Default Therapy
The Greek crisis has been solved…again. Let’s see…that’s probably about 24 “solutions” during the last 24 months.
But since these solutions never seem to solve anything, Europe’s central bankers, technocrats and politicians get to huddle together every few weeks and solve the crisis over and over again. It’s kind of like Disneyland for euro-meddlers. They get to keep going on their favorite ride over and over again.
Sure, they have to wait in line for a while each time, but the ride is so worth it! Lots of meddling, lots of intervening, lots of “tough negotiations,” lots of prescribing what’s best for others, while spending lots of money that belongs to someone else.
If that’s not an “E-Ticket,” what is?
The newest Greek solution — approved Monday by the fully employed politicians in the Greek Parliament — will hack 150,000 workers from the government payroll, while also slashing the minimum wage in the private sector by a whopping 22%!
Thus, after days of “tense negotiations,” the ECB and the Greek leadership finally hammered out a deal to save the troubled nation from default. The folks on Wall Street were riotously happy; the Greeks were merely rioting…and it is not difficult to see why.
The newest austerity deal is not a rescue plan; it is a captivity plan. It provides the same kind of “rescue” that a circus provides an elephant: Dance on a stool under the Big Top twice a day and we won’t forget to toss some hay into your cage.
To change metaphors, the newest austerity plan is an imprisonment pan: It straps leg-irons onto a nation that is already shackled to a monstrous debt load and a deeply depressed economy. The country’s GDP is tumbling faster than Icarus into the Aegean Sea.
“Anyone who thinks austerity is a way to fix a debt crisis should consider how this ‘medicine’ has worked on the Greek patient,” observes Chris Hunter, our colleague over at the Bonner Family Office. “Athens adopted strict budget targets in May 2010 in return for a €110 billion rescue. Last year the Greek economy shrank by 6% and the country’s budget deficit is still close to 10% of GDP. Meanwhile, unemployment has risen to a depression-level 18%. And over half of young Greeks are out of work.
Hence the riots against austerity — against more-of-what-has-failed-miserably-several-times-already. And these are real rioters — not like those touchy-feely, iPad-toting Occupy Wall Street folks — with real grievances.
Their main gripe: Why should I pay someone else’s debts? Why should I suffer because a prior generation spent much more than it earned, while also awarding itself retirement benefits the country cannot afford?
Good questions.
And yet, the solution to Greece’s fiscal squeeze may not be as elusive as the euro-meddlers and rescue-package architects make it seem. In lieu of extreme austerity measures, bond-restructuring deals and tranches of billion-dollar bailouts, the answer may simply be one little word: Default.
It’s so simple the Greeks could do it all by themselves, without any help at all from the ECB, the Federal Reserve or any of their friends in Germany.
Even so, most financial pundits use words like “unthinkable” or “disastrous” to describe the prospect of a Greek default. But history testifies to the contrary. Default is actually quite “thinkable” and rarely as disastrous as the “solution” the Greeks are now receiving. As the nearby chart shows, default is hardly a foreign concept on the European continent.
Greece, itself, has defaulted or restructured its debt five different times since the country declared its independence in 1821. Over those 193 years, the country has spent about half of its time in default or restructuring. And yet, Greece still managed to scrape together enough cash along the way to build a few train lines, repair a few roads and host the 2004 Olympic Games.
So why change tactics now? Why not let an insolvent debtor default and invite capitalism to do its work?
That’s the process an Austro-Hungarian economist by the name of Joseph Schumpeter used to call “creative destruction”…and it has worked pretty well over the years, believe it or not. When nations let failing ventures fail, viable ventures usually rise up to take their place. Over the long term, this process nurtures economic growth.
Remember, not every venture fails, only the failing ones.
The Europeans have forgotten the ideas that their favorite son, Schumpeter, promoted. But then, so have we Americans. And so have most of the other Developed Nations of the world — the so-called Welfare States.
Consider the divergent fates of two countries that came face-to-face with a financial crisis in 1990. One of these countries is still merely muddling along…20 years later! The other country is flourishing.
That’s because one of these countries, Japan, responded to its crisis by coddling its crippled corporations and by throwing monumental sums of taxpayer dollars at failing financial institutions. The other country, Brazil, responded to its crisis with relatively savage measures. It defaulted on its debts, devalued its currency (more than once) and did not stand in the way of corporate failure. Brazil’s responses were far from perfect, but they were much less imperfect than were Japan’s.
