Wednesday, April 28, 2010

Sovereign Default - Who is at Fault?

I am watching the Greek crisis as it takes its painful course, and have noted that there are some views which seem to suggest that Germany has an obligation to rush to the rescue. A Guardian article is typical, though the extract below does not really capture the overall sentiment of the article:

After days and days of hesitation and apparent indecision, when speaking to the audience at the rally in Bocholt, Merkel played the populist card. We're right to tell the Greeks: you have to save money, you have to be candid and you have to work on your honesty, otherwise we can't help you, Merkel said.

It's one thing to ask Greece for strict austerity measures in return for a bailout deal. But when Merkel implicitly said that the Greeks weren't honest and had poured money down the drain, she didn't ask for anything. She didn't even try to calm the fear among Germans that contributing billions to the Greek bailout will lead to further wage cuts and tax freezes.

Perhaps, the sentiment is best expressed with the picture of Angela Merkel that accompanied the article. The picture is quite disgraceful:



What we are seeing is a pass the parcel of blame, and Germany looks like will be left holding the package. However, all of this is to lose sight of the reality of the situation. The Greek debt is the fault of Greece, and nobody else.

There have been suggestions that somehow Greece was enticed into debt, that it really is not their fault. It is the view that Greece is like a consumer persuaded into a dodgy Hire Purchase agreement, without realising the consequences of signing on the dotted line. However, in this case, our consumer has lied about their level of debt on the application form. We might have less sympathy for this consumer...

However, it is not like a consumer signing a deal, as there is a critical difference. Whilst a consumer might plead ignorance, lack of understanding of the consequences of their own actions, not understanding the real cost of the loan and so forth, this is not the case with a government. In the case of governments, they employ experts whose sole job is to examine the economic consequences of the policies of government. There is no excuse of ignorance. Every time that a government metaphorically signs on that dotted line, they do so with expert advice.

What of the Greek people? Greece is a democracy, and therefore the Greek people themselves might be seen as culpable. They elected the governments that racked up the debts, and they might be seen to take a collective responsibility, as part of the contract implicit in democracy. However, I am reluctant to blame the Greek people in some respects. I do not know the role of the press in this debacle, and whether there was a sufficient momentum of criticism of the debt accumulation to give the Greek people an informed view of the eventual consequences. At the very least, the lies of the government not only hid the extent of the problem from the creditors but also from the electorate.

On the other hand, the response to the crisis is not encouraging. The strikes that are being undertaken to prevent the austerity measures are a wilful denial of the reality of the situation. Greece is broke, does not have the means to pay the bills, and are asking for credit. If they continue with their current spending, they will not pay back the money, and it is reasonable to ask that they tighten their belts, and start living within their means. It is not wickedness of Germany to ask for this, but reasonable. There is absolutely no moral obligation for Germany to bail out Greece. The government of Greece made their choices, and are responsible for the consequences.

In addition to the implication that Germany should, in all cases, bail out Greece, economic arguments have been put forwards, as in this fairly typical example:

But there are other aspects of the crisis which are common to many – most advanced economies have had their finances stretched to breaking point by the recession – and unless some kind of line is soon drawn in the sand, Greece's problems will spread to the next weakest link in the chain, widely thought of as Portugal, and then perhaps to others too.

What's more, German and French banks are big holders of Greek and Portugese debt. Default itself might trigger a second round of banking collapses, with further deflationary consequences for affected nations.

This is a variant of what I will call the chain reaction argument. This is the idea that a line in the sand must be drawn in Greece to prevent further banking crises or further sovereign debt crises. The problem is that, as has been found with Greece, even if the debtor countries massively reduce expenditure, the bailouts will be of massive proportions. The level of bailout money for Greece just keeps on climbing, and the same will apply to the next 'at risk' countries. If the creditor countries open their cheque books, where will it end?

If they start, at what point will they call a halt? At Portugal, at Spain? More to the point, the countries supplying credit are already running their own deficits. They must borrow yet more money to bail out the debtor nations, thereby creating greater risk of having their own debt crises, and borrowing money to lend to countries that appear to be reluctant to face up to the consequences of their previous profligacy; in other words borrowing money to lend to poor credit risks that insist on continuation of spendthrift ways.

