http://www.nytimes.com/2010/05/14/opinion/14krugman.html?emc=eta1
We enjoyed a very nice pre-graduation dinner last night for one of our student groups and one of the brightest students we've seen asked about why the stock market dropped 1,000 points recently. My immediate response was "Greece". The student's response was what about those technical/computer/super nova/high powered trading issues? My response to that was: we've heard nothing in a week to prove anything having to do with high speed trading causing the drop.
Then, why Greece? It's a conversation we wish we could have finished with the student involved but the evening took another turn so we'll move on here to the "Greece" subject. Greece, in and of itself, is not the answer either, but Europe is. First, the stock market: who knows? Maybe George Soros? The stock market usually builds in anticipated events early. So, the assumption that, worst case, Greece could weaken the EU and the "Euro" by tanking, would create lessened demand for major America-based firms that now do a substantial portion of their business in overseas markets. That fits. Most of the big technology companies do more then 50% of their sales overseas (hence, the recent 9 month wait by Oracle to see if the European Union would approve its purchase of Sun). But, again, we'll leave the stock market, and theories about it, to George Soros, Warren Buffet, etc.
On Greece. Greece is Michigan. The size of the economies is comparable. But, the difference is in the macroeconomic positioning. The weakness of the EU and the "Euro" from the beginning was that their equivalent of our Federal Reserve was dealing with "countries" who consider themselves to have autonomy. Our Fed is dealing with "states" who can do something stupid but do not have the latitude to override certain key monetary policies.
So, Greece was (or is still) a threat to Europe because of what it represents (a potential domino effect - for those of us who remember Viet Nam - with Spain, Portugal, etc.). But, as Krugman says attached: "... we have a clear path to economic recovery, while Greece doesn't ... We may be running deficits of comparable size, but our economic position - and, as a result, our fiscal outlook - is vastly better."
We note with interest that Britain, which is in worse fiscal shape than the U.S., but did not adopt the "Euro" (and was criticized by the European Union for that lack of support), remains able to borrow at fairly low interest rates. Again Krugman: "Having your own currency, it seems, makes a big difference."
Europe has stepped up to "infuse" a trillion dollar stimulus into the situation. This may ultimately work. But, the Germans do not appear to be amused and the situation has yet to come to any closure.
What is clear is that those who want to compare Greece to the U.S. because of the debt to GDP ratios of both countries and then turn that into attacks on health care spending are just looking for excuses to cry wolf. We're not Greece. And, Michigan is not Greece.
But, sometimes, any little thing (especially if it's financial), is a trigger for the stock market to sell off.
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I really believe we are witnessing the beginnings of the death of the Euro as a currency. The reason is the unsustainable structure around which the Euro was built. The difference between Michigan and Greece is that Michigan is understood to be a separate entity from the United States Federal Government and the value of the US dollar is not backed by Michigan's taxing powers. The Euro on the other hand is backed by the collective taxation powers of the various governments, a fundamental difference, especially as there is no Euro-wide taxation authority. The ECB considers Greek bonds to be reserve assets, similar to how Treasury bills are in the US.
ReplyDeleteThis is the problem facing Europe that has no easy solution: Greek bonds are held as reserves by banks across Europe, especially in Greece. If they default, all these banks suffer substantially, and potentially fail. On the other hand, bailing out Greece creates a moral hazard situation where individual countries in Europe understand they will be helped in troubled times and thus feel less pressure to actually lower deficits (a politically unpopular move).
This is why the Euro continues to lose value compared to the dollar, despite the bailout. Investors realize that while the bailout may keep Greece (and Spain, Portugal, etc.) solvent for now, this arrangement does nothing to solve the underlying problem of too much debt and an unwillingness to cut deficits. I remember it was reported that at the time of the sudden crash last Thursday the TV screens in the trading floors were displaying the violent riots in Greece at the prospect of slightly cutting the deficit (not even the amount required to actually fix the problem). Surely that played a role, as investors realized that European citizens would not stomach the deficit reductions necessary to fix the situation.
The bailouts have bought Europe some time, but a lot of work needs to be done to change Europe or the Euro will continue to fade. Healthier countries like Germany will only stomach a falling Euro and a bailout of poorly managed countries for so long before demanding change.
I found this to be an interesting editorial supporting your position, Charlie:
ReplyDeletehttp://voices.washingtonpost.com/ezra-klein/2010/05/galbraith_the_danger_posed_by.html
It shows just how clearly we aren't Greece, and why our deficit 'problem' really isn't one.
Aaron - *gasp* we agree! hehe. You're 100% right. I've read a lot over the past few weeks about Greece, and about their societal proclivity toward cheating on taxes, etc... it's a mess.
Aphex - glad we agree about Greece, but I cannot say the same about Galbraith. I certainly agree that the US situation is very different from Greece (as is the UK as Krugman pointed out) since we control our own currency. But I do not agree that it follows that deficits therefore pose no threat and are instead a good thing. I believe he is making a few key mistakes in his arguments.
ReplyDeleteFirst, he says we should't worry because even with our forecasted deficits, Treasury yields are still low (and going lower due to Europe). However, yields on Greek debt fell from 6% to 4.5% during most of 2009. Then rose dramatically as we witnessed during 2010. Market sentiments can change quickly and drastically. If some of the major purchasers of US government debt shifted to buying other assets or, even wore,selling US debt (someone like China maybe), yields could rise swiftly.
He is wrong in assuming that if we don't fund our deficits and pay for things by creating money, there won't be consequences for the economy. This causes inflation, something investors will only take so much of before both demanding higher interest rates and diversifying out of dollar denominated assets. The US has been fortunate in timing at the moment as its inflationary pressures (deficit spending and expansionary monetary policy) have been met with deflationary pressures from the private sector as banks reduce lending to fix their balance sheets. The private sector banking will not contract forever, and when it begins to expand again I fully expect inflation to rise.
His last segment where he talks about how deficits are savings is just plain wrong. Deficits are the opposite of saving, they subtract from national savings. If you want long-run growth then you need national savings. Of course, reducing government spending will reduce GDP that year, but tax revenues will fall by less than that amount. Also, those idle resources will be allocated to other productive areas of the economy. It will be painful, but it is necessary. If he is trying to suggest that Europe's problems right now are from not enough government spending rather than running too large deficits for too long, he is just plain wrong.
Finally, Japan since 1988 is not exactly the country on which I would like to model my economy. They are put up as an example of what to avoid (1.5% GDP growth in 90s and 0.8% in the 2000s. Yes they aren't defaulting yet, but they aren't growing. Japan is an example of failed Keynesianism: massive deficit spending (public debt rose from below 80% of GDP to around 200%) and little growth to show for it.
Aaron: Just exceptional comments all. Craig, thank you for your perspective. Aaron, it is literally hard for me to follow the reaction of the so called "markets" to what the EU is doing to save Greece, etc. The "Euro" is dropping (perhaps to where it should be) but the overall premise of the EU is being challenged here, and, perhaps, rightly so.
ReplyDeleteYou're 100% right about Japan, Charlie. No doubt there. I found his view to be a little heartening anyway, but I may just be kidding myself ;)
ReplyDeleteAlso silly that my last entry was posted under a weird name, I was tinkering with some settings. Hopefully it'll be less cryptic this time.