwillingness to do the unpleasant but necessary belt tightening.
Tourism provides one in five jobs in the Greek economy and a full sixteen percent of its gross domestic product. Being tied to location, it cannot be manufactured elsewhere. Being tied to history and culture, it is inherently Greek. And the best way to attenuate the effects of the austere cutbacks in government spending necessitated by Greece’s financial crisis is to grow their economy as fast as possible. The debt to GDP ratio goes down both by reducing the numerator and increasing the denominator. Yet the Greek riots against the austerity program are sure to diminish tourism.
It is difficult not to sympathize with German hesitation to bail Greece out. Germany has labored for nearly 20 years to bring the former East Germany up to par with the West. Greece leapt into the euro on questionable accounting and proceeded to splash around the cheap credit that German stolidity in finances extended to the rest of the eurozone. One in three Greeks is a government employee. Hairdressers can retire at age 50 with full pensions because their jobs are categorized as hazardous.
But now much more outrageous is that than our Foreign Service Officer’s Union refusing rewarding diplomats that serve in war zones? When Secretary Rice tried to give preferential promotion to diplomats that volunteered for service in Iraq or Afghanistan, the union representatives argued that every posting is dangerous — as though volunteering to serve in Iraq took no more courage than volunteering to serve in Costa Rica. Currently two-thirds of foreign postings are designated as hazardous duty posts.
With markets tanking yesterday in part on fears over Greece’s economic state and people starting to utter the words “financial crisis” again, I called Desmond Lachman to get an overview of the situation. Lachman is a resident fellow at the American Enterprise Institute. Previously, he served as a managing director and chief emerging market economic strategist at Salomon Smith Barney, and as a deputy director in the International Monetary Fund’s Policy Development and Review Department. A lightly edited transcript of our conversation follows.
Ezra Klein: What has happened to Greece? We’ve gone from rarely hearing about them, to occasionally hearing about them, to being told the global financial system is threatened by them. But they’re tiny! How is this happening?
Desmond Lachman: The market has figured out that Greece is insolvent. They really can’t address their budget deficit by the amount that the IMF is asking them to do without sinking their economy. That means the market is realizing Greece can’t repay the $400 billion of sovereign debt they’ve got.
And then the bigger problem is that the markets are looking at Portugal and Spain and Ireland and the concern is that the European banking system is vulnerable to these crises because the European banks own these bonds. Spain has a trillion in bonds, and when you add Portugal and Greece and Ireland, you’re talking $2 trillion. If there’s a default on that, these bonds are in French, German and Dutch banks. So it’s not just think rinky-dinky little economy, you’re talking about the whole European banking system. Greece is like Bear Stearns. But there’s a few Lehmans out there. And the question is, what happens if they come unstuck?
EK: Let me back you up even before the market’s reaction to the IMF and E.U.’s bailout proposal. How did Greece get here?
DL: It’s October of 2009. The new prime minister is elected and the first thing he does is say he’s looked through the books and the budget deficit that seemed to be 6.5 percent of GDP was actually more than 12 percent of GDP. And the Europeans already had a limit of 3 percent of GDP to be in the E.U. So what was going on? First, the Greeks were lying. Second, now people begin to wonder if you can be in the E.U. with such a high deficit.
So then people began focusing on Greece’s debt and realized that Greece looks like a Ponzi scheme. The government is just borrowing money to repay interest on their debt. And then people realized how bad Greece’s finances were. Then people didn’t want to lend money to Greece, and so Greece couldn’t pay its debts, and that’s how the crisis started.
Paul Krugman at NYT:
So, is Greece the next Lehman? No. It isn’t either big enough or interconnected enough to cause global financial markets to freeze up the way they did in 2008. Whatever caused that brief 1,000-point swoon in the Dow, it wasn’t justified by actual events in Europe.
Nor should you take seriously analysts claiming that we’re seeing the start of a run on all government debt. U.S. borrowing costs actually plunged on Thursday to their lowest level in months. And while worriers warned that Britain could be the next Greece, British rates also fell slightly.
That’s the good news. The bad news is that Greece’s problems are deeper than Europe’s leaders are willing to acknowledge, even now — and they’re shared, to a lesser degree, by other European countries. Many observers now expect the Greek tragedy to end in default; I’m increasingly convinced that they’re too optimistic, that default will be accompanied or followed by departure from the euro.
In some ways, this is a chronicle of a crisis foretold. I remember quipping, back when the Maastricht Treaty setting Europe on the path to the euro was signed, that they chose the wrong Dutch city for the ceremony. It should have taken place in Arnhem, the site of World War II’s infamous “bridge too far,” where an overly ambitious Allied battle plan ended in disaster.
The problem, as obvious in prospect as it is now, is that Europe lacks some of the key attributes of a successful currency area. Above all, it lacks a central government.
Consider the often-made comparison between Greece and the state of California. Both are in deep fiscal trouble, both have a history of fiscal irresponsibility. And the political deadlock in California is, if anything, worse — after all, despite the demonstrations, Greece’s Parliament has, in fact, approved harsh austerity measures.