I normally try to take a more objective view of the economic crisis, but there just seems to be so much complexity being overlaid over a simple situation that I am becoming more frustrated. I have just submitted a new article to TFR magazine (it should be published in the print and online version soon) and it points out that we are not looking at 'contagion' to other countries, like a disease is contagious, but rather that the doctors are learning how to diagnose the disease - and the disease is fiscal profligacy. There are a host of countries that have the same problems, including the UK and US. It is time for these countries to act, as there simply aren't going to be any saviours that will ride to the rescue. Even a small country like Greece, with a relatively tiny economy and relatively small absolute debt levels is having trouble raising a rescue package.

Above all, this is not a contagious disease, but is the fault of the profligate countries for living beyond their means. In Greece it is (at least) primarily the fault of the government, and the same can be said of the other countries that are at risk. There are no excuses - they had the resource of 'experts' to draw on, the resource to examine the risks, and the resources to make decisions. There is no risk of contagion, as there is no disease. It is, plain and simple, a self-inflicted problem, and the solution to the problem lies in the hands of the policy makers.

The solution also (to a lesser extent) now lies in the hands of the electorates of each country. The reality of the consequences of profligate debt accumulation are now evident, and even the mainstream media are facing the reality of the tough choices. The electorates no longer have an excuse - the reality of the dire situation is now being placed in front of them. In the case of the UK, it is time they demanded of their politicians real honesty over what they plan to do. If not, they are by default culpable. The UK is lucky in this respect, having an election at the very moment that the light of reality is shining on the consequences of fiscal irresponsibility. They have a moment, brief as it is, to demand a change, and demand reform.

For other countries, there may not be such an opportunity before it is too late. In these countries, it is up to the third estate - the press - to wake up and pressure for reform. They need to shift attitudes, to create a groundswell of opinion that rejects the buy now pay later profligacy, and takes the lesser pain of reform now. It is time to pressure governments to tell the truth, and accept that they can not borrow and spend forever. It is time to accept that there are going to be no saviours, that the resource for the scale of bailouts needed will never be there. It is time to wake up from this complacent slide into ruination.

Notes:

I have watched with sadness as the UK election descends into the farce about the Prime Minister's calling a person a bigot. Whilst this is unpleasant, it seems to just be another distraction from real debate - the question of what is to be done about the economy. Whilst Gordon Brown's character is a legitimate subject for debate, the greater debate is buried.

I am, as you may guess, frustrated. I am still not sure whether the EU will hold off the crisis for a little longer, but in all cases, the ground of the crisis is now clearly in sight. Maybe there will be a last ditch rescue, and the crisis will take another pause....but maybe this is the start of the final phase. Your thoughts, guesses are welcomed in the comments section. My gut reaction is the start of the last phase, but I have called it wrong before.

As a final note, I have taken a different approach in this post, and hope that it is coherent. Let me know what you think.

12 comments:

  1. Hi Cynicus,

    I think you're being too soft on Germany.

    They're as culpable as the Greeks in all of this. They've maintained an artificial economic environment within the eurozone to preserve their much-vaunted export-led economy, while studiously ignoring the housing bubble this created in the economies of peripheral Eurozone countries.

    Just as my own country of residence, France, uses the Euro project as a means to keep Germany in concrete boots, each member state just participates for their own self-interested reasons.

    Germany won't be on the side of the gods once it's killed off all its client states and its export-reliant GDP tanks (again).

    The export profligacy of Germany is a distortion in the world economy just as surely as the ineptitude of the Greek state.

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  2. Say you were a money lender and you had two clients. Old Hans who is sensible and at a 5% interest rate you expect to make a profit. Young Sean is a bit more flighty and so should be charged 10% interest. You then decided to charge everyone the same interest rate of 5%.

    Sean borrows loads because 5% is far too good a deal for him not to. Then he realises he cannot pay back the money. Do you have some resposibility for not putting in the actual risks of the loan in the interest rate?

    If a lender lends money at the wrong rate is the borrower entirely responsible for the loss or should the lender also be blamed? Should sub-prime defaulters in the US be put into a workhouse?

