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There's this
dinky little country in the "where's that?" region of the eastern
Mediterranean -- south of Albania and Macedonia, and west of Turkey. The population
is 10 million, a little less than Los Angeles (13m). Greece has a debt/GDP of
107%, and a budget deficit of about 13% of GDP. Figures not too far off from
the United States, actually. The basic problem with the Greek government, and
practically all governments today -- just look at what has been going on in
California or Illinois -- is that they are politically incapabable of
reducing their deficits without some sort of default process. The lenders
have to say "no more." These governments aren't going to cut
themselves off. Even if the politicians tried, they would be faced (and are
faced) with pressure from entrenched interest groups, whether in the form of
striking public employees, government departments that don't want their
budgets cut, pork recipients who don't want to be cut off, and the
beneficiaries of various government programs.
Without outside support (a "bailout"), Greece would probably now
find it difficult to impossible to issue debt. If it did issue debt, it would
be at yields and maturities (high, short) that would likely force a default
in the near future. If the government is unable to issue new debt, then it
will be unable to pay maturing debt. They kicked the can until they ran out
of road.
So what? What would happen next is that the government's checking account
would finally run out. This would, unfortunately, be rather shocking, but
politcians are not much for subtle hints.
First, the debt itself. Contrary to popular belief, debt doesn't go to zero
just because someone misses a payment. All kinds of things could happen. The
existing debt could be paid at a later date, or at a reduced rate of
interest. It could even be paid in full, after a brief payment delay. (I
think the Russian debt was paid in full following the Russian default in
1998.) The debt would immediately trade on the market at a price reflecting
the likelihood of future payment, full or partial, and the potential timing
of those future payments, discounted to the present. I would guess this would
be around €0.80 to begin with. So, holders of Greek government debt
might take an immediate €0.20 loss. OK, so what. Anyone who owns that
debt today, after all that has happened thus far, is not exactly unaware of
the risks.
How about in Greece itself? The government would have to balance its budget.
How horrible is that? This might not be so hard as it sounds, because the
country won't be making payments on the existing debt, at least for a while.
If debt/GDP is 107%, and the average coupon on the existing debt is 5%, then
you'd be saving about 5.35% of GDP right there, at least in terms of
cashflow. Then, of course, all the various parasitic hangers-on (unions, pork
recipients) would -- I hope -- get kicked off the gravy train. Basic
government services would likely continue. Government employees aren't going
to stop showing up for work. They know better than that. (In California, most
government employees showed up for work on their unpaid "furlough"
days.)
Contrary to popular belief, a government doesn't just go poof because there's
a default. Just like a company doesn't disappear when they go bankrupt. The
U.S. airlines have spent probably half of the last 20 years in bankruptcy,
but the planes still fly. However, while a company can certainly be
liquidated, nobody is going to liquidate a government. The main practical
effect is that the government won't be able to borrow, and also won't make
debt payments -- two things which, arguably, might be good.
Apparently, Greece has been in some form of default for 105 of the past 200
years! They are no strangers to this process.
The next thing that would likely happen is that other at-risk governments
(Portugal, Spain, Ireland, possibly Italy) would also have a funding crisis.
This is not really because of "contagion." "Contagion" is
a metaphor. The metaphor is of an infectious disease. It's not as if
Greece was "healthy" and then became "sick" through no
fault of its own -- oh, never that! Never never! Nor is Spain is
"healthy" right now. Government bureaucrats (and their pet
economists) love these sorts of metaphors because it helps them avoid blame.
Spain and Greece have been chronically ill for years, because of their own
internal decisions. What would really happen is that the problems that both
have finally got too big to ignore. A better metaphor would be a non-infectious
disease. Like gross obesity combined with diabetes, caused by a constant
diet of Doritos and Red Bull. Both Spain and Greece are in the "too far
gone to save" ward of the local hospital, weighing 450 lbs each and
unable to get out of bed. Then, one week, they both died. Big surprise.
Let's just assume that all of these countries go into default, including
Italy. We would have a similar sort of dynamic, although on a larger scale.
So what?
