YES VIRGINIA, THERE IS A DIFFERENCE BETWEEN GREECE AND THE US
Roosevelt Institute Senior Fellow Marshall Auerback and Braintruster at the New Deal 2.0 explores the comparison between Greece and the US:
YES VIRGINIA, THERE IS A DIFFERENCE BETWEEN GREECE AND THE US
By Marshall Auerback
Many market analysts, commentators and economists claim to be having a hard time finding a metric in which the US is in better financial shape than Greece. Ken Rogoff, for example, recently warned that a Greek default would usher in a series of sovereign defaults, and suggested recently on NPR that the crisis also had implications for the US.
The historian, Niall Ferguson, made a similar claim a few months ago in the Financial Times, “A Greek Crisis is Coming to America”. The cries of the deficit hawks grow louder: Repent all yee fiscal profligates, before the “day of reckoning” comes.
Let’s dial down the Biblical hysteria a wee bit while there’s still time for rational debate. The action in the markets over the past few days in response to the intensifying pressures in the euro zone suggests that investors are beginning to differentiate between countries which are sovereign issuers of currency, such as the US or Japan, and non-sovereign issuers, such as Greece, or indeed any of the other nations within the euro zone. The US dollar is rising in value, notwithstanding the federal deficit, whilst debt distress in the so-called “PIIGS”, especially Greece, are intensifying, thereby driving down the euro to fresh 12 month lows against the dollar.
The relative performance of various currencies against the US dollar is highly instructive in this regard. Over the past 3 months, the Australian, New Zealand and Canadian dollars have all registered gains of some 4% against the greenback. The worst performer? Not surprisingly, the euro, down 6.3% over that period. Whether consciously or not, the markets are demonstrating intuitively that they understand the distinctions between users of currencies (who face an external funding constraint), and those nations that face no constraint in their deficit spending activities, because they are creators of currency.
That the US has the reserve currency is an irrelevant consideration here. The key distinction remains user vs. creator. The euro zone nations are part of the former; Canada, Australia, the UK, Japan and the US are representatives of the latter.
Using “PIIGS” countries as analogues to the US, or the UK, as Rogoff, Ferguson and countless other commentators do is wrong. Their faulty analysis comes as a result of the failure of deficit critics to distinguish between the monetary arrangements of sovereign and nonsovereign nations. Any sovereign government (of which none within the EMU enjoy that status any longer) can deal with a collapse in revenue and an increase in outlays from a financial perspective without invoking the sort of deadlocks that are now crippling the EMU zone. That is why, for example, the Japanese yen is not in freefall against the dollar, despite having a public debt to GDP ratio in excess of 200%, almost 2.5 times that of the US. In fact, over the past few days, the yen has actually appreciated against the dollar. Now why would that be the case, if the lesson we were supposed to learn was about the evils of “unsustainable” government deficit spending?
Fiscal sustainability has no relevance in a system where there are no OPERATIONAL constraints on the ability of a government to spend. US Social Security checks will not bounce. Nor will the Canadian or Japanese equivalents. Similarly, their bonds will always be able to pay out interest. Note, that this doesn’t mean that there are no real resource constraints on government spending:
Let’s be clear: anyone who advances the use of fiscal policy as an effective counter-stabilization tool is always careful to point out that these interventions can come at a cost. That cost could well be inflation if, as a result of the fiscal expansion, we reach full employment, resource constraints begin to appear yet the government continues to spend. But if the economy recovers, tax revenues will increase and safety net spending will fall. In the US that means we will likely be back to “normal” with deficits around 2-4% depending on the state of the economy, which is where we’ve been for the past 30 years aside from 1998-2001.
Why won’t these deficits be inflationary? As Professor Scott Fullwiler noted in a recent email correspondence with me, once the recovery is underway and the economy gets to a significantly higher capacity utilization where price pressures could emerge, the deficit will be declining substantially, and be at least a partial offset, as the discretionary spending brought about by social welfare expenditures comes down. It’s axiomatic that the faster the economy grows, the smaller the deficit becomes unless the government continues to spend recklessly, which we certainly do not advocate.
And by the time we get to a point where we might have inflation, the deficit is back to 2-3%, which again is where we’ve been for the past 30 years while average inflation has been about 2%. Note: inflation does not equate to default. You and I could well buy credit default swaps on any country in the world, but we are unable to collect if any of the relevant countries register a positive rate of inflation – even a double digit rate of inflation – because inflation is not tantamount to default. Nor do the ratings agencies recognize default in this manner. Default is defined as a failure to perform a task or fulfill an obligation, especially failure to meet a financial obligation. Inflation is NOT incorporated into the definition when it comes to questions of national insolvency.