The origins and structures of their respective crises were very different from one another. But those differences were not as significant as their differing responses.
Japan has spent 20 years coddling its insolvent banks and corporations. Brazil has spent 20 years moving in the opposite direction…more or less. Brazil tolerated a dose of creative destruction. Japan did not. It still doesn’t. Brazil’s central planners abandoned much of their central planning, not because the planners wanted to, but because they lacked the resources to do otherwise. Japan, on the other hand, possessed the national wealth and resources to continue rescuing and meddling.
Too bad for Japan. Its economy has muddled along for two decades, while its stock market has produced a loss of 2% per year across that entire 20-year timeframe. By contrast, the Brazilian economy and stock market have both boomed during the last two decades, despite some very serious bumps along the way.
Brazil’s resurgence is typical of countries that allow some measure of creative destruction to operate within their borders. Economies are able to endure a crisis and then resume growing, as long as governments are willing to “rip off the Band-Aid” rather than dosing themselves with morphine. During the last 20 years, many countries have defaulted and/or devalued, then resumed growing rapidly. Russia, Chile, and Indonesia are a few prominent examples.
More recently, Iceland’s default and devaluation provides a textbook example of “default therapy”… or what Nobel laureate, Paul Krugman, termed “bankrupting yourself to recovery.” In late 2008, Iceland’s economy hit an iceberg. Although the country never reneged on any sovereign debt, its banks defaulted on $85 billion of foreign debt — more than double the $40 billion Russia defaulted on in 1998.
Not surprisingly, the Icelandic krona collapsed and the economy plunged into a deep recession. Icelanders suffered an 18 percent slump in their disposable incomes and unemployment approached 10 percent, compared with one percent before the crisis.
But the country’s pain and suffering did not last very long.
The krona’s 80 percent slump against the euro and the US dollar sent the trade deficit into surplus within months. Today, the Icelandic economy is growing once again and the country is already able to borrow money again from the international capital markets.
“Iceland didn’t have the ability to save the banks,” Finance Minister, Steingrimur Sigfusson, explained recently, when discussing Iceland’s decision to let its banks default. “This wasn’t our free choice.”
Hmmm…Sounds like a recurring theme…
Just maybe, a country with “no choice” is better off than a country with access to hundred-billion-dollar “rescue plans.” Just maybe, defaulting is less disastrous than borrowing money to defer a default.
Certainly, the divergent paths of the Icelandic and Greek economies testify to the generative powers of “default therapy.” Iceland’s GDP is on the upswing already, while Greece’s GDP is sliding ever lower. Reflecting these trends, the Icelandic stock market is up 60% over the last three years, while the Greek stock market is down 60%. Apparently, economies function best when failure actually fails — clearing the way for new successes.
So just maybe, default is a better course of action for Greece than indentured servitude to the ECB. A couple of Icelandic tourists told us exactly that in Zermatt, Switzerland last fall when we were conducting our Farewell Euro Tour.
A few European politicians are beginning to express a similar point of view. The Dutch representative of the European Commission, Neelie Kroes, suggested that one man overboard would not sink the ship. “It’s always said,” Kroes remarked, “that if you let one country get out, or ask it to get out, then the whole structure collapses. But that’s simply not true.”
Godfrey Bloom, a British Member of the European Parliament from the UK Independence Party, applauded Kroes’ remark. “Finally reality is beginning to dawn in Brussels and across Europe,” said Bloom. “One of the most senior European Commissioners has announced that ‘it is simply not true’ that if Greece were to leave the euro there would be disaster across the European financial system. This is what we in the UKIP have been saying for months, years even.
“The best way to help Greece, and by extension ourselves,” Bloom continued, “is if we give them a helping hand down and out from the eurozone, rather than spending billions of pounds of taxpayer’s money building a golden prison. Our Government has been playing along to the doomster dialogue in order to justify its throwing money at the lost cause… No more British money should be spent making a bad situation worse.”
Amen…and no more European money either…or American money…or Swiss money…or Japanese money.
Greece will never agree to stay put inside its “Golden prison.” It will break out eventually…but probably not before the wardens at the ECB and IMF waste another hundred billion dollars reinforcing the prison’s locks and walls.
This latest Greek bailout will fail just as decisively as all the bailouts that have preceded it.
Regards,
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