The main fear here is that something would happen to the euro. Presumably, it
would go down. Why? Here's the crux of the matter: because the ECB doesn't
know how to properly manage its currency. What should be the simple
cause-and-effect of capitalism -- rotten governments have to shape up,
holders of their debt get smacked around too, and maybe everyone learns a
little lesson as a result -- becomes a currency issue, when it shouldn't be.
Why should a default by Greece on its euro-denominated debt cause a problem
with the euro? Russia (population 142 million) and Brazil (population 192
million) defaulted on their dollar-denominated debt in 1998 and ... nothing
happened to the dollar. Argentina (population 40 million) defaulted on its
dollar debt in 2002, and Turkey (population 73 million) defaulted in 2001.
Mexico would have defaulted in 1995, if not for a U.S. bailout. Dollarized
Ecuador (population 13 million) defaulted in 2008. Practically all the Latin
American countries default on their dollar-denominated debt about once a
generation. It's a common thing.
Indeed, the best thing is usually for these governments to just default
fair-and-square, and avoid any entanglement with the bloodsucking IMF.
The U.S. dollar didn't have much problem during these past episodes of governments
defaulting on dollar-denominated debt. But, let's say there is indeed a bit
more turmoil for the euro. This is the point where the ECB would have to
bring a little bit of managerial expertise to the table -- by reducing the
euro monetary base in unsterilized intervention (or actually by any
means) in response to declining demand for euros, if that materializes.
Unfortunately, the ECB doesn't have any expertise to bring to the table. They
are incompetents. You can see the problem.
People have the impression -- from many bad experiences in the past -- that a
government default causes all sorts of economic problems. But why should this
be? Let's say you own a little resort down by the beach in the Greek Isles.
The sun is still there. The beach is still there. The pretty girls keep
showing up. Your hotel hasn't fallen down. Pasty-white office workers from
Britain and Sweden are still willing to visit for their week off. Why do you
care whether or not the government made the payments on some of its debt?
Does it matter?
It shouldn't matter. But, it often does, because government defaults are
often accompanied by:
1) Currency turmoil. However, since
Greece uses the euro, this shouldn't be a problem unless the ECB screws up.
2) Higher taxes, fees, appropriation of property etc. Governments
often go completely insane when they have money problems, and start grabbing
all the wealth they can lay their hands on. Tough going if you are a private
businessman. Ideally, Greece would not raise taxes, but rather lower them.
If Greece sticks with the Magic Formula -- even in a default! -- the
effect on the private economy would be minimized.
Low Taxes
Stable Money
Thus, the best solution for Greece and the rest of euroland, in my opinion
is:
1) The ECB should properly manage the
euro via the adjustment of base money supply so that there is no
unwanted currency turmoil.
2) Germany etc. tell Greece that they have to bear the effects of
their prior decisions. Greece defaults.
3) Greece then cleans up their internal finances and politics. Maybe
they could ban the government from issuing debt, as the Japanese government
did in 1950.
4) Then, Greece adopts a flat-tax system to ramp up the economy.
5) The combination of a relatively stable currency (euro) and a flat
tax system makes Greece a "tiger economy" for the next twenty
years. Remember our Magic Formula: Low Taxes, Stable Money.
You probably think that #4 is sort of unlikely, right? Remember, it's what
Russia did right after their 1998 default. It's only unlikely because you
think it's unlikely. Russians didn't see it that way. They thought it was
necessary. Indeed, you could even say that they needed to default to
finally get to the point where they were ready to say: "We're not going
to put up with this crap anymore. We're Russians! We deserve better!"
When they got to that point, it was very clear to them that a 13% flat tax
was necessary.
This is more-or-less the way that capitalism is supposed to work.
"Capitalism" is a system. It is not "whatever happens
happens." It is not "we blew stuff up with our incompetence."
It is not the lack of a system, or chaos. The system of capitalism
depends on a stable currency, taxes low enough that people can prosper, and
failure where it is due.
* * *
Unfortunately, a lot of people today just don't get the idea of the euro.
This includes the eurozone leaders themselves.
