Athens Greece Austerity

Although austerity is the worst possible economic decision Greece could make right now, it has no choice because Germany – rightfully so, it should be added – doesn’t want to put its healthy economy and own citizens’ well-being on the line any more than you would co-sign on your neighbor’s mortgage and credit card debts.  **

I am going to give you a brief economics lesson in a few short minutes.  Economists like to make things hard but for those of you wanting to know why Greece, and the Euro, continues to be such a problem for the world, here is a breakdown.  It isn’t nearly as difficult as you might think.

To understand the situation with Greece, the Euro, and austerity, let’s start at home.

Most of you are from the United States.  When the United States borrows money, it promises to repay a certain amount of fixed dollars.  It does not promise to repay purchasing power.  The same government, through the duly elected Congress, controls the printing presses.  If we found ourselves in a real financial bind, we could print more money, making each dollar less valuable, until we had printed enough to repay all of the dollars owed.

[mainbodyad]Unfortunately, there are side effects to the medicine; in this case, it would hurt our reputation, making it very difficult to raise money in the future because investors wouldn’t trust us, and the price of everything from milk and cheese to gasoline and housing would appear to increase because it now takes more dollars to buy the same quantity of goods.  The point is, if we needed to go nuclear on the currency, we could.  It would be terrible.  Many people would suffer.  Think of it as the financial equivalent of having to amputate your own leg to stave off diabetes.  But it would be better than the alternative.

Greece No Longer Controls the Printing Presses

This was the case for the individual countries in Europe before the introduction of the Euro.  It isn’t, anymore.

Back then, if a nation like Greece wanted to spend money, it would borrow Greek drachmas from savers.  Had things gone wrong, instead of resorting to austerity (mass budget cutting, risking deflation), the government could have always printed more drachmas.  Would that have been ideal?  Again, no.  But as badly as it would have hurt, the pain would be a lot less than the alternative.

When the nations of Europe combined into a single currency, they all had to issue bonds (borrow money) denominated in Euros if they spent more than they earned in any given year.  Unlike the old days, no individual country controlled the printing presses.  Everyone had to work together, cooperatively, and agree upon a course of action.  To turn on those printing presses, you needed to take a vote.  (I’m oversimplifying here but this gets to the economic heart of the matter.)

When Greece got in trouble due to the economic meltdown, it didn’t have enough Euros on hand to repay the debt it owed.  Had it not paid back the lenders who let it “rent” their Euros to finance the national budget, widespread panic would result.  The problem?  Greece went to its neighbors and said, “We need to print more Euros to lessen our debt burden!” but countries like Germany, which have behaved responsibly and enjoy a good economy, effectively said, “Not a chance.  Why would we cause prices to rise for our citizens?  This is your problem, not ours.  Cut your expenses and live within your means.”

Why Austerity Risks Massive Deflation in Greece

That sounds reasonable to the average person: If you are spending more than you earn, you cut your expenses.  On the national level, it isn’t so simple.  In Greece, a huge part of the economy depends on government spending and salaries.  If you start cutting those, the citizens who formerly had jobs and benefits lose them.  Suddenly, they have no paycheck to spend at local furniture stores, grocery stores, automobile dealerships, or coffee shops.  Those businesses face a drop-off in customers and have to layoff their own staff, cut back on their inventory, and reduce hours of operation.  This creates a death spiral called deflation.  It is the opposite of inflation.  As the nation enters deflation, tax receipts drop off a cliff.

In other words, the Greek government runs the risk that by cutting $1 in costs, they may find themselves destroying $2 in tax income, making the black hole even worse.  This is what your average mom-and-pop voter doesn’t understand.  They don’t get why politicians and economists are so unwilling to live within a nation’s means, spending less than it earns.  Simple.  Every dollar in budget cuts on the expense side has a chance at creating more than a dollar in revenue loss on the income side as the so-called velocity of money slows.  It is the flip side of the Milton Friedman coin, which demonstrated that targeted tax cuts can increase the velocity of money and make a government generate more tax dollars despite lower bracket rates.

In this particular case, cutting expenses is one of the worst possible things Greece can do.  If it were ordinary economic times, it would be advisable.  You would want to see a 10 year plan to lower the Greece government debt and spending as a percentage of GDP, just like Canada did when it effectively paid off 50% of its national debt without the average citizen noticing.*  Austerity is going to hurt the Greek people.  It is going to result in some senior citizens eating cat food.  It will result in widespread civil unrest and riots.  Unfortunately, austerity is probably unavoidable at this point.

Germany Is Acting Rationally, Which Basically Means It Sucks to Be Greece

Here is the kicker: Though austerity is a nightmare for Greece and the worst possible option it has right now, it is “too damn bad”, to borrow a phrase, because Germany is acting rationally.  The Germans have an almost tangible fear of inflation, having gone through the nightmare of the hyperinflation of the Weimar Republic.  They will do almost anything to keep it under control.  It is part of their national scar, history, psyche, and culture.  All things considered, the current system is working just fine for Germany.  They are the responsible older brother who has saved his money, lived within his means, taken advantage of the arrangement, and is now being asked to clean up everyone else’s mess.

Germany Euro Bonds and Greek Austerity

Why should the people of Germany risk their own financial well-being, after decades of behaving responsibly, to bail out their neighbors?

