The Greek Crisis

I don't know about the readers of this blog, but I am now at a stage of simply being overwhelmed by the ongoing and endless rescues of the Euro. Every day the news pours out on the latest initiative, the latest plan, the latest crisis meeting/summit, the latest bad news......In light of this, it was a pleasure to read the latest take on the story from Spiegel Online, which cuts through much of the fluff on Greece. The headline and sub-head offer a great summary:

European Politicians in Denial as Greece Unravels


Europe's politicians are losing touch with reality. Greece is broke, and yet Brussels wants to send the country billions in new loans, to which there is growing opposition within the coalition government in Berlin. Rescue efforts are hopelessly bogged down by bickering over who will ultimately step up.

This was the part that I really liked:

The Greek economy is not productive enough to generate growth. Aside from olive oil, textiles and a few chemicals, there are hardly any Greek products suitable for export. On the contrary, Greece is dependent on food imports to feed its population.

"Greece has been living beyond its means for years," an unpublished study by the German Institute for Economic Research (DIW) concludes. "The consumption of goods has exceeded economic output by far."

Especially devastating is the assessment that the DIW experts make about the condition of an industry that is generally seen as a potential engine for growth: tourism. According to the DIW study, the Greek tourism industry concentrates on the summer months, with almost nothing happening throughout the rest of the year. There is almost no tourism in the cities, which translates into low overall capacity utilization and high costs for hotel operators. By contrast, capacity utilization in the hotel sector is much more uniform in other Mediterranean countries.

I have long argued that this is one of the fundamental problems that sits beneath the economic crisis. It is the fantasy that a country can just continue to endlessly consume more than it produces. Whilst Greece may be an extreme case, it is very apparent that Greece is not alone. I am going to quote at length from the first post of this blog, which is from an essay I wrote in 2007:

I am going to start by looking at the world from the point of view of many modern economists. Whilst none of the economists would accept that what I am about to portray is their belief, when you look hard, you will find that this must be their basic belief. If not, then they have no justification for their pronouncements of success for the UK economy.

Imagine a family living in the UK, not an atypical family, not a typical family, but an ordinary middle class family. We will call them the Wilsons. The father has a job in management for a chain of retailers, and earns £30,000 per year. The mother has a good job in a local hotel where she is the marketing manager and earns £30,000 per year. They therefore have an income of £60,000 a year. They have two children at the local school.

The Wilsons have purchased a home, which cost them £300,000, which is five times their combined income, using a 95% mortgage. The house has increased in value by £30,000 a year, in each of the three years since they purchased it. They are very pleased to see their house growing in value, as it is like having another earner in the house, except this earner pays virtually no tax on the income, making it an even better earner than themselves.

The Wilsons have a relatively large mortgage, but interest rates are low. Despite this, they struggle to balance the quality of life that they enjoy against their income. As such, they make use of credit cards to occasionally purchase items. Each year, for three years, they have added £6000 to the family debts through overspending on the ‘little luxuries’ in life, such as holidays, and new goods for the house. At the end of the second year in the house, Mr. Wilson decided that he would fulfil his dream of owning a Mercedes, and re-mortgaged the house to realise £20,000 of the increase in value of this asset. He used this as the down payment on the car, and took a loan for £20,000 to pay for the remainder.

Overall, the Wilsons non-mortgage debt stands at £18,000 for the credit cards, and £15,000 remains of the loan for the car. They are starting to find the payments on these debts are stretching them, and they seem to be using the credit cards a bit more often than before.

Next door to the Wilsons live the Jones family. The Jones family know and respect their next door neighbours. They can see how successful they are. They are always doing something to the house, making improvements, and they seem to be living the good life. Only recently the Wilsons bought a new Mercedes and Mr. Jones feels a little jealous, as he would love a Mercedes too.

The Jones family, have less income than the Wilsons, but every year they save a few thousand pounds. They have no debt except for their mortgage, and only spend what they earn. They purchased their house at the same time as the Wilsons, and are steadily paying their mortgage. Their belts are tight, but they get by, and look forward to better days ahead.

Which of these two families is the more wealthy family?

The answer largely depends on whether you are an economist who has been a cheerleader for the boom of the last ten years, or whether you are a person grounded in the real world. The Wilsons have been the motor of growth in the Anglo-Saxon economies. Apparently we have gone through a period of sustained growth and, in moments of hubris (Gordon Brown in the UK being a wonderful example), we promote the ‘success’ of the Western economies to the rest of the world. The trouble arises when we ask a simple question; ‘Where is this growth?’

