A War Between Debtors and Creditors That We Are All Losing

From “Obama’s Fate Rests in Part on Europe,” Eduardo Porter, NYT:

“Battle lines have been drawn across the Continent between a political establishment that defends austerity at all costs in the name of preserving the euro, and increasingly radical oppositions.

“This kind of political polarization may be a standard feature of financial crises.  Economists have noted that such crises naturally widen the chasm between the interests of creditors — like banks, investors and even governments — and debtors, who are suddenly made insolvent by a crisis that takes away their jobs and destroys the value of their homes.

“Creditors push austerity as the best way for debtors to repay their debts.  They oppose efforts to write down or renegotiate loans, or to allow higher inflation to erode their value.  And creditors, better financed and organized, usually gain the upper hand.  Debtors, who are generally poorer, lose.

This cleavage is evident in Europe, where German voters have staunchly opposed committing more German resources to aid indebted Southern European countries.  It is also evident on Capitol Hill, where Republicans have countered the administration’s stimulus plans with proposals to cut public spending to finance tax cuts that would favor the most affluent Americans.  The ensuing gridlock has paralyzed policy-making on both sides of the Atlantic.  And it could produce a lot of economic damage.

“When Lehman Brothers went bankrupt in 2008, sending the global financial system into a tailspin, its debts amounted to about $600 billion.  Government debt alone in Greece, Spain, Portugal and Ireland…adds up to about $1.9 trillion.”  Emphasis added.

The Fair Thing Isn’t Always the Right Thing

A “Grexit” may be the fair thing, but it may not be the right thing.  It may be cutting off the nose of Greece to spite Europe’s face.

From “The Fairness Trap,” James Surowiecki, The New Yorker:

“This [a Grexit] isn’t an outcome that anyone wants.  Even though a devalued currency would make Greece’s exports cheaper and attract tourists, it would do so at a terrible price, destroying huge amounts of wealth and seriously harming the country’s G.D.P.  It would be costly for the rest of Europe, too.  Greece owes almost half a trillion euros, and containing the damage would likely require the recapitalization of banks, continent-wide deposit insurance (to prevent bank runs), and more aid to Portugal, Spain, and Italy….  That’s a very high price to pay for getting rid of Greece, and much more expensive than letting it stay.

Rationally, then, this standoff should end with a compromise — relaxing some austerity measures, and giving Greece a little more aid and time to reform.  And we may still end up there.  But the catch is that Europe isn’t arguing just about what the most sensible economic policy is.  It’s arguing about what is fair.  German voters and politicians think it’s unfair to ask Germany to continue to foot the bill for countries that lived beyond their means and piled up huge debts they can’t repay.  They think it’s unfair to expect Germany to make an open-ended commitment to support these countries in the absence of meaningful reform.  But Greek voters are equally certain that it’s unfair for them to suffer years of slim government budgets and high unemployment in order to repay foreign banks and richer northern neighbors, which have reaped outsized benefits from closer European integration.  The grievances aren’t unreasonable, on either side, but the focus on fairness, by making it harder to reach any kind of agreement at all, could prove disastrous.

“The basic problem is that we care so much about fairness that we are often willing to sacrifice economic well-being to enforce it.

“You can see this in the way the U. S. has dealt with the foreclosure crisis.  Plenty of economists recommended giving mortgage relief to underwater homeowners, but that has not happened on any meaningful scale, in part because so many voters see it as unfair to those who are still obediently paying their mortgages.  Mortgage relief would almost certainly have helped all homeowners, not just underwater ones — by limiting the spillover impact of foreclosures on house price — but, still, the idea that some people would be getting something for nothing irritated voters.

“The fairness problem is exacerbated by the fact that our definitions of what counts as fair typically reflects…a ‘self-serving bias.’  You’d think that the Greeks’ resentment of austerity might be attenuated by the recognition of how much money Germany has already paid and how much damage was done by rampant Greek tax dodging.  Or Germans might acknowledge that their devotion to low inflation makes it much harder for struggling economies like Greece to start growing again.  Indeed, the self-serving bias leads us to define fairness in ways that redound to our benefit, and to discount information that might conflict with our perspective.  This effect is even more pronounced when bargainers don’t feel that they pare part of the same community — a phenomenon that psychologists call ‘social distance.’  The pervasive rhetoric that frames the conflict in terms of national stereotypes — hardworking, frugal Germans versus frivolous, corrupt Greeks, or tightfisted, imperialistic Germans versus freewheeling, independent Greeks — makes it all the more difficult to reach a reasonable compromise.