The notion that every country should have its own currency -- the Keynesian
paradigm of "currency management" -- still hangs heavy in the air.
This is particularly true among English-speaking people. There is a lot of
talk now that Greece should be "kicked out of the eurozone," or
that Greece should voluntarily withdraw from the eurozone and issue its own
currency, which presumably floats. All of this seems rather bizarre to me.
Why is it that Greece somehow needs its own currency, when Illinois
(population 13 million) does not? There is no reason.
Just imagine if Illinois had its own currency, managed by its own central
bank. There is a foreign exchange market between the Illinois peso and the
U.S. dollar. Everyone in Illinois gets paid in the Illinois peso. Companies
there have peso-denominated accounting. To do business with entities outside
of Illinois, they have to go to the foreign exchange market. Anyone who wants
to borrow or lend to entities outside of Illinois faces all sorts of forex
difficulties. Of course, there are occasional "currency crises"
because both the peso and the dollar are mismanaged by their respective central
banking incompetents.
We can easily imagine all the completely stupid, unnecessary problems this
would create. This is roughly what Europe looked like before 2000. There were
so many stupid, unnecessary problems that they all agreed to use a currency
issued by the ECB, which is to say, the Germans, who are (relatively) good at
managing currencies.
Less incompetent, anyway.
European countries used to get by -- in 1910 for example, or 1960 -- with
their own currencies because they were all pegged to gold. Thus, their
exchange rates didn't fluctuate. You could say they were all actually using
the same currency, gold. The euro is really a return to the normal European
way of doing things, which is to have a single monetary standard (gold or
euro) in use continent-wide. It's so hard to do business otherwise.
A few countries understand the problems of having their own floating,
mismanaged currency, and have adopted the dollar or the euro unilaterally,
without being part of the eurozone or United States. For example:
Ecuador, El Salvador, Panama, East Timor, the British Virgin Islands, the
Marshall Islands, the Federated States of Micronesia, Palau, and Turks and
Caicos all use U.S. dollars as local currency. There is no domestic currency.
In several countries, dollars circulate as a de facto local currency,
although there is no official dollarization policy. This includes Peru,
Uruguay and Cambodia. You can buy things and get change in dollars, just as
if you were in San Diego.
A number of other countries use dollar pegs, including China, Hong Kong,
Malaysia, Kuwait, Syria, certain Gulf states, Lebanon, and a few others.
Kosovo, Monaco, Andorra, San Marina, Vatican City and Montenegro use euros,
although they are not part of the eurozone. Plus, there are another 23 countries
and territories (mostly in Africa) which use a currency pegged to the euro.
Liechenstein uses the Swiss franc. Bhutan uses the Indian rupee. Tuvalu uses
the Australian dollar and Niue uses the New Zealand dollar.
Let's imagine what might happen if Greece were "kicked out of the
eurozone," presumably against their will by irate Germans. Would the
government then issue their own currency? They might, or they might not.
Maybe they would just let Greeks use the euro, as they have becomed
accustomed to. The Germans might complain: "No, you can't use the euro!
That's our currency!" So what. Greece is no longer part of the eurozone.
That means that they don't have to do what the Germans say anymore. Greece
could be just like Montenegro, and use the euro "without
permission."
Ha ha ha.
Or, maybe the Greek government would issue its own currency, which would
probably blow up in no time at all. Then, Greeks would still be using the
euro, but it would be on an informal basis rather than an official basis. Just
like the U.S. dollar in Peru (population 29 million) or Cambodia (population
15 million).
Now, let's consider if the Greek government decided to voluntarily withdraw
from the eurozone. The Greek government could still use euros. But, we will
assume that they replace euros with their own currency, the
"crapatski."
This would leave a lot of existing contracts denominated in euros. For
example, bank deposits of Greek banks would still be in euros, and wage
agreements. The government would probably then have a mandatory conversion of
these obligations into crapatskis. So, if you are a typical Greek citizen,
your bank account is now payable in crapatskis, and you are getting paid in
crapatskis at work. If you are a smart Greek citizen, you will probably drain
your bank account and trade the crapatski bills for euro bills on the black
market as soon as possible. However, most Greeks wouldn't be that smart. Too
bad for them.