    Hans here would be Germany and France who had the correct euro interest rate for their economy. Sean would be the PIGS who had an interest rate far to low for theirs.

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  3. The phrase "busted flush" comes to mind.

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  4. Electorates get the fiscal come-uppance they deserve, ie what they vote for over a long term period. If candidate A promises bread and circuses for all, paid for by 'taxing the rich' and borrowing the rest, and Candidate B promises to only spend what he raises in taxes, which come from the broad mass of the populace, which do you think will get the popular vote?

    The trouble is, as I think Adam Smith said,
    'There is a lot of ruin in a Nation'. Thus you can have many years of profligacy, decades even, and all will seem well. The doom mongers will be proved wrong time and time again, and the spenders will laugh, and say 'Don't worry, we won't raise your taxes to pay for all this extra spending, we'll just borrow it instead.' And they'll get the votes time after time. Just as Labour did in the last couple of elections, and the Greeks have for decades.

    It only ever comes to a head when reality actually bites. When the price of your bonds is falling through the floor, and the cost of new debt reaches astronomical levels, and your currency falls like a stone, raising the price of imported goods many fold. When the amount of govt spending just on paying the interest rises every year, and you get into a cycle of borrowing more, just to pay the interest on the old debt. Then the world threatens to come crashing around your ears, and even the most myopic politician realises something must be done, even if the electorate won't like it.

    We in the UK are not there yet, by a long chalk. There is a lot more ruin in this Nation, sadly. When we have run our debt to GDP ratio up to about 125% in 4 or 5 years time is when we will probably hit the buffers.

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  5. The media has become increasingly distracting, seeming to muddy the true nature of our reality rather than clarifying it.

    "I am, as you may guess, frustrated."

    By starting your article with a review of an article in the Guardian you seem to me to be beating the same path as most in the media ("those with a different ideology are obviously wrong" ) rather than exploring the situation itself as you usually do (and to me is much more interesting, useful).

    Maybe you are right, but Is it really worthwhile having a go at the wrongheaded, confused and misleading sh*te that appears in one particular newspaper? There is an almost infinite amount of it being spouted by so-called experts and non-experts in the press and on blogs etc.

    "There is no excuse of ignorance".
    It seems that the constant deluge of comment and opinion-pieces on opinion pieces guarantees a state of ignorance. No wonder so many people vote irrationally.

    "Greece is a democracy, and therefore the Greek people themselves might be seen as culpable. "
    When the media pushes so much attention onto the triviality of Brown's remark, can we really say that democracy is working?

    I heard that after the UTV political 'pop-idol' debate a quarter of million people registered to vote. Again, this seems to me a signal of democracy's inability to cope with our irrational nature and the ease with which the public can be manipulated.

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  6. Ruralidiocy: Thanks for the comment, but I do not think that you have dealt with the issue of the governments involved not having the expertise to see the consequences of their actions. When each country joined the Euro, they knew what they were joining....As for Germany's success in exports, I think that is too long a debate for a brief comment, but I am not sure I would agree with your analysis.

    Red Dave: A similar point to ruralidiocy. Sean is not an individual but a government. They are in a position to act responsibly, and do not have to accept the cheap credit. It is an active choice.

    Sobers: Perhaps you are right that it will take a while for all of this to come to a head, but there is certainly a change taking place. The important part is that markets needed to start to believe that 'rich world' countries can default. That belief is taking hold, and that means the risks have increased. As for timing...that is a difficult problem.

    Lord Sidcup: I have seen similar articles in other outlets, but the Guardian was my first port of call for an example (as it is most likely to have an illustrative example that is current). However, I will note your comment on what is more useful.

    With regards to democracy in action, I agree that it is not a pretty sight. At least some of the media are pushing for a refocus on the issue of the economy. As an example, I saw an interesting article reporting on the 'black holes' in economic policy found by the IFS.The trouble is that it takes both transmission *and* reception for this to have an impact.....

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  7. I tend to agree with Sobers, we are a fair way off the day of reckoning for the UK. In fact if the next government does start to get a grip of the deficit, then whilst things may seem tough we will no doubt bumble on for many years.

    The thing that may tip us over the edge is our reliance on importing raw materials, whether it be oil or whatever. I can only see the cost of these rising, leading to pressures on consumers and manufacturers and thus preventing the fabled 'growth' that every one keeps talking about.