By contrast, the talk of Greek default is prevalent across the markets and that is a reasonable concern in the context of the euro zone. The default option is considered a foregone conclusion, even allowing for the massive 110 billion euro bailout, which was designed to inspire “shock and awe” amongst investors, but instead has simply engendered shock. If Greece costs 110 billion euros to bail out, how much next time for Spain, Italy, or even France?
If the markets have concerns about national solvency, they won’t extend credit. And that is the problem facing all of the euro zone countries. Greece, Portugal, Italy, France, and Germany are all users of the euro—not issuers. In that respect, they more like any American state or municipality, all of which are users of the US federal government’s dollar.
And deficits per se will not create the conditions for default in the US. If the US continues to run net export deficits, (all the more likely given the ongoing fall in the value of the euro), then if the private domestic sector is to net save, the US government has to net spend – that is, run deficits. That is a basic accounting identity, nothing more, nothing less. If the US government tries, under these circumstances to run surpluses it will first of all force the private domestic sector into deficits (and increasing debt) and ultimately fail because the latter will eventually seek to increase their saving ratio again.
And the same logic applies for Greece. The call is for the IMF/EU package to reduce its budget deficit as a percentage of GDP from the current 13.6% to 8.1% in 2011. How will they achieve that? Trying to engineer a reduction in the deficit via austerity programs (or freezes or whatever else one might like to call them) at a time when private spending is still insufficient to maintain adequate real GDP growth is a recipe for disaster. IT WILL INCREASE THE DEFICIT.
Consider Ireland as Exhibit A in this regard. Ireland began cutting back deficit spending in 2008, when its banking crisis began to spread and its budget deficit as a percentage of GDP was 7.3%. The economy promptly contracted by 10% and, surprise, surprise, the deficit exploded to 14.3% of GDP (http://epp.eurostat.ec.europa.eu/cache/ITY_PUBLIC/2-22042010-BP/EN/2-22042010-BP-EN.PDF). We would wager heavy odds that a similar fate lies in store for Greece, given the EU’s inability to understand or recognize basic financial balances and the interrelationships amongst the various sectors of the economy in terms of how they impact one another. Neither a government, nor the IMF, can predict with any certainty what the outcome will be – ultimately private saving desires will drive the outcome, as Bill Mitchell has noted repeatedly (http://bilbo.economicoutlook.net/blog/?p=9533#more-9533).
Why do we have huge budget deficits across the globe? It’s not because our officials have all suddenly become Soviet style apparatchiks, but largely because the slower global economy has led to lower revenues (less income=less taxes paid since most tax revenue is based on income, and lower tax brackets) and higher spending on the social safety net. Gutting this social safety net because we extrapolate the wrong lessons from the euro zone’s particular (and self-imposed) predicament constitutes the height of economic ignorance. It also reflects a transparently political agenda which the US would be ill-advised to embrace. The rescue packages, the IMF intervention and all the talk about orderly defaults cannot overcome the EMU’s fundamental design flaw. Let neo-liberalism die with the euro.
Marshall,
Thought-provoking post. I totally agree that an adverse feedback loop (“the doom loop”) can form whereby attempts to close deficits lead to higher deficits. This is why poor economic growth stats usually tank the bonds of risky sovereign issuers, whereas they rally ours.
In this post you acknowledge deficit financing comes at a cost but argue that the output gap is the guarantor of policy: as long as the “economic speed limit” is respected, deficit spending can be removed before there is a problem. The output gap is what makes the whole thing work; the Atlas holding up a globa of massive government intervention to prevent debt deflation following a leverage binge. What is interesting is how universal this belief is. Analysis with diametrically opposed views (I’m thinking Scott Sumner, Paul Krugman, yourself) will all agree that the output gap saves us from future inflaiton.
What I suggest is that the output gap is not that interesting of a concept. “Exceeding the speed limit” of the economy CAN produce inflation, but it is not the only cause of inflation. In fact inflation is caused by unanchored expectations that result in forward buying, which in turn increases velocity. This can occur under substantial output gaps, as was seen in Latin America throughout the post-debt crisis period. Whatever currency Latin countries issued debt in is irrelevant to that point.
The dynamic of un-anchoring inflation expectations is not well understood. One reason is that Keynesians focus so strongly on ouput gap effects. The other is that economists tend to treat velocity as the stable residual of an econometric formula. In fact, it is just a fancy name for “animal spirits”, spirits which we know are not stable.