This is roughly what happened in Argentina in 2002, when the existing
currency board arrangement was replaced by a domestic floating currency,
which immediately cratered.
What about that government debt amounting to 107% of GDP? Much of that is
held by foreigners. It still needs to be paid in euros. If it isn't, that
constitutes a breach of agreement, which is a default. So, either way, the
Greek government would default on its bonds, either by not paying in euros,
or by "paying" in crapatskis, which are also not euros.
Let's say you own €2 billion of Greek government debt. The Greek government
says: "Don't worry about default! We're going to pay you in these
crapatskis we made on the laser printer last night." Whew! You're not
worried at all.
Even if the Greek government wanted to pay off the debt in euros, where would
it get the euros from? All of its tax revenues are now in the form of
crapatskis.
Probably, the crapatski would soon plummet in value. Indeed, I would say the
only reason for the existence of the crapatski is to have something that
could be devalued. What then? The Greek economy would shrink, of course. This
makes the debt even harder to pay off. If the debt is 107% of GDP today, but
GDP (in euro terms) falls by 50% because the crapatski implodes, then the
debt becomes 214% of GDP. Fuggeddaboudit.
I think we can see that there are really no advantages to be gained by having
Greece leave the eurozone and issue its own currency. Maybe the only apparent
advantage is printing-press finance. If the Greek government suddenly
converted to crapatskis, nobody would buy their bonds anymore -- including
Greeks themselves. The result would be exactly the same as a default on the
euro debt. They would be shut out of the debt market. Then, they would have
that big 13%-of-GDP deficit to finance. This could conceivably be
"financed" by pure money-printing. However, that charade would only
last for a little while -- a few months -- before everything collapsed in a
heap of hyperinflation. The end result would be much, much worse than if
Greece simply stayed part of the eurozone and defaulted on its debt. Also,
the end result would be that Greeks would stop using crapatskis, and use
euros instead, on the black market if necessary. This is what happened in
Zimbabwe.
I think European leaders understand this. People in Spain don't want to go back
to the peseta. Italians don't want to go back to the lira. Greeks don't want
to go back to the drachma. They know -- from decades of experience -- how
much it sucks to have a low-quality currency. This is why I think this notion
of "dropping out of the eurozone" and going back to an independent
floating currency is circulating primarily in the English-speaking world.
Because, if you look at the countries which haven't had generations of
bad experience with crap currencies -- the countries which haven't learned
their lessons yet -- what are they? The U.S. and Britain, mostly. It is
in the English-speaking world that the Keynesian ideology of monetary
manipulation and convenient devaluation ("quantitative easing") is
ascendant. The English-speaking Keynesians are the ones braying: "those
Europeans should be more like us!" The Europeans themsleves don't buy
this baloney, at least not as much. That's why they set up the euro project
in the first place.
Sometimes you find someone who can just sum up the conventional wisdom for
you. Here's Steve Liesman of CNBC, on February 11, 2010:
"Isn't the difference between Greece
and the U.S. that the U.S. has a printing press and Greece doesn't. At some
point it is no longer any good for Greece to be part of a union where it
can't have any control over its monetary policy."
Do you see what I mean about the Anglophone economists?
The
euro should really have been pegged to gold. I suppose it will be,
eventually. After the requisite period of bad experience, of course.
Nathan
Lewis
Nathan
Lewis was formerly the chief international economist of a leading economic
forecasting firm. He now works in asset management. Lewis has written for the
Financial Times, the Wall Street Journal Asia, the Japan Times, Pravda, and
other publications. He has appeared on financial television in the United
States, Japan, and the Middle East. About the Book: Gold: The Once and Future
Money (Wiley, 2007, ISBN: 978-0-470-04766-8, $27.95) is available at
bookstores nationwide, from all major online booksellers, and direct from the
publisher at www.wileyfinance.com or 800-225-5945. In Canada, call
800-567-4797.
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