But California’s fiscal woes just don’t matter as much, even to its own residents, as those of Greece. Why? Because much of the money spent in California comes from Washington, not Sacramento. State funding may be slashed, but Medicare reimbursements, Social Security checks, and payments to defense contractors will keep on coming.
What this means, among other things, is that California’s budget woes won’t keep the state from sharing in a broader U.S. economic recovery. Greece’s budget cuts, on the other hand, will have a strong depressing effect on an already depressed economy.
A large part of his argument is that Europe is not an optimal currency area because it lacks a large central government enacting transfer payments among the various regions. That argument will be familiar to students of macroeconomics. (See, e.g., the case study on monetary union in chapter 12 of my intermediate macro textbook.)
Is that right? I am not so sure. The United States in the 19th century had a common currency, but it did not have a large, centralized fiscal authority. The federal government was much smaller than it is today. In some ways, the U.S. then looks like Europe today. Yet the common currency among the states worked out fine.
Once upon a time, one might have said that the U.S. back then had a particularly vicious business cycle. But Christy Romer’s path-breaking research has demolished that claim.
One might argue that the 19th century had a different set of labor institutions than we have today, and these facilitated the adjustment of wages. That argument, suggested by the research of Chris Hanes, may have some merit. If that is the case, then maybe that is the path forward for Greece and the rest of Europe. As Paul suggests, increasing wage flexibility won’t be painless. Yet it might be easier than giving up on the Euro experiment.
A final possibility is that the key difference is labor mobility: Americans were willing to move among the states, whereas Greeks have to stay in Greece because they don’t speak German. If that is the key difference, then Paul may well be right that the Euro experiment is over.
Mankiw’s claim, however, that the U.S. currency was an optimal currency area in the 19th century is less convincing. In terms of labor mobility, Gavin Wright has shown that South was an almost entirely separate labor market up until the 1930s-1940s. There was very little labor movement going into and out of the South up until New Deal programs and World War II spending opened up the region. Thus, the cost of the South’s membership in the U.S. currency union may have exceeded the benefit up until the latter half of the 20th century. Interestingly, Hugh Rockoff makes the case the U.S. economy did not become an OCA until the 1930s!
I will go one further in this debate. It is not clear to me even now that all of the United States is an OCA. Do we really think Michigan and Texas over the past decade or so benefited from the same monetary policy? And do we think both states had an adequate amount of economic shock absorbers? Given the vast differences between these two states in their business cycles, diversification of industry, union influence, and wage stickiness it easy to wonder whether these states should belong to the same currency union. Yes, they have access to fiscal transfers, labor mobility is great (I myself left a job in Michigan for this one in Texas), culturally they are similar, and politically there is will for the dollar union. Still, given the disparate impact of U.S. monetary policy on different regions of the country one does wonder whether all the United States is truly an OCA.
Ryan Avent at Free Exchange at The Economist:
Certainly rich ground for speculation. One might ask whether labour costs in Michigan, relative to other states, are the issue. Would depreciation help, in that case? Or is it better to try and force structural change onto sinking states? And are transfers between states actually adequate? It’s interesting, Americans are somewhat more comfortable with the idea that population mobility across states is perfectly wonderful, and it’s not a huge tragedy if once thriving areas depopulate. Preservation of, say, North Dakota as a functioning economic entity doesn’t get nearly the priority as would the preservation of a sovereign European state. I guess this is because of the historical and cultural legacy in European countries. American states are more like lines on maps than ancestral homelands.
Back to Greece. David Randall at Forbes:
For once, American tourists have something in common with international currency traders: This summer, they are all wondering how the Greek financial crisis will impact the dollar.
Yesterday, the value of the euro fell to a 14-month low, ending the day at $1.25 for every dollar. Over the last six months, the euro has fallen 17%, leading some economists to speculate that the crisis will prompt some countries to leave the euro zone.
On the face of it, the uncertainty in the financial markets should make a trip to Europe much more affordable this summer. But few things are straightforward in the world of international currency. (There’s also the question of whether you’re really getting a good deal if it’s cheaper to go to a place where riots are breaking out, but that’s for another post.)
To start with, you’ll need to decide when to convert your money from dollars to euros. It is better to try to lock in the 14-month low now, or should you wait a few weeks to see if it will go lower?
Even experts aren’t too sure. “Foreign currencies are one of the most difficult things in the world to time,” Bob Johnson, an economist at Morningstar, told me. “If you have flexibility there could be more downside to the euro in the next couple of weeks, but the euro has come down a great deal from where it was a couple of months ago.”
The strength of the American economy compared with the economies of Europe will most likely continue to push up the value of the dollar over time regardless of what happens in Greece, he said.
David Dayen at Firedoglake:
The Greek President said the country is on the brink of the abyss and urged calm.