“From the perspective of society as a whole, concern with fairness has all kinds of benefits:  it limits exploitation, promotes meritocracy, and motivates workers.  But in a negotiation where neither side can have what it really wants, and where the least bad solution is as good as it gets, worrying too much about fairness can be suicidal.  To move Europe away from the brink, voters and politicians on all sides need to stop asking themselves what’s fair and start asking themselves what’s possible.”  Emphasis added.

 

 

Explain This, GOP

Mitt and the GOP keep scaring people by saying that we are like Greece.  If that’s true, why is it that the U. S. can borrow for ten years for less than 1.75%.  Greece can’t borrow at all except from bailout funds and some very high-flying hedge funds.  Meanwhile, Spain is paying more than 6% to borrow for ten years, and Italy is paying 5.6%.

The rest of the world has much more confidence in us than our own Republican party.  Yet they say Obama is “un-American.”

Leaders in Europe Ceding Control by Their Inacton

If Europe’s leaders don’t set policy at the top soon, the street is going to take over, and panic and fear will dictate events, not elected officials.

Spain is experiencing a run on its banks (either moving money from weak banks to stronger ones or out of the country entirely) that is only going to gain more momentum, and Spain’s deposit insurance system is bankrupt.  There is still time for Europe to offer European-wide deposit insurance that would quell this run before it becomes a full-blown panic.  Of course, Germany doesn’t want to do this.

European leaders have to decide if they want to cut Greece loose, but try to save other countries like Spain.  That’s the first decision.  Are you going to try to save everyone, are you going to try to save everyone but Greece, or are you going to let the whole thing go to hell?

Europe could offer euro-zone deposit insurance to everybody in the euro zone or dump Greece and offer it to the remaining countries.

Europe could offer euro-zone bonds guaranteeing countries’ debt to everybody or dump Greece and offer them to the remaining countries.

But Europe’s leaders are in a state of paralysis, which in itself is a form of decision-making, an abdication of control and responsibility.

Greece has become an excuse for not addressing the problems of other weak periphery countries, like Spain and Italy.  But ignoring these problems doesn’t make them go away.  Not deciding becomes a decision.

We saw what happened in this country when events overtook our leaders in September 2008, and our entire financial system was brought to the brink of collapse.  We saw Treasury Secretary Henry Paulson go down on his knees, begging Nancy Pelosi to stay in bailout talks after the Republicans walked out.  For Paulson, the arrogant former head of Goldman Sachs and the quintessential Master of the Universe, to be brought to such a shocking state tells you how close we came to tipping over the edge, how close we came to another depression.

Europe is on its knees, and Angela Merkel is on her way out of the room.

Timing Is Everything

The big fear in Europe now* is that Greece will leave the euro zone at the same time that Spain’s banking system has a meltdown.  The European bailout fund of about $1 trillion couldn’t handle both these events.

The big fear at the White House has to be that the great unraveling in Europe, which seems inevitable and will cause our financial markets to panic at least short-term, will happen so close to the election that Americans freak out and Mitt wins before our markets settle down.

The European death spiral and our election seem to be on a collision course.  Obama needs it either to happen soon or wait till after November 6.  We know it won’t happen in August because they’re all on vacation.

Merkel would much rather have a President Romney to share her gospel of austerity.  I’m guessing she will do what she can to help him, just as the Iranians helped Reagan get elected back during the hostage crisis.

*See “Europe’s Worst Fear:  Spain and Greece Spiral Down Together,” Landon Thomas, Jr., NYT

Alex Tsipras Gets Some Help from Obama and Hollande

At the G-8 summit, both President Obama and new French President Hollande gave a boost to Alexis Tsipras, who is expected to win Greece’s new round of elections next month, by urging Germany’s Angela Merkel  to soften her tough austerity stance and focus more on growth.  Tsipras, leader of the far left Syriza party, is campaigning on keeping Greece in the euro zone, but forcing its creditors to renegotiate the tough terms of their loans to Greece.

