John Cochrane has a superb op-ed in today's WSJ: "Greek Myths and the Euro Tragedy." Superb because he argues clearly and concisely that conventional wisdom on the subject of a possible Greek default, and how that might be really bad for the euro, is completely wrong.
"We're told a Greek default would imperil the euro. The opposite is true." A Greek default would only harm the euro if the ECB failed to act responsibly.
"A currency union is strongest without fiscal union." Giving investors the impression that other countries and the ECB itself stand ready to bail out profligate governments only creates moral hazard. Allowing Greece to default or restructure its debt would show the world that the ECB means business.
"... the euro's founders ... set debt and deficit limits. The problem is not that these limits were too loose. The problem is having them at all." The market is the best enforcer of limits on debt, not politicians. Those who borrow too much soon find that the cost of borrowing becomes prohibitive, and they then have no choice but to either reduce their spending or restructure their debt.
"We're told that a Greek default will threaten the financial system. But how? Greece has no millions of complex swap contracts, no obscure derivatives, no inter-twined counterparties. This isn't new finance, it's plain-vanilla sovereign debt." Those who read "Panic," the book I reviewed last week, will understand that this is a crucial point. The financial panic of '08 and early '09 was in large part driven by the market's lack of understanding of the risks inherent in complex derivative securities. In the case of Greek bonds, the risks are simple and straightforward.
"Letting someone lose money on sovereign debt is the acid test for the euro. If not now, when? It won't happen in good times, nor to a smaller country."
"The only way to solve the underlying euro-zone fiscal mess (and our own) is to slash government spending and to focus on growth. ... growth does not come from spending. Greece's spending over 50% of GDP did not result in robust growth and full coffers. At least the looming worldwide sovereign debt crisis is heaving 'fiscal stimulus' on the ash heap of bad ideas." This point is also crucial, as I have tried to point out before. Deficit-financed spending can never stimulate an economy, so slashing spending in order to reduce financing needs is not likely to kill an economy. It is likely, however, to improve investor confidence and economic efficiency, and those in turn become key ingredients for badly-needed future growth.
What this all means is that the market is likely overestimating the risks to Europe and the euro. The problem is not nearly as bad or intractable as the market seems to think.
Except for the simple fact that that the EU is determined to bailout Greek debt. That really could create significant problems -- just like the US bailing out the US financial system is massively misallocating capital throughout the economy.
ReplyDeleteIf only politicians would follow this simple logic: let the markets work. But this seems to be the very last idea that might be considered, if ever.
Ironically he is tossing stones in a glass house. Americans were told the same thing about bailing out the banks, GSEs, and the auto companies.
ReplyDeleteThe acid test for America was to let the market sort out the weak institutions but the Fed opted to perpetuate the moral hazard a wee-bit longer.
However, the result is always the same, except, the price tag for Americans much higher.
It's interesting - after WW-1, the Brits went back on the gold standard and didn't depreciate their currency. The French printed money. In the following years, the British economy struggled with high unemployment - albeit with a credit-worthy sovereign credit - and the French economy did great. The "underweight Europe" trade is crowded - it'll be interesting to see what impact a $1.22 Euro has
ReplyDeleteFor those interested, Stratfor has an article on the mechanics and consequences of 1) Germany leaves the Eurozone, and 2) Greece leaves the eurozone. It is a good compliment to Scott's fine post above. Go to http://www.stratfor.com
ReplyDeleteScroll down to Geopolitical Weekly The article is free...no login required.
Tom,
One of my alltime favorite quotes is from Winston Churchill.
"We can always count on America to do the right thing...after they have exausted all the alternatives."
Here's hoping the price of experimentation isn't too high.
NM, MS, AL, LA, WV, ND, AK, SD, KY, VA, MT, HA, ME, AR, OK, SC, MO, MD--these are the states that receive back $1.30 or more for every dollar sent to Uncle Sam (source, Tax Foundation).
ReplyDeleteIf we brought these states into balance, red ink would radically reduced.
There are 20 states on this list, all with two Senators--40 votes in the Senate.
Good luck turning these weakling, subsidized pink states into citizens who pull their own weight.
If every state received back from the federal government roughly what it paid in, then we would have a balanced budget.
Greece is a lesson.
I have written extensively on the need to have an orderly default for Greece.
ReplyDeleteJust before ECB propped up European pig bonds, the Greek 10 year was just under 50. The market had baked in the cake a 50% haircut.
German bankers have said many times that a haircut was the way to go, but the politicians refuse on the ground of “no country in the union can default”.
The problem is that Greece will default anyway, but when it does, the debt levels will be about 40% higher than today …. which means even more red ink than what would have been the case today.
George: excellent point. That's one more of countless examples of how government intervention in markets only makes things worse in the end.
ReplyDelete