    The problem the UK faces is that we are probably uncompetitive with many other countries due to a whole variety of reasons. Until we are competitive then we will be unable to grow our way out of the debt problem we are facing.

    My best guess is years of tough times, but the debt issue probably won't get worse, but equally it probably won't improve very fast either.

    I think the stresses here and in Europe will probably end up in the break up first of the Euro and then the EU itself as national self interest takes priority for most people.

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  8. The absurdity of having a single currency without a federal fiscal policy is about all the current crisis over Greece proves, as well as the ridiculously conservative monetary policy of the ECB.

    The Eurozone as a whole tends to have a trade surplus – the individual trade deficits in some countries are irrelevant.

    If demand for German goods was stimulated in other Eurozone countries through fiscal policy, Germany would benefit, not lose. Moreover, the EU already has an institution that can bailout any member countries by creating euros at will: it’s called the European Central Bank.

    The ECB should buy up Greek government bonds and the bonds of other nations facing debt crises.

    A European wide fiscal policy should also be implemented.

    In any single nation, the rich areas by definition redistribute wealth to the poorer areas.

    If the rich nations in the EU don’t want to redistribute some wealth to Greece (whose puny GDP is about 3% of the whole union), then the EU in its present form is a pathetic neoliberal sham.

    If it can’t be reformed into a federal system with a Keynesian economic policy, then it can be abolished.

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  9. This is actually a good article about the Greek situation, if you ignore the nonsense at the beginning about fiscal "profligacy":

    http://voices.washingtonpost.com/postpartisan/2010/04/the_greek_crisis_blame_germany.html.

    Quite simply, Greece and Germany are already so closely tied that they are like one nation
    state.

    A German bailout for Greece would be akin to the US federal government bailing out California: a national government helping one of its own states.

    If the Germans dont see it that way, too bad for Germany: their trade surplus with Greece can collapse causing higher unemployment and eocnomic contraction in Germany.

    The comment of Ruralidiocy above is right on the money. I like your amusing talk of German "export profligacy".

    If the Germans want a rising market for their goods within the EU, then how the hell will they get it without Keynesian demand policies?

    Better to subsitute federal fiscal policy for Greek bond issues - or get the ECb to buy up Greek bonds.

    If the EU is viewed as one large nation internal consumption of goods produced within the EU is precisely what is good for domestic demand-led (= Keynesian) economic growth, as it decreases consumption of goods imported from outside the EU.

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  10. Josiah Stamp's GhostApril 30, 2010 at 1:40 AM

    Blaming the Greek people at any level is plain daft. Since when did governments follow the will of the people?

    Do Governments praise their populace and sing their praises when times are good or do they claim the credit?

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  11. Don't blame the political establishment. The fault lies with the media and with the public - both of whom are completely unwilling to accept that anything is really wrong.

    If a political party did as you suggest and came out with the measures to tackle the deficit, and the elephant in the room - the actual debt - they would lose the election. Immediately.

    Watch the TV debates. The act of making 6BN "efficiency" cuts (an absolute drop in the ocean compared to the level of the problem) gets grilled as though it is the century's worst crime.

    The public just don't believe the depth of the problem. They, and the media who inform them, are in complete denial. And while that's the case, many will vote for the party that promises them an easy ride. Even if its a complete lie.

    This is extremely unfortunate, but its the way things are. However, I am seeing a quiet spread of disquiet. People are beginning to take on board the austerity message. The truth is quietly creeping in.

    I very much hope we have a Conservative win and I hope that then, despite the unpopularity the party will court, they do what is necessary and save the country. Again.

    Want to see a demonstration that the Conservatives do actual understand the problem and are ready to tackle it? Here you go:-

    http://conservativehome.blogs.com/platform/2010/04/andrew-lilico-denial-must-end-do-not-bail-out-greece.html

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  12. CynicusEconomicus thanks for the reply. Sean at least in the Irish case is not just a government. Many Sean's borrowed from the banks at low interest rates with little solvency testing. These then could not pay the banks back. And the government took over the banks and their debts.

    Actually your right this still looks like the governments fault...

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