The Greeks are the Wilsons. Yes, they have lived a good life. But the bills have simply grown to the point where they do not have enough income to repay them. This aspect of economics has never been complicated. If you are continually borrowing to pay for consumption, you will indeed have a high standard of living - for a while. Unless your income growth is outstripping the rate of debt accumulation, it is only a question of time before the credit becomes too much to service. It is not a case of 'if', but 'when'.

It is very curious how much effort and time goes into denying this simple formulation. The answer to the problems of too much debt is apparently to just borrow more....We see it endlessly from economists, politicians and commentators. Austerity is self-defeating. The answer is to borrow more. 'Yes', when borrowing more, the economy will appear to grow. Just like the Wilsons, there will be an illusion of wealth for a little longer. However, like the Wilsons, it can not change their actual real income; it cannot change the ability to create real wealth.

The Spiegel article gets to exactly this point with Greece. Greece simply does not have the ability to continue to have the high standard of living that it has previously enjoyed. That standard of living was supported by unsustainable debt accumulation. They just do not create enough wealth to either continue to live as they have done, or pay back the debts accumulated in giving them an illusion of wealth.

I just do not understand how it is that this simple and evident reality can be ignored by so many. In the case of Greece, it is plain to see. And just as it is plain to see in the case of Greece, it is also plain to see in the cases of other economies. They may not be as dramatic as Greece, but the same principle applies.It really is very simple.

Austerity in the UK

I know I bang on about Krugman, but his pronouncements become ever more silly, and I would like to relate his latest silliness to the post above. This is his commentary on austerity in the UK:

Britain, in particular, was supposed to be a showcase for “expansionary austerity,” the notion that instead of increasing government spending to fight recessions, you should slash spending instead — and that this would lead to faster economic growth. “Those who argue that dealing with our deficit and promoting growth are somehow alternatives are wrong,” declared David Cameron, Britain’s prime minister. “You cannot put off the first in order to promote the second.”

[and later]

And we may get tipped in the wrong direction by Continental Europe, where austerity policies are having the same effect as in Britain, with many signs pointing to recession this year. 

The infuriating thing about this tragedy is that it was completely unnecessary. Half a century ago, any economist — or for that matter any undergraduate who had read Paul Samuelson’s textbook “Economics” — could have told you that austerity in the face of depression was a very bad idea. But policy makers, pundits and, I’m sorry to say, many economists decided, largely for political reasons, to forget what they used to know. And millions of workers are paying the price for their willful amnesia.

There is one very fundamental problem with his use of the exemplar of the UK for the evils of austerity; there is no 'austerity' in the UK, just talk of it. It is a point made very well in a post in the Money Illusion:

But I am seeing article after article claiming that the coming recession is due to fiscal tightening.  I was curious to see just how tight British fiscal policy actually is, so I checked the “Economic and Financial indicators” section at the back of a recent issue of The Economist. They list indicators for 44 countries, including virtually all of the important economies in the world.  Here are the three biggest budget deficits of 2011:
1.  Egypt  10% of GDP
2.  Greece:  9.5% of GDP
3.  Britain:   8.8% of GDP
Egypt was thrown into turmoil by a revolution in early 2011.  Greece is, well, we all know about Greece.  And then there’s Great Britain, third biggest deficit in the world.

There is absolutely nothing that can be described as 'austere' about the rate of borrowing in the UK. Quite the opposite - it is shockingly profligate. In reality, the UK is doing exactly what Krugman has long argued for, and has now been doing it for a long time. The UK is borrowing and spending with abandon. The really shocking thing about the UK economy is that, despite following this reckless path, it is still seeing shrinkage of the economy.

What Krugman means is that the UK government should increase the rate of debt accumulation to even higher levels. It is his solution to all ills. Just borrow more, or print more money. He cannot even see that the UK is already doing exactly what he recommends, that it has been doing so for a long time, and that it has not worked. Quite the opposite. For all the debt accumulation, the UK economy is still shrinking.

As regular readers know, I do not argue the case of expansionary austerity. I can at least agree with Krugman on this point. Real austerity will be a hard and painful path. If the UK were to balance the government budget tomorrow, the UK economy will nosedive. However, as I argue above, in the end, there is no real choice but to see the economy nosedive at some point. It is not 'if', it is 'when'. Again, as argued above, Krugman's solution will keep the illusion going for a while, assuming that bond markets play ball, but it will only prolong an illusion.

In the post above, I talked of the way that modern economists might see the two families. At the time of writing I was not familiar with Krugman. However, he is exactly the kind of economist who would propose that the Wilsons are the wealthier of the two families. He seems to really believe this......it is shocking. It is why his pronouncements are so very, very wrong.