Economic growth has been slow since the bottom in 2009. The debate among economists is whether this is due to something that’s been dubbed “secular stagnation” or something else. The secular stagnation crowd has several arguments but generally believes that the various drivers of growth in the last century are played out. The drivers include higher productivity, an expanding work force, and the transition from a rural to an industrial society. I’m more partial to those who argue that there’s a long-term debt cycle, or supercycle, that has mini booms and busts but over the long term produces a high rate of growth. But once debt levels reach a certain point, the debt supercycle reverses. Debt levels began a peak around 2007 and likely have to decline for a while. Shrinking debt levels will reduce growth rates. Here’s a good explanation from Kenneth Rogoff.
Modern macroeconomics has been slow to get to grips with the analytics of how to incorporate debt supercycles into canonical models, but there has been much progress in recent years (see Geanokoplos 2014 for a survey) and the broad contours help explain the now well-documented empirical regularities. As credit booms, asset prices rise, raising their value as collateral, thereby helping to expand credit and raise asset prices even more. When the bubble ultimately bursts, often catalysed by an underlying adverse shock to the real economy, the whole process spins into a harsh and precipitous reverse.
Of course, policy played an important role. However, there has been far too much focus on orthodox policy responses and not enough on heterodox responses that might have been better suited to a crisis greatly amplified by financial market breakdown. In particular, policymakers should have more vigorously pursued debt write-downs (e.g. subprime debt in the US and periphery-country debt in Europe), accompanied by bank restructuring and recapitalisation.
It’s easy to find people who are worried about the global financial situation. Here’s a sample. It’s an article about efforts at the U.N. and other global organizations to create a permanent procedure for handling debts of countries who borrow too much. Some of them argue that borrowers and lenders haven’t learned anything from the last borrowing binge and that we’re on the edge of significant problems. The evidence presented indicates that some countries are going to have problems and some lenders are likely to lose money, but it doesn’t make the case for a global crisis.
As the recriminations fly between Europe’s capitals, campaigners are warning that the global community has failed to learn the lessons of the Greek debt crisis – or even of Argentina’s default in 2001, the consequences of which are still being contested furiously in courts on both sides of the Atlantic.
As Janet Yellen’s Federal Reserve prepares to raise interest rates, boosting the value of the dollar, while the plunging price of crude puts intense pressure on the finances of oil-exporting countries, there are growing fears of a new debt crisis in the making.
Ann Pettifor of Prime Economics, who foreshadowed the credit crunch in her 2003 book The Coming First World Debt Crisis, says: “We’re going to have another financial crisis. Brazil’s already in great trouble with the strength of the dollar; I dread to think what’s happening in South Africa; then there’s Malaysia. We’re back to where we were, and that for me is really frightening.”
In an interview with the Telegraph of London, two PIMCO managing directors said that the Eurozone is untenable in its current structure. Ultimately, they say, Europe has to change its structure so that the countries move closer together. Monetary policy can’t be centralized while fiscal policy is decentralized. In their discussion on PIMCO’s web site about the firm’s outlook for the next six to 12 months, the managing directors talking with others weren’t as negative over the short term, expecting a solution to be found to Greece’s current problems.
Persistently weak growth in the eurozone had led to voter unrest and the rise of populist parties such as Podemos in Spain, Syriza in Greece, and Front National in France, said PIMCO managing directors Andrew Bosomworth and Mike Amey.
“The lesson from history is that the status quo we have now is not a tenable structure,” said Mr Bosomworth. “There’s no historical precedent that this sort of structure, which is centralised monetary policy, decentralised fiscal policy, can last over multiple decades.”
The general view is that Greece has too much debt to repay and the lenders at some point will have to forgive or generously renegotiate some of it. This post disagrees. He presents data to show that there wasn’t austerity in Greece of any note and that Greece’s borrowing boom resulted in a spending boom and not, as in other countries, a boom in housing or other investments. It’s interesting reading throughout.
