Arnold Kling  

Wish You Lived in Europe?

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Terrific NYU Symposium on the Greek tragedy.

Paul Wachtel

California is not Greece.

I do not know what will happen if California defaults but I do remember what happened when NYC defaulted on its general obligation bonds in 1975 (I owned some). Investment banks, banks and the state government sat down and restructured the debts and imposed restrictions on the fiscal activities of the city. Essentially, there were institutions that could intervene and impose an acceptable restructuring.

Who is going to do that for Greece? The European capital market institutions would not be able (or even willing) to step up to the plate and negotiate a restructuring. The ECB is not allowed to. And the EC is not up to it.

There is an alternative -- the IMF has specific experience in this regard. But, allowing the IMF in would be an admission that the Euro area has not quite made it as currency union. The IMF, given its historical origin with exchange rate mechanisms, would convey a message that the big Euro players would not like to see. It would tar the reputation of the Euro even if there are no contagion effects on other PIIGS. Moreover, allowing Greece out of the Euro (or kicking) it out would be even worse.

That is why, I think, the Germans will pay up. They will pay to maintain the reputation of the Euro. Americans underestimate the commitment to the Euro.

Read the whole thing. Thanks to Mark Thoma for the pointer.

Some random remarks of mine follow:

1. Suppose Germany bails out Greece. Will the German taxpayers/voters stand for it?

2. In my opinion, the people who said that the euro would never work have been proven correct. If there were no euro, then Greece could reduce its deficit and at the same time devalue its currency. If you cannot devalue, then if Keynes is correct, the reduced deficit is going to cause a horrific recession. So if Germany or the IMF imposes conditions on a bailout that require Greece to tighten its belt, there could be rioting in the streets in Greece. On the other hand, if Germany does the bailout and Greece gets off scot-free in terms of being able to run deficits, I assume there will be rioting in the streets in Germany (not to mention a bad case of moral hazard in the other PIIGS.)

3. The PIGGS have government health insurance. Would you feel protected by it if you lived in one of those countries now?

4. The first phase of financial crisis gave capitalism a bad name. This phase may give European social democracy a bad name.

COMMENTS (14 to date)
Martin S writes:

The German public will not riot. That is just ridiculous.

Greek GDP is about 358bn $. That is small compared to Euro area GDP. US GDP is larger than Euro area GDP but smaller than EU GDP, so basically the same order of magnitude.

So bailing out Greece is much easier for Europe than financing the Iraq war is for the US.

Suppose Germany did the entire bailout by itself. Would be about 10% of German GDP give or take a bit. Now add these 10% of GDP to defense spending. Then the German policy of just writing everyone checks is still a lot cheaper than US defense policy. So what is the concern that they could not afford it ?

Pay for it. Simple economics. Incentives matter. Germany even pays the US for its troop presence and insists it be continued in more than negligible numbers. (That way the US defense commitment of Germany is credible.)

Or another comparison Germany spends about 100 bn EUR per year on unemployment benefits.....

The Euro a failure ? That misunderstands everything. The Euro is a political project. Germany promised France the Euro in exchange for reunification. I'd call that extremely successful foreign policy. When did Germany live in peace for 64 years the last time ? Ever? At least not since before Napoleon.

Besides the German public is especially unlikely to riot over too much spending on foreign countries. In Germany that would be as popular as riots over too high defense spending in the US.

It's like family. You just sometimes gotta bailout your irresponsible brother. And, yes that creates moral hazard. You cannot have everything. Compare the results of the policy to the results of US policy in Central America & the Carribean. Time the US taxpayer demanded a similar return on investment.

Les Cargill writes:

The Euro is in a bubble. This is a bad year for bubbles.

david writes:

Wait, why is Keynes suddenly correct again?

Richard writes:

Why does Germany care if Greece defaults on its Euro-denominated debts?

Private firms that owe Euros go bankrupt all the time. Does that hurt the ability of the German government to borrow in Euros? How is a Greek sovereign debt default any different?

I don't get it. If California defaulted on its dollar-denominated debts, does that somehow hurt other states or countries or firms that borrow in dollars? Would it make any difference to other debtors if California borrowed in Euros rather than dollars?

Patrick writes:

Germany doesn't care about Greece defaulting. It cares about the Euro being exposed as the colossal mistake it was.

You can have fiscal sovereignty. You can have an international currency. But not both.

Robbie writes:

I think you have misjudged how the Germans will react to their government bailing out the greeks with virtually no srings attached. I doubt very much whether there will be rioting on the streets or even particularly popular opposition to such a move. As with the bank bailouts it will be sold by saying that unless they pay €200bn (guess) now then there will be much more than €200bn worth of damage to German citizens, I think this will succeed in making giving away billions seem like the prudent option.

David N. Welton writes:

Do I feel protected by the state health care system in Italy? Well, it certainly has its defects, but on the other hand, the system in the US does too. As an independent consultant, I simply don't have to worry or waste time fiddling around with expensive health care plans. Of course I pay for it through taxes, but I paid plenty of taxes in the US, too. Have you ever seen those 'peace of mind' advertisements the insurance companies run? Well, that's what it's like here. There's real value not just in the health care itself (which, like I said, has problems: it's far from perfect, and probably could benefit from some market-oriented reforms), but in just not having to worry about it.