But what do the people have to be calm about? The government – and actually, it was the previous government to the current one – basically conspired to hide their debt problems with banks like Goldman Sachs. In the aftermath, those banks owed money will get theirs from the IMF, with a pass-through of Greece. But the people will suffer with lower pay, higher taxes, and general suffering for everyone but the elites. They have every right to be angry, although the deaths may temper that frustration somewhat.
Meanwhile, the big issue is the potential for “contagion” to spread to other countries beyond Greece. Spain and Portugal are the biggest potential culprits. And the passage of the austerity package does not put it into law – the Parliaments of the other countries in the Eurozone must also pass the measures.
And now, with the news today, Reuters:
A $1 trillion global emergency package to stabilize the euro unleashed a spectacular rally in world stocks on Monday but analysts said EU leaders had only bought time to tackle deep-seated fiscal problems.
The “shock and awe” rescue plan — the biggest since G20 leaders threw money at the global economy following the collapse of Lehman Brothers in 2008 — triggered the biggest one-day rise in European shares in 17 months after panic selling last week.
Wall Street also surged as confidence returned, at least temporarily. The Dow Jones Industrial average jumped 3.63 percent and the narrower Standard & Poor’s financial share index was up 4.7 percent amid relief among banks.
The package of standby funds and loan guarantees that could be tapped by euro zone governments shut out of credit markets, plus central bank liquidity measures and bond purchases to steady markets impressed financial analysts by its sheer scale.
Senior International Monetary Fund official Marek Belka said the emergency package was “morphine” for the markets but should not be regarded as a long-term solution.
Is the massive EU bailout a case of “too much, too late”? At $1 trillion, give or take (depending on the highly-uncertain value of the euro), it’s certainly enormous: Mohamed El-Erian calls it “a completely new level and dimension” in terms of European policy response. But the late-night negotiations of European finance ministers might yet fail to pass muster with national governments. After all, as Kevin Drum notes, the $700 billion TARP bill was initially voted down by the House of Representatives, and this deal has to be ratified by not one but many different legislatures.
Meanwhile, Peter Boone and Simon Johnson have some very scary numbers about Greece in particular: it will have to cut spending by a whopping 11% of GDP; its debt-to-GDP ratio will rise to at least 149% of GDP in a best-case scenario; and realistically Greek GDP could fall by 12% between now and 2011. Now that’s a recession.
So, the question of the day is, will bond markets feel suitably shocked and awed by the eurozone’s decision to throw more than $950 billion at the Greece problem in order to prevent the spread of contagion?
For some reason, I can’t get this scene from Dirty Harry out of my head when I think about the answer. To paraphrase it for our purposes, wouldn’t this whole drama be easier if some eurozone finance minister could confront bond traders with the following speech:
I know what you’re thinking. Is this my last rescue package, or do I have another source of credit in reserve? Well, to tell the truth, in all this excitement I kinda lost track myself. But being this is a €720bn rescue package, the most powerful one in the world, and would wipe away any short position you’ve taken in the past week, you’ve got to ask yourself one question. ‘Do I feel lucky?’ Well do you, punk?“
The thing is, Dirty Harry is a lot more convincing than Angela Merkel.
1. The fundamental cause of the financial crisis has been people and institutions thinking they are more wealthy than they are; this spread to Europe as well and now we are seeing the comeuppance.
2. Although accounting conventions differ, and numbers should not be shifted out of context, many major European banks are highly leveraged. The mechanics of the so-called “shadow banking system” — namely the ability of short-term creditors to flee on a moment’s notice — remain in place.
3. The major European powers would not have come up with a nearly $1 trillion bailout, also involving de facto loss of ECB independence, unless they were scared ****less.
4. They are trying to do a version of TARP-in-advance-of-the-panic and in my view that panic would have come today.
5. Here is one view, consistent with my own: “My quick thoughts on markets are as follows: great for risk assets, terrible news for bonds, great news for southern European bonds, bad news for the flight to quality UST trade, and ultimately terrible news for the EUR. Maybe the EUR tries to rally on this, but it the end this bailout has done nothing positive for the EUR. The market will inevitably look at the ECB as being forced by the EU to monetize the debts of EU rogue nations…”
6. Basically the ECB is monetizing bad government debt claims.
7. The Fed has reactivated its dollar swap lines to Europe.
8. “Greece’s 10-year borrowing costs plunged by almost half — an astonishing 5.9 percentage points — to 6.5 percent.” And Deutsche Bank is up ten percent.
9. This doesn’t solve any of the basic fiscal problems, so ultimately it raises the stakes and creates a chance of even greater financial failure. Simon Johnson comments.
10. Question: does this sentence sounds scary or non-scary?: ““We shall defend the euro whatever it takes,” Mr. Rehn said.”
11. Felix Salmon writes: “They’re not all partners together anymore: now they’re bifurcating into the rich lenders, on the one hand, and the formerly-profligate debtors, on the other. The mind-boggling sums involved are only going to increase resentments both of the south in the north and of the north in the south.”
12. How much time has the EU bought itself?