Sudden stops are always painful: economics has not discovered a hangover cure. But the way to minimize the pain is to cut spending without cutting output, which requires selling to others what residents can no longer afford. In other words, unless Greece boosts exports, spending cuts will amplify the output loss in the same way that Keynesian multipliers amplified the output gain from borrowing.
The problem is that Greece produces very little of what the world wants to consume. Its exports of goods comprise mainly fruits, olive oil, raw cotton, tobacco, and some refined petroleum products. Germany, which many argue should spend more, imports just 0.2% of its goods from Greece. Tourism is a mature industry with plenty of regional competitors. The country produces no machines, electronics, or chemicals. Of every $10 of world trade in information technology, Greece accounts for $0.01.
Greece never had the productive structure to be as rich as it was: its income was inflated by massive amounts of borrowed money that was not used to upgrade its productive capacity. According to the Atlas of Economic Complexity, which I co-authored, in 2008 the gap between Greece’s income and the knowledge content of its exports was the largest among a sample of 128 countries.
This post argues that Greece really can’t leave the euro. Even if it does leave the monetary union, it won’t be able to issue debt in a new currency, because no one will buy it. The post also spends a lot of time attacking the conventional wisdom that Greece needs a different monetary policy than Germany and many of the other countries in the European Union. What Greece needs are policies that favor growth and productivity. What it has and has had are policies that strangle business, growth, and productivity.
The economies of New York, California and Texas are nothing like those of West Virginia and Mississippi, not to mention that economic activity in Manhattan, Beverly Hills and Highland Park in no way resembles what’s taking place in Buffalo, San Bernardino and Denton, yet the dollar is the accepted medium of exchange without much in the way of protest in all the locales mentioned despite their “very different economies.” Implicit in the assertion about the alleged horrors of a common currency is that the relatively weak economies of Arthurdale (WV) and Oxford (MS) are held back by the dollar such that each state should issue a currency of its own. Hello WV Ringgit and MS Peso. About the economic productivity that would vanish under such a scenario, many books could be written.
In the magazine’s defense, what it presumes about money is not uncommon on both the left and right, and that’s the problem. While many on the right pay lip service to the tautology that there’s no free lunch, alongside their reliably emotional opponents on the left who act as though lunch can be free (government spending seemingly just happens, with no one fleeced to pay for it…), each subscribes to the falsehood that “money” is magical, and can be played around with by wise minds to achieve all manner of wondrous economic outcomes.
The Economist takes Greece’s officials to the woodshed for their actions since taking office. The article details the ways in which Greece alienated other European officials, missed opportunities to build coalitions, and failed to think long term. The result is Greece backed away from almost all the demands it made at the start of the negotiations and signed a deal to continue the status quo for another four months. Greece’s actions also make it unlikely it will gain significantly better terms in any longer term deal, says The Economist.
Mr Varoufakis’s gaffe is a mere footnote in a list of mishaps that have characterised Greece’s miserable experience in the euro. But it is depressingly typical for a government that, for all its high popularity at home, has squandered every opportunity to improve its lot, and ultimately that of the euro zone.
Even as Mr Varoufakis and his colleagues in Greece’s ruling Syriza party have loftily declared that the changes they seek would benefit all Europeans, not just Greeks, their negotiating strategy has been small-minded, self-defeating and naive.
Some of this may be put down to inexperience. A few Europeans were guilty of assuming that Alexis Tsipras, the prime minister, would perform what Greeks call a kolotoumba (“somersault”) the instant he took office. But Syriza has no excuse for making idle references to the Nazi occupation of Greece. Nor has it helped by playing games with its partners in the Eurogroup of finance ministers. European officials have been incensed by a Hellenic habit of leaking supposedly private discussion papers.
Greece’s latest loan bailout package expires Feb. 28, and the parties seem far apart from negotiating a new package or other solution. Here’s a good review of the latest back and forth between Greece and European officials (mainly Germany). Its conclusion is that Greece is likely to exit the euro soon.