President Obama has to thread the needle carefully here to try to avert disaster in Europe.  If he is seen as being too much in bed with the socialist Hollande and the even-further-left Tsipras, he gives ammunition to the crazies on the American right and their Obama is a socialist/communist meme.  His support for leftists in Europe will be touted as a warning for what he will do here in a second term.

But the truth is that what needs to be done, both in Europe and the United States, is classic Keynesian economics, which both Democrats and Republicans used to accept and follow.

Europe — Breaking Up Is Hard To Do

From “A Tempting Rationale For Leaving the Euro,” Eduardo Porter, NYT:

“Europe would be in much better shape if the euro didn’t exist and each member country had its own currency.  Monetary union has shackled together nations with vastly different economies, depriving them of an independent monetary policy that can help them through rough times.  The interest rate and exchange rate that serve Germany also have to serve Spain, though that country has more than four times Germany’s joblessness.

“The euro fed the illusion that Greece, Spain and Italy were as creditworthy as Germany or the Netherlands, propelling a decade-long credit boom in Europe’s less-developed periphery.  And it was spectacularly ill-designed to deal with the shock when capital flows to those nations suddenly stopped.  Weak countries not only had to rely on their own devices; they had to do so without a currency or a monetary policy of their own to absorb the blow.

“Greece probably couldn’t be surgically excised [from the euro zone].  Once investors realized that countries could leave the euro, interest rates would soar on the next most likely candidates.  There would be a huge capital flight out of peripheral countries into Germany, as savers tried to protect their euros from potential devaluation.”

Greece’s Game of Chicken

It is almost certain that Greece will hold another election to try to form a government and that the leader of the Coalition of the Radical Left known as Syriza, Alxis Tsipras, will get more votes than anyone else.

So, in effect, Greece will have a communist government.  I don’t believe the Greek people have suddenly become communists, but they reject the harsh terms of the bailout deal supported by the two major mainstream parties.  Those parties got less than 40% of the vote on May 6.  The Greeks want to re-negotiate that deal for less onerous terms, and think that they can do so without being forced to leave the euro.  They are convinced they can have their baklava and eat it too.  They believe they have leverage with the IMF, the European Community, and the European Central Bank, none of which wants to see Greece default.

Angela Merkel is saying they don’t have any leverage and the deal can’t be renegotiated.  But she is in a weaker position than just a few weeks ago.  She has lost her French ally Nicolas Sarkozy, and has to deal with the Socialist Francois Hollande, who is more sympathetic to Greece.  She just lost a German regional election to the Social Democrats, who also are more sympathetic to Greece.  Her rigid policies are under attack both at home and abroad.

So we’ll see who blinks first, the Greeks or their lenders.   But the harsh terms of the loan agreement approved in February make it look more and more like the Treaty of Versailles, which also seemed like a good idea at the time, but led desperate people to support extreme leaders and ultimately to World War II.  The Germans, of all people, should understand what happens politically when you try to get blood from a stone economically.

Having defeated fascism, the U. S. was appalled at the possibility that Greece might go communist, so we gave them tremendous amounts of aid, first under the Truman Doctrine and then under the Marshall Plan, to prevent that from happening.  Almost 70 years after that successful effort, the communists are on the verge of victory in Greece.  Heck of a job, Angela.

Hard Times Help the Crazies

Most of the attention has been focused on Francois Hollande’s defeat of Nicolas Sarkozy in France, but Greece had elections too.   In an ominous sign, both the radical left and the neo-Nazi right did well.  Both campaigned against budget cuts.

The Coalition of the Radical Left, Syriza, got 16%.

The neo-Nazi Golden Dawn got seats in Parliament for the first time (21 seats out of 300) with almost 7% of the vote.  By contrast, Golden Dawn got less than 1% just three years ago.

The two mainstream parties, which have been pushing austerity to satisfy Greece’s creditors and Germany’s demands, did poorly.  Center-right New Democracy got 20%, down from 34% three years ago.  The Socialists got 14%, compared to 44% three years ago.