Listening Closely

Here at burningpants we are wide readers in the area of economics, partly because it allows us to take a helicopter view of what’s happening in the world and partly because we like reading about big ideas discussed elegantly.

In the past we’ve used burningpants to introduce you to the ideas of the Pantheon of the greats: Friedman, Keynes, Von Hayek (who incidentally hated each other – for a better, hilarious explanation watch the video below), Hicks and my personal favourites; Lucas and Pigou.

But today we want to introduce you to a thinker from Harvard called Martin Feldstein who we’ve been following for a while.

We like Professor Feldstein for the same reasons that we are attracted to the work of Milton Friedman.

They are both realistic about the way humans think and behave, but specifically Feldstein was the only economist who said that the Euro, the idea of a single currency in Europe, just wouldn’t work.

He said it loud and proud in November 1997, before it actually started, and right now he is saying that probably the best thing for the entire world would be to let the Greek economy fail.

His reasons for saying the Euro wouldn’t work are clear. He said that the social drivers in the countries involved were so different and that the way in which they used money was so different that this would eventually lead to conflict, the involvement of the IMF and the negative attention of the United States.

It turns out he was right.

The Euro brought together a series of nations that borrow and spend (bring pleasure forward) like Greece, Spain, Portugal and Italy with nations that defer pleasure like Germany, Holland and Denmark and it seems the spenders are once again asking to be bailed out by the savers.

As this blog is being put to bed the world markets are tumbling because of the uncertainty of what is happening in Greece, the country which is leading the iceberg-like list of loan defaulters in the Mediterranean.

It’s worth a bit of a side bar here to talk about national savings rates.

The reality of this overspending time bomb has been staring us all in the face for a while. According to data from the Bureau of Economic Analysis in America, Greece has been spending more than it has been earning since the middle 1980′s and even now in the middle of this crisis it is spending seven cents more than every dollar it’s earning, which means its personal savings rate is reported as -0.7.

This is important, because despite the GFC there are a number of European countries that are spending more than they are earning – Portugal, Spain Ireland, the UK and Italy are still reporting negative savings rates.

Let me just repeat that because it bears repeating – despite the global financial crisis these countries still appear to be spending more than they are earning.

There are some countries that have exited overspending – the United States has gone into positive savings numbers, now saving about 2.3% of its GDP (up from 0-0.4%) but it’s worth pointing out there are countries that never overspent.

The countries that have stayed positive for the longest time include Australia (now saving 14% of GDP – twice our normal rate), Canada (8% of GDP) China (20%) South Korea (18%) and in the case of Europe good old Germany, which is being once again asked to bail out its neighbours, with a national savings rate of 11% of GDP.

It’s also worth remembering that despite everything Germany has been through, this is the second time they have been asked to do this – they already bailed out East Germany when the Berlin Wall came down in 1989.

But right now the signs that something serious and long term is changing in Europe are ominous.

For a start last week the Greek bailout package ballooned  into a $1 trillion debt stabilisation fund, including a $39 billion line of credit from the IMF, which coincided with the European Central Bank announcing that it would begin purchasing junk-rated Greek debt.

This is a debt recovery attempt of a size never attempted anywhere on earth.

But the facts seem to indicate this isn’t going to work – and the United States have already indicated that they don’t think it is going to work by publically announcing that they think the Greeks lack the discipline to stick to the austerity package required and that if they default they will not bail them out again.

It seems however that it also won’t work on more fundamental levels too. The problems aren’t just liquidity, psychology or the idea of speculators profiting from turmoil, but much more prosaic.

Many economists believe that Germany and France, the engines of European growth, simply can’t borrow enough or tax enough to cover the rest of Europe’s debts and impending deficits.

This means that unless there is some kind of growth miracle (extremely unlikely given the violent reaction to even a hint of cuts in Greece) we should expect to see sovereign defaults all across the rim of the Mediterranean.

The one solution to this might be for the European Central Bank to go on a 1930s-style money printing spree to buy all the junk debt in Europe and drive inflation through the roof – essentially making all the state entitlements that are hanging over each country worthless.

You have to admit the inflationary route might be an attractive one, especially as it would be easy to blame on other people and will offer a permanent solution.

It seems though from all of the chest beating in Europe at the moment that Greece must be saved from default at all costs. But it’s also emerging that the need to bail out Greece is based on a series of pernicious myths.

Myth 1. Systemic Risk

The idea here is that if Greece defaults people won’t believe in governments any more. It’s hard to see how this argument stacks up; the Greek financial services market isn’t a particularly complex one – it’s based on the same inter government lending ideas that have been in existence for hundreds of years. If they default, people will lose money – it’s happened before (even to Australia) and it will probably happen again. It’s hard to see why this one would be worse than all the others.

Myth 2. The Euro must be saved

We’re told a Greek default would kill the Euro, but perhaps the opposite is actually true. Maybe Greece should have to stand up, default and then renegotiate with bondholders, because countries are no different from companies. If they borrow and cannot pay back, investors lose money. The currency is unaffected.

The Euro could become a monetary union with full fiscal union. I hate to think what EU budgets and taxes would look like if they were all run from Brussels, but at least that system might impose some discipline on national governments’ incentive to borrow, spend, and demand bailouts.

Myth 3 The Crisis Would Spread

We get the word crisis from the Greek word oddly enough and the thesis is that if Greece defaults, so does Spain, Portugal and Italy. Maybe. It seems the only thing that we could possibly learn from his bail out is that if you default on your loans you will be bailed out. It could be argued that if the IMF doesn’t bail out Greece then the other countries are less likely to default.

Maybe, just maybe, it’s time to turn to the teachings of one of our other favourite economists – Von Hayek – who teaches that savings are the only key to freedom and that debt is the road to nothing more than serfdom.