Put another way, why should a German senior citizen have to face higher milk prices just to keep a Greek senior citizen from eating cat food?  The Germans have done most things right.  The Germans lived within their means.  The Germans had a balanced economy.  The Germans have a debt load of roughly half of the Greeks as measured as a percentage of GDP.  Why should they pay for the stupidity of their neighbors?  Isn’t the obligation of the German government to the German people?  To their well-being?  To their happiness and security?  I would argue, yes.  They need to do whatever keeps butter and cheese affordable in their country; what keeps their workers manufacturing and serving; what keeps their national treasury full.

Economists and commentators – correctly – point out that the entire Greek tragedy could be solved in no time if the Euro using nations would agree to issue mutually-backed Euro bonds to get through the crisis.  But, again, this is the important moral and ethical question: Why should they?  Why should the people and government of Germany put their own safety at risk by co-signing on loans just to bail out their spendthrift neighbor?

Would you co-sign on your neighbor’s house to keep them out of foreclosure?  I didn’t think so.

Ultimately, the Euro Will Probably Fail

The single currency of the United States works because the citizens of each state think of themselves as Americans first.  We move interchangeably between states.  Each state has the same cultural background and shared language.  Each state is subject to the rulings of a single Supreme Court and Constitution.  The nations of Europe have history going back thousands of years.  The French think of themselves as French first, European second.  Likewise with the Italians, Swiss, Spanish, and Greek.  Can you blame them?

[mainbodyad]Given the biological imperatives of human nature, I think it would take a World War II level event to ever unite Europe under a single government, currency, and culture. Even then, I am not certain it can be successful in the long-run.  The only other way it could happen would be if there were spending control puts in place so countries like Germany would know they weren’t going to get screwed by backing consolidated Euro bonds to cooperate with their neighbors.

The moral?  Long term, a nation cannot be successful if it has the power to borrow money in a currency but does not have the power to devalue that currency or have automatic, constitutional cost controls in place to limit government spending.

* Footnote: Back in the mid 1990’s, the nation of Canada decided it wanted to reduce its national debt.  The plan called for holding the debt level steady and letting the natural 3% to 4% inflation rate slowly chip away at the “real” cost of the debt.  Within 15 years, the national debt was the same as it had been in Canadian dollars, but it was half of the percentage of the Gross Domestic Product, representing a 50% drop in the “real” debt liability.  It was brilliantly executed and achieved without austerity.  It is a great model to be replicated for nations during normal peacetime expansions.

** Image published under Creative Commons Attribution 2.0 Generic License, originally taken on November 12th, 2006 at 9::45:18 by Rob & Lisa Meehan.  Titled View of the Acropolis from Lykavittos Hill.

  • Gilvus

    Thanks for explaining this to us little people 🙂

    On another note, though – one could argue that Germany signed a pact, sort of like the economic equivalent of a military alliance. Maybe your ally instigated a war (against your wishes) by annexing your mutual neighbor, but due to your pact, you march off to war anyway. Or it’s like a group of people paying for medical insurance even though they know one of their members occasionally fights grizzly bears with a rubber chicken. For sport.

    • Joshua Kennon

      That is a very valid argument worthy of consideration.

  • Mishra100

    I would like to add the case of the United States. The US needs to cut it’s deficit and start raising a surplus. Such a large cut in government spending will definitely take a large toll on the economy causing possible deflation as you state with Greece here. 

    This is why I believe the best system when you are in these desperate measures is this: devalue currency to offset your debt, make large cuts in government spending, then lower taxes all as close together as possible. This way, that government worker who loses their job does lose their stream of income. But the taxes were lowered so every American is getting more money back which keeps money into the system in which that worker has lost. At that point, you move into the possible “Milton Friedman system” in which lower taxes does produce more money for the government. The government pays down debt, and the citizen gains back the power to control the market with their purchases, instead of giving it to someone else to decide what they should do with your own money which could easily spend it inefficiently. 

    • Joshua Kennon

      The challenge that we face in the United States is that there are only three items in the budget that are large enough to cut to reach break-even or surplus.  

      1. Defense
      2. Social Security
      3. Medicare

      Nothing else matters.  Everything else is a pathetic, tiny rounding error that does absolutely nothing for the budget.  At the rate we are spending, we will soon add a fourth item:

      4. Interest on the national debt

      Right now, thank God, that fourth item is held down by artificially low interest rates.  Otherwise, the deficits would be even worse and the cuts deeper.

      The only way you could balance the budget on the expense side is to:

      1. Raise the Social Security retirement age, which I completely support.  People approaching retirement now shouldn’t be harmed; they should be grandfathered into the system since it isn’t fair to pull the rug out from underneath them.

      2. Adjust Medicare benefits.  The good thing about the Medicare system is that in terms of financial efficiency, it is very good, typically requiring only a few percentage points of overhead.  That efficiency doesn’t make up for the looming massive deficits, though.  You cannot pay $1 into a system and take $4 in benefits at a time when the older-person-to-young-worker ratio is collapsing.  Either the population has to grow through natural birth, immigration, or a combination thereof, or benefits must be cut.  It makes no sense to spend $200,000 in tax payer money to keep a 97 year old alive for another three days.  The unfortunate thing no one wants to talk about is that almost all medical bills of that magnitude are incurred in the final 24 hours of life, even if the person is at the end of their natural life, anyway.  The system won’t address it now due to all the Republican talk of “death panels”.  There are already death panels, but they exist in the form of corporate health insurance benefit boards.  That is