I don't really see health insurance as the problem with Greece/debts/the Euro; that strikes me as more of a dig against a system you happen to dislike. On the other hand, if you were talking about pensions, you would be absolutely right. There is no way people can continue to retire so early (60, or often younger), live so long, and keep paying out such generous pensions, something has to give.

MernaMoose writes:

4. The first phase of financial crisis gave capitalism a bad name. This phase may give European social democracy a bad name.

We can only hope.

Robbie, I'm afraid you're right. :(

MernaMoose writes:

So as an engineer and not an economist I'd like to pose a two part question to you economists here, where I might (I think) get a better answer:

a) Were the bailouts the Fed did really necessary to "save" the US economy? Or were they about as rational as bailing out the Greek Tragedy (read: allow the socialists to live on and over spend their budget another day)?

b) Have the bailout funds the Fed spent actually been "repaid", as I hear the lefty's in the blogosphere claiming so loud and proud?

I tend to strongly doubt a), and positively disbelieve b). If it was all repaid (as opposed to being largely pork) then why hasn't the Fed's debt come way way down?

But I'm no economist so I'm not sure....the theme around here of how hard it is to get accurate info comes to mind.

I recall the lead-up to the Iraq war. I spent hours at one point (before the invasion) trying to see if there was a clear answer to "do it" or "don't do it". You could find convincing documents and arguments from military "authorities", taking both sides of the argument. In retrospect it seems clear which side was right, but back then I was left with little basis to judge, beyond my own instincts (which said, don't do it). For me this whole bailout story has the same character.

Damien writes:

4. The first phase of financial crisis gave capitalism a bad name. This phase may give European social democracy a bad name.

Judging by the editorials newspapers are printing in Europe (at least in Belgium), this seems unlikely. The standard narrative is that evil speculators are now targetting the euro and that what's needed is a crackdown on speculation.

Werner writes:


Without proclaiming profound economic knowledge,
I just wish to point out that the rivalry and political competition between the French president and the director of the IMF, Strauss-Kahn, with regards to the french presidential election in 2012, might equally play a role in the refusal to grant an outsider (the IMF) standing on this matter.

Not a fan of either (EU or IMF) governmental agency, I do cheer however for the most austere and principled approach. Doubt it to be found within the halls of the Strabourg/Brussels technocrats.

Furthermore, on point (1) I'd like to point out that voter intentions, even if unbiased (cf. Caplan 2007) or tending towards an economic 'healthy' prespective, have very little voice or exit opportunities as to EU decision-making

And on point (4)
I concur with Damien above with respect to the Blegian - very pour - situation of public opinion.
En plus, and alas, the educational/political system in the old continent does not favor critical reflecting upon social democracy. The extent of cultural/social reproach to profit-making as a motive is alarmingly big.


foxmuldar writes:

From what I've been seeing on the PIIGS mess, I don't see how anything will be solved unless the Socialist Unions in Greece are willing to give back some of their benefits. Videos showing unions demonstrating in the streets tells me they don't want to give in on anything. Therefore I'd tell Greece their on their own.

The EU has made statements this week that they are willing to help, but I think that was just talk to prop up the Euro which has been taking a nose dive against the dollar. Angela Merkel said Germany may not be willing to lend money to Greece.

Most of the European nations are thinking the same way but haven't said so in order to keep the euro from falling further. My guess is that not much will be done. More talks but in the end, Greece will continue to be a basket case.

Cangrande writes:

@ Martin S.
"The German public will not riot. That is just ridiculous. ..... Besides the German public is especially unlikely to riot over too much spending on foreign countries. In Germany that would be as popular as riots over too high defense spending in the US."

Riot we will not, that's right.
But if you read what my compatriots have to say in various newspaper-forums on reports about the likelyhood of Germany bailing out Greece you will see that we are damn angry even at the prospect. And our government, or rather the parties (CDU, CSU + FDP = basically all Conservatives) which presently form the Germany government, would get a taste of our aggravation at the next election.

However, our opposition is even worse. Politicians from the ranks of the (left-leaning) Greens, the Social Democrats and the far-left "Die Linke" have signalled that they would even be more willing to throw out hard-earned German money to Mediterranean squanderers.
Of course it would be done on the sly, through a joint European bond, which would veil the losses of the taxpayer and thereby dampen resistance. However, as they say: You can fool some people all of the time, but not all people ... .
Not even we Germans taxpayer will be fools foreever.

So internally a German bailout for Greece might well give a boost to radical parties on the right.

Mick Rolland writes:

The threat of a "horrendous recession" if the deficit is reduced is overblown. The problem if public spending is reduced will not be economic, but political: Unions and receivers of (wasteful) subsidies will most probably revolt.

If public spending is massively reduced (such as after a war), that would free up an enormous amount of resources for productive purposes, if the economy is minimally flexible.

Deficits do crowd out private spending. In Greece and other countries, massive deficits induce lazy behaviour in banks, who cease to look for productive activities and instead lend "risk free" (as "states don't go bankrupt" -or do they?). In Europe,in the US and in Japan, the only reason deficits don't provoke massive interest rate rises is the massive intervention of central banks (who are still credible, but they are walking a fine line).

If Greece does not reduce its deficit, it might trigger a downgrade of its bonds, who would cease to be eligible as collateral for the ECB. Then the crowding out would be obvious.

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