Marshall’s latest

REPEAT AFTER ME: THE USA DOES NOT HAVE A ‘GREECE PROBLEM’

By Marshall Auerback


To paraphrase Shakespeare, things are indeed rotten in the State of Denmark (and Germany, France, Italy, Greece, Spain, Portugal, and almost everywhere else in the euro zone). An entire continent appears determined to commit collective hara kiri (link), whilst the rest of the world is encouraged to draw precisely the wrong kinds of lessons from Europe’s self-imposed economic meltdown. So-called respectable policy makers continue to legitimize the continent’s fully-fledged embrace of austerity on the allegedly respectable grounds of “fiscal sustainability”.

The latest to pronounce on this matter is the Governor of the Bank of England, Mervyn King. This is a particularly sad, as the BOE – the Old Lady of Threadneedle Street – has actually played a uniquely constructive role amongst central banks in the area of financial services reform proposals. King, and his associate, Andrew Haldane, Executive Director for Financial Stability at the Bank of England, have been outspoken critics of “too big to fail” banks (link), and the asymmetric nature of banker compensation (“heads I win, tails the taxpayer loses”). This stands in marked contrast to America’s feckless triumvirate of Tim Geithner, Lawrence Summers, and Ben Bernanke, none of whom appears to have encountered a banker’s bonus that they didn’t like.

But when it comes to matters of “fiscal sustainability” King sounds no better than a court jester (or, at the very least, a member of President Obama’s National Commission on Fiscal Responsibility and Reform). In an interview with The Telegraph (link), the Bank of England Governor suggests that the US and UK – both sovereign issuers of their own currency – must deal with the challenges posed by their own fiscal deficits, lest a Greece scenario be far behind:

“It is absolutely vital, absolutely vital, for governments to get on top of this problem. We cannot afford to allow concerns about sovereign debt to spread into a wider crisis dealing with sovereign debt. Dealing with a banking crisis was bad enough. This would be worse.”

“A wider crisis dealing with sovereign debt”? Anybody’s internal BS detector ought to be flashing red when a policy maker makes sweeping statements like this. The Bank of England Governor substantially undermines his own credibility by failing to make 3 key distinctions:

1. There is a fundamental difference between debt held by the government and debt held in the non-government sector. All debt is not created equal. Private debt has to be serviced using the currency that the state issues.
2. Likewise, deficit critics, such as King, obfuscate reality when they fail to highlight the differences between the monetary arrangements of sovereign and non-sovereign nations, the latter facing a constraint comparable to private debt.
3. Related to point 2, there is a fundamental difference between public debt held in the currency of the sovereign government holding the debt and public debt held in a foreign currency. A government can never go insolvent in its own currency. If it is insolvent as a consequence of holdings of foreign debt then it should default and renegotiate the debt in its own currency. In those cases, the debtor has the power not the creditor.

Functionally, the euro dilemma is somewhat akin to the Latin American dilemma, such as countries like Argentina regularly experienced. The nations of the European Monetary Union have given up their monetary sovereignty by giving up their national currencies, and adopting a supranational one. By divorcing fiscal and monetary authorities, they have relinquished their public sector’s capacity to provide high levels of employment and output. Non-sovereign countries are limited in their ability to spend by taxation and bond revenues and this applies perfectly well to Greece, Portugal and even countries like Germany and France. Deficit spending in effect requires borrowing in a “foreign currency”, according to the dictates of private markets and the nation states are externally constrained.

King implicitly recognizes this fact, as he acknowledges the central design flaw at the heart of the European Monetary Union – “within the Euro Area it’s become very clear that there is a need for a fiscal union to make the Monetary Union work.”

This is undoubtedly correct: To eliminate this structural problem, the countries of the EMU must either leave the euro zone, or establish a supranational fiscal entity which can fulfill the role of a sovereign government to deficit spend and fill a declining private sector output gap. Otherwise, the euro zone nations remain trapped – forced to forgo spending to repay debt and service their interest payments via a market based system of finance.

