Are Europe and Greek Debt like the Titanic and the Iceberg?

After the American Century

Imagine that Europe is a large ocean liner called the Titanic, and that it is sailing straight toward a massive iceberg that has appeared in the Mediterranean off the coast of Greece. The original idea  for the ship was to create watertight compartments (national economies) below deck, so that if one or more of them filled with water (debt), the others would not also fill up. But this original plan was not fully carried out in the actual construction. The ship turns out not to be unsinkable because its compartments are not sufficiently strong, watertight, or numerous.

If I could go back in time and rebuild the Titanic, I would carry out the original design more completely. Greek debt is the iceberg smashing into the Euro, and I would rather each national economy had largely to stand on its own. Unfortunately, the European "reform" that seems to be favored by most leaders today is to remove most of the interior barriers and thicken the outside hull of the ship as a whole. The idea is that superior leadership and regulation from the center will avoid most of the fiscal icebergs of the future, and that when they do come the improved hull with be strong enough. I would rather not make well-functioning economies hostage to the Italians, the Greeks, the Spanish, and the Portuguese, or for that matter to any country that in the future might get itself into financial trouble.

What can Europe learn from this fiasco? I suggest that it ought to learn to keep the national economies more separate, rather than the widespread idea that what Europe needs is more integration. Better, surely, (1) to prevent banks from loaning more than 4% of their total worth to a single country, and (2) to limit how much money any nation can borrow abroad, making it finance a minimum 75% of its own national debt. If its own citizens will not buy most of the debt, why should anyone else?

More than two years ago I argued that Greece should not be bailed out. I wrote then, "Greece cannot pay its bills, even in the short run. With a national debt that is more than 110% of its gross national product, and a deficit of more than 10% for this year, Greece's debt will only get worse unless and until it enacts real reforms. So far it has failed to do enough, and the deficit will only get worse."

Most of what I wrote then is sadly still accurate now, except that the rest of Europe and the IMF have been pumping money into Greece while insisting on draconian reforms. But it has not worked. The choices then as now are either Greece leaves the common currency and goes back to its traditional overspending (with periodic drachma devaluation) or it really puts its house in order. Sadly, the second task is beyond its political capacity, as its recent, failed election process demonstrates.

As the crisis has been prolonged, money has been fleeing the country for safe havens before the collapse which seems to draw slowly but inexorably closer. It is difficult to know precisely how much money has been transferred or carried personally away from Greece, but it is more than €1 billion. This money could have helped keep the economy going. It is like taking blood from a dying man. Adding further to the misery, tourists are wary of booking trips to Greece, because it may descend into financial and political chaos. Why go there when other places are far more stable?

The only bright spot here is that the rest of Europe has had 27 months to prepare itself, by putting some firewalls in place. Whether these are good enough is not clear.

Had the Greeks been hit with a natural disaster like an earthquake, they would deserve sympathy and charity. But for years the Greek insisted on spending more than they could afford. They gave massive pay increases and early retirement to state employees that were not funded by taxation. Tax evasion was massive. There is no reason for the other European states to give or to loan them any more money. Giving them another handout will only delay for a short time the day of reckoning.

Can the Euro Crisis Be Solved? Not in Greece

After the American Century

The Euro Crisis has not gone away. Several times there have been meetings and pledges of more money. The Greek Governemtn keeps making cutbacks, and the Greeks themselves keep protesting. The EU keeps up the pressure with one hand and gives the Greeks money with the other. Nothing seems to change for the better, and the financial fallout continues.

Who would have thought that all European consumers would be nervous because the Greeks profligately overspent? Why should this matter to other countries? Because the banks are all inter-related, and in Greece they are over-exposed. What is now possible is a kind of gigantic domino effect, in which the fall of Greece will topple some banks abroad, which will in turn have a knock on effect right across Europe and across the globe. 

Once upon a time the world was less connected, and some countries made a regular practice of overspending and then devaluting their currency. Take Mexico as an example. Starting in the 1950s for two decades the exchange rate was 12.5 pesos to one American dollar. But in 1976 this rate became impossible to maintain, and Mexico lowered the value of its currency to 20.4 pesos to the dollar. By June, 1982 the rate was 25 to the dollar, but things rapidly got much worse reaching 150 to the dollar by the end of the year. This was a serious crisis for Mexico. It got worse in the following decade, but it did not drag other larger economies to ruin.

By comparison, Greece has a smaller economy than Mexico, but it is much more tied into the economies of its neighbors. Mexico's peso fell pretty much on its own, but Greece has the same currency as much of Europe. 

So how bad is it in Greece? Worse than it was a year ago. The yearly deficit is getting bigger, not smaller, despite passage of austerity measures. It reached 19.2 billion euroes ($26.1 billion) for the first three quarters of 2011 compared to 16.65 billion euros for the same period last year. That is considerably worse than the EU Commission predicted in 2009, as can be seen in the chart above. The EU thought the deficit would be "only" about 12.3 billion for all of this year, but it looks to be about twice that once we have all four quarters. The cumulative deficit is growing even faster than the annual deficit, because it includes interest payments. The Greek rat hole is getting much larger, not smaller, as the size of the debt is exploding. Worse still, the cutbacks now being feverishly passed in Greece will reduce economic activity, in turn reducing revenues from taxation. It is a vicious circle, and nothing suggests that the Greeks are going to be able to avoid catastrophe. 

It may be time to give up on saving them and instead bail out the banks outside Greece, so that the European economy can continue to function. The banks should not be allowed to make a profit on their incompetence, of course, but it looks as though we must save them from ruin. I suggest this not for any love of banks, but because it seems the only plausible course of action to protect the rest of the EU. 

I said the European banks have been irresponsible. How so? Consider a chart from the Financial Times.

Far more than any other EU nation Greece has relied on foreign banks to buy its debt. This was smart of Greece, perhaps, but just plain stupid on the part of the banks. I would suggest an EU regulation that created a sliding scale for the amount of debt any member country could sell to outsiders. In other words, the worse the deficit, the less debt could be externally financed. A nation with almost no deficit would be able to borrow more and far more easily. Frugal virtue would be rewarded, profligacy punished, and punished much sooner than has happened in the present crisis.

Going off the cliff with Greece could ruin the EU economy for some years, and the Europe that might emerge after such a collapse will have fallen well behind Asia and the United States. Decoupling the banks from Greece will not be pretty, and the Euro will fall, but it will fall less and fall for a shorter time.In such a scenario, any Christmas bonuses for bankers would be obscene.