So I would argue that deficit monetization can and does unleash these “spirits” in the direction of hedging against a loss in purchasing power of their currency. This hedging takes the form of forward buying for unshophisticated (read “poor”) holders, and all sorts of financial shenanigans for sophisticated ones. In effect, the dynamic of inflation in Latin America was a constant search by the government to produce purchasing power (“money illusion”) for their newly-printed currency in the face of a populace singularly determined to prevent them from doing so. The wage-earning middle class were the losers in this battle, and we saw income inequality continually rise as a result.
As an exercise, I would ask Keynesians, MMT proponents, and whatever it is that monetary interventionists call themselves these days, to think of all the ways that inflation can occur under an output gap, and to argue for why none of them apply to the U.S. in the current period.
So basically what you are saying is that the US is different from these other countries because we can print and spend an unlimited amount of money with virtually no consequences?
The ECB can do same so why dont they just print a couple of hundred pallet loads and send them to Greece?
“Over the past 3 months, the Australian, New Zealand and Canadian dollars have all registered gains of some 4% against the greenback.”
This is carry traders taking advantage of ZIRP and trading US dollars for higher yielding currencies.
Note, that this doesn’t mean that there are no real resource constraints on government spending
This seems to make sense to me. The only serious inflation I have seen was 197o’s. Seemed to be caused by the oil price shock… not the oil price itself, but people attempting to make themselves whole by raising prices, and then raising wages where they had bargaining power.
Of course the great economists said that the inflation was caused by not enough unemployment. Which is the way they fixed it.
Thank you Rdan
Its absolutely amazing how many people can not read.
Auerback:”Note, that this doesn’t mean that there are no real resource constraints on government spending”
AndyC:”So basically what you are saying is that the US is different from these other countries because we can print and spend an unlimited amount of money with virtually no consequences? “
(sound of head banging against wall repeatedly)
Let neo-liberalism die with the euro.
Awe, isn’t that heart warming? Had to throw his little jab in at the end, because he feels so threated that the Socialists are falling on their faces.
Although don’t worry…We gonna keep spending, I mean god-forbid there should be any pain in low end when all we have to do is drag down entire economy and all the producers, and that way we can all be part of the lowest common denominator just like our heros in Europe.
Thank you Greg. I’ve only made this point about 50 times today, so it’s nice to know that a few people can make the distinction that you’ve highlighted!
You’re right, Jimi. I’m glad to see you view governments such as Germany’s Christian Democrats as something akin to socialism. Clearly, a good display of political perspective. It goes along with your economic perspective. We tried your way in the 1930s. How did that work out for us?
Greg
What he’s suggesting is ponzi
Come on Jimi. Two years ago Neo-liberalism handed the world the worst economic debacle in 80 years. One that has been moderated by Keynesian spending. Surely Neo-liberalism deserves a shot … in the back of the head. If you want “economic freedom” you’re going to have to figure out a way to achieve it in a stable and reliable fashion. Figure that out, and maybe we liberals will surprise you and find some merits in your arguments. But right now, you’re selling from an empty cart.
Now if the Keynesians neglect to stop spending when (if) the economy recovers, and fail to pay down the debt, then you’ll have reason to complain.
Marshall,
Nice thought provoking post. I agree with you Greece is not like the US. The US can print money, Greece can’t.
My question is. Would the comparison be more apt between Greece and California? Neither can print money (unlike the ECB or the Fed). Greece could concievably leave the Euro (or be tossed) but California is stuck.
And it looks like the PIIGS are going to need more bailouts in the future, as will Greece specifically. So what incentive does the Bundesbank have to cough up more in the future? Especially when its pretty obvious that Greece is not going to make any efforts to fix the problems that got them in the crack in the first place. Wouldn’t it be smarter for the stronger Euro countries (France, Germany, Netherlands etc) to dump the PIIGS out of the Euro and go along without them?
Islam will change
Marshall,
Wealth isn’t created by a Government. Wealth is only distributed by a Government. The leftists mantra of so called “Neo-Liberalism” has created the highest standard of living the planet has ever seen, so it worked out well.
Jimi
“Wealth isn’t created by a Government. Wealth is only distributed by a Government.
I’ve heard this argument SOOOOO many times, it really is getting old. Tell me a coherent story of how “wealth” is “created”. You must first; define wealth. Next; define creation. Then describe a system of money that would start ex nihilo and accomodate wealth creation. Not just accomodate wealth creation but accomodate it at the level we’ve grown accustomed to in the 20th and 21st centuries. Not at some pre industrial revolution level.
I’m going easy on you because its much harder to actually work within the current world monetary framework that involves multiple currencies all following different pegging or free floating exchanges (all which affect how we measure “wealth or “price”).
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I’ll add to your comment though. WEALTH IS PROTECTED BY THE GOVT. Which if you were responsible for your self would actually give you very little wealth at all, or very poor protection.