But King then inexplicably extrapolates the problems of the euro zone which stem from this uniquely Euro design flaw and exploits it to support a neo-liberal philosophy fundamentally antithetical to fiscal freedom and full employment.

The Bank of England Governor – and others of his ilk – are misguided and disingenuous when they seek to draw broader conclusions from this uniquely euro zone related crisis. Think about Japan – they have had years of deflationary environments with rising public debt obligations and relatively large deficits to GDP. Have they defaulted? Have they even once struggled to pay the interest and settlement on maturity? Of course not, even when they experienced debt downgrades from the major ratings agencies throughout the 1990s.

Retaining the current bifurcated monetary/fiscal structure of the euro zone does leave the individual countries within the EMU in the death throes of debt deflation, barring a relaxation of the self-imposed fiscal constraints, or a substantial fall in the value of the euro (which will facilitate growth via the export sector, at the cost of significantly damaging America’s own export sector). This week’s €750bn rescue package will buy time, but will not address the insolvency at the core of the problem, and may well exacerbate it, given that the funding is predicated on the maintenance of a harsh austerity regime.

José Luis Rodríguez Zapatero, Spain’s Socialist prime minister, angered his trade union allies but cheered financial markets on Wednesday when he announced a surprise 5 per cent cut in civil service pay to accelerate cuts to the budget deficit.

The austerity drive – echoing moves by Ireland and Greece – followed intense pressure from Spain’s European neighbors, the International Monetary Fund on the spurious grounds that such cuts would establish “credibility” with the markets. Well, that wasn’t exactly a winning formula for success when tried before in East Asia during the 1997/98 financial crisis, and it is unlikely to be so again this time.

Indeed, in the current context, the European authorities are simply trying to localize the income deflation in the “PIIGS” through strong orchestrated IMF-style fiscal austerity, while seeking to prevent a strong downward spiral of the euro. But the contradiction in this policy is that a deflation in the “PIIGS” will simply spread to the other members of the euro zone with an effect essentially analogous to that of a competitive devaluation internationally.

The European Union is the largest economic bloc in the world right now. This is why it is so critical that Europeans get out of the EMU straightjacket and allow government deficit spending to do its job. Anything else will entail a deflationary trap, no matter how the euro zone’s policy makers initially try to localize the deflation. And the deflation is almost certain to spread outward, if sovereign states such as the US or UK absorb the wrong lessons from Greece, as Mr., King and his fellow deficit-phobes in the US are aggressively advocating.

There are two direct contagion vectors off the fiscal retrenchment being imposed on the periphery countries of the euro zone.

First, to the banking systems of the periphery and the core nations, as private loan defaults spread on domestic private income deflation induced by the fiscal retrenchment. Second, to the core nations that export to the PIIGS and run export led growth strategies. So 30-40% of Germany’s exports go to Greece, Italy, Ireland, Portugal and Spain directly, another 30% to the rest of Europe.

These are far from trivial feedback loops, and of course, the third contagion vector is to rest of world growth as domestic private income deflation combined with a maxi euro devaluation means exporters to the euro zone, and competitors with euro zone firms in global tradable product markets, are going to see top line revenue growth dry up before year end.

Let’s repeat this for the 100th time: the US government, the Japanese Government, or the UK government, amongst others, do NOT face a Greek style constraint – they can just credit bank accounts for interest and repayment in the same fashion as if they were buying some helmets for the military or some pencils for a government school. True, individual American states do face a fiscal crisis (much like the EMU nations) as users of the dollar, which is why some 48 out of 50 now face fiscal crises (a problem that could easily be alleviated were the US Federal Government to undertake a comprehensive system of revenue sharing on a per capita basis with the various individual states). But, if any “lesson” is to be learned from Greece, Ireland, or any other euro zone nation, it is not the one that Mr. King is seeking to impart. Rather, it is the futility of imposing arbitrary limits on fiscal policy devoid of economic context. Unfortunately, few are recognizing the latter point. The prevailing “lesson” being drawn from the Greek experience, therefore, will almost certainly lead the US, and the UK, to the same miserable economic outcome along with higher deficits in the process. As they say in Europe, “Finanzkapital uber alles”.

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