Earlier, I claimed that despite the grave consequences, Greece should default. Default would not be pretty for Greece or the rest of the world, but I firmly believe it is better than the alternative.
The international consequences of a Greek default would have a significant impact on Greece itself. When Europe’s banking system starts to collapse, its difficult to imagine many people taking trips to Santorini. It’s export markets will suffer. The conditions would not allow Greece to quickly return to prosperity.
Voluntary default also guarantees austerity for the Greeks. Greece would not be able to borrow if it defaults, and with Greece borrowing 10.5% of its budget, losing access to credit means Greece must decrease their spending by that amount.
This degree of austerity in not good for economic prospects. People would lose jobs and government support. Without that money available for consumption, businesses that rely on people purchasing their goods and services also suffer. Businesses have to lower prices to sell their goods to people with less money. But lowering prices means less income, so the businesses lay off employees. With fewer people employed, there is less money for consumption, and the cycle continues. This is called a deflationary spiral.
However, Greece should continue paying its debts only if they can generate economic growth. Growth would create increased tax revenues and making paying down the debts possible, and Greece could return to being funded by the markets instead of EU/IMF bailouts.
The problem is that the prospects for growth are slim. They’ve run up credit card debt, and been given another credit card to give them a chance to get back on their feet. The plan requires economic growth to work, but rather than using the line of credit to invest and generate growth, austerity is a condition for continued access to credit. This leads to the same deflationary spiral as default.
The Greek economy is contracting. The chances that its debt could ever reach a level where they could be funded by the market again are almost non-existent. And over the past two years, Greece continued a pattern of unpleasantly surprising with higher than expected deficits (BBC headlines from April 2010 – Greece’s budget deficit worse than first thought and April 2011 – Greece budget deficit worse than thought).
Default at least stops transfer of Greek wealth to foreign creditors, and if you have no chance of ever paying off your debts, you’re better off not transferring your wealth elsewhere (not to mention taking on more debt). They can make sure that they have the most possible resources to begin rebuilding, and Greece won’t lose any of its islands or historical landmarks in the process.
Furthermore, the deflationary spiral is only possible under one condition: lack of control over the money supply. If Greece had its own currency, it could monetize its budget deficit (i.e. buy government bonds with freshly printed currency, like we do). Its ability to monetize its debt is limited by the dangers of inflation, but monetization would prevent the massive disruption of immediately cutting 10% of government expenditures. Greece has no power over its money supply on the euro, but if it returns to its own currency, it would have the power to dampen the blow of default.
Why Everyone Pretends Greece Won’t Default
Everyone has a stake in Greece continuing to pay its creditors. Maybe IMF and European leaders genuinely believe they can prevent full-fledged default (although they just allowed a 20% haircut). Maybe it is a case of optimism bias. Maybe its conceit in their intelligence and abilities. Maybe they can’t give up the dream of a politically unified Europe. Maybe they can’t bear to be seen doing nothing as each monthly crisis takes hold.
No one wants to be the guy who pushes the big red button and blows everything up. This is understandable. No one really knows how far we have to fall. Greece, Ireland, Portugal, Spain, and Italy are all essentially bankrupt with no reasonable prospect of repaying their debts at full value. America is left with zombie banks that roam the earth in an undead state by not having to report their assets at market value. With unemployment as it stands, any drop from here risks large-scale social upheaval. We let things get pretty bad, and the moment we stop living on literally borrowed time, the powers-that-be can no longer hide the full extent of our uncomfortable condition.
Therein lies the unenlightened self-interest in biding time. Things will definitely get worse on the watch of the person who lets everything crumble and the rebuilding process begin. In a democratic system, they will not get to remain in power. Their party will not remain in power. The people in power and in high-status, high-income positions have a stake in perpetuating the status quo as long as possible, so any fundamental change will be resisted as long as possible. Greece is the logical defector from the current economic arrangement, but selfish desire to keep the party going is the most compelling explanation for why they don’t.
Don’t Steer Away From The Brick Wall, Add More Fuel
This perpetuation is extremely unfortunate because everyday world governments continue to waste resources trying to sustain an unsustainable system. The opportunity costs of current policies are tremendous. Not only is our potential return low, every dollar that props up consumption or the financial system is one that can’t be invested in productive activities. We mortgage our prospects for the future by maintaining a failing present.
The best example of how maintaining the current system has cost the US the opportunity for a brighter future in the NASA budget. NASA represents the limit of human knowledge, capability, and achievement. Now that we have banks to coddle, we suddenly don’t have the luxury of pursuing the possible.
This waste of resources is made with such lack of creativity that the wastefulness seems purposeful. What is stimulating about filling holes in state budgets and unemployment insurance schemes? What sort of investment is buying bonds from banks that need the money just to get back to even? These are very obvious attempts to sustain rather than grow. That money can’t push us ahead. It can only keep us where we are.
Consider this: the Federal Reserve lent $16 trillion to businesses and financial institutions (many of them non-US) in the wake of the financial crisis. The total amount of household debt in the US is $13.4 trillion. I’m sure all those families would have appreciated the terms of those sweetheart loans. The Fed could have refinanced all existing household debt. In refinancing, the lenders would receive cash in replace of toxic assets to bolster there balance sheets. With the improved terms, borrowers would have discretionary income to boost consumption and be more likely to repay the debts. (Pending inflation) this holistic approach would have worked for everyone instead of just politically-connected banks.
My inner conspiracy theorist says that the responses are designed to keep citizens as debt serfs that are totally dependent on government. The intention may not be conscious, but that’s the result. Its hard to get insight into motive, but there are only two explanations for these policies: our leaders are incompetent, or our leaders are evil. It is likely that they are incompetent, and I’m unwilling to dismiss the other possibility.
The unintended consequences are more troubling than the waste itself. We are being held hostage by a financial system that put a noose around its own neck. Governments prop up the financial system with public resources, and then the financial system turns back around and says that we won’t lend governments money unless it cuts expenditures to the general public. But when the next crisis comes along, and there is always money to keep banks from facing the natural result of their reckless and sociopathic behavior. Bankers keep raking in huge bonuses. They use the bonuses to purchase the loyalty of the next government. The money continues to flow away from the places where it is most needed to most wealthy and undeserving.
The Great Reset
This game should end. We cannot trust those in power to ease us through this. It is time for massive cleansing of liabilities from the system and a fresh start. We can clean the slate through defaults. We can clean the slate through bankruptcies. We can clean the slate through massive inflation. We can clean the slate through refinancings as I suggested. Big change is going to happen regardless, and it will be better if we take it on ourselves rather than continue to put ineffective and unjust band-aids on a gaping head-wound.
Its not going to be pleasant, but I hope that once everyone understands the gravity of our situation, we can bear the costs and take the necessary steps to get back on the right track. Otherwise, we’ll have to watch the world around us crash in slow motion. These banks are on the verge of bankruptcy yet again. More resources will be freely transferred to the top unless someone stops it.
(Image courtesy of wlodi)