So, what has changed? Did Germany truly expect a real solution to this issue? Or was the finance ministry just pretending to play hardball to save face with the German public? This wouldn’t be the first time for Germany to claim it was calling Greece’s bluff and then fall apart at the end of the day. It has happened pretty much every time Germany has negotiated a bailout deal since the eurozone debt crisis began in 2009.
But this time could be different. A report in German newspaper Frankfurter Allgemeine Zeitung quotes an unnamed central banker from the ECB who believes that the Grexit may now be inevitable. “One gets the impression that the Greeks want to get out [of the euro] and are just looking for an escape goat,” at this point, the unnamed central banker told the paper.
There’s a debate in Europe about whether to continue austerity. There’s also a debate in the U.S. about austerity that involves the Fed increasing interest rates and the federal government reducing spending, or at least spending growth. Here’s a case against these kinds of austerity in the U.S. and Europe. Its simple premise is that austerity hasn’t produced good results in the parts of Europe where it’s been tried, so why try it in the U.S.?
The theory behind austerity is fairly simple: The economic problems of the Eurozone and the United States stem from an excess of debt invested unproductively in assets. Too much government spending directly or indirectly made its way into unproductive assets such as real estate or consumer spending or over-generous safety nets. That was bad enough, but for advocates of austerity, too much debt is the main enemy and reducing debt is the main goal. Debt is seen as the Damoclean sword hanging over an economy, constraining options, limiting growth, and sucking vital capital out of the system to service that debt. And then, if and when governments try to devalue their currency to pay off the debt, creditors pay the price.
Austerity then demanded that countries bring their debt down to an acceptable level relative to GDP. That was and is the theory, that too high a debt-to-GDP ratio imposes a burden on growth and imperils economic health. And that theory had no greater proponents than the Germans, who demanded that debt-laden countries such as Greece, Spain and Portugal drastically curtail public spending, generate more tax revenue, and pay down their debt.
The announcement by the European Central Bank that it will embark on a large-scale asset-buying program seemed to put a floor under many markets and relieve the fears that were rising about the European economy. But the efforts aren’t enough to end the depression that exists in much of the continent. Martin Feldstein of Harvard agrees that the QE isn’t enough. The European governments have a lot more work to do to make the economy reasonably healthy. He explains why and gives the policymakers some ideas.
Thus, QE’s success in the US reflected the Fed’s ability to drive down long-term interest rates. In contrast, long-term interest rates in the eurozone are already extremely low, with ten-year bond rates at about 50 basis points in Germany and France and only 150 basis points in Italy and Spain.
So the key mechanism that worked in the US will not work in the eurozone. Driving down the euro’s dollar exchange rate from its $1.15 level (where it was before the adoption of QE) to parity or even lower will help, but it probably will not be enough.
But, fortunately, QE is not the only tool at policymakers’ disposal.
The head of the newly-victorious political party in Greece wrote an open letter to Germany, published in a German newspaper, earlier in January. The letter explains the party’s view of economic conditions in Greece and Europe and why Germany should stop insisting that the austerity program continue and the debts be paid on schedule. At one time it refers to the European establishment as a cleptocracy.
In 2010, the Greek state ceased to be able to service its debt. Unfortunately, European officials decided to pretend that this problem could be overcome by means of the largest loan in history on condition of fiscal austerity that would, with mathematical precision, shrink the national income from which both new and old loans must be paid. An insolvency problem was thus dealt with as if it were a case of illiquidity.
In other words, Europe adopted the tactics of the least reputable bankers who refuse to acknowledge bad loans, preferring to grant new ones to the insolvent entity so as to pretend that the original loan is performing while extending the bankruptcy into the future. Nothing more than common sense was required to see that the application of the ‘extend and pretend’ tactic would lead my country to a tragic state. That instead of Greece’s stabilization, Europe was creating the circumstances for a self-reinforcing crisis that undermines the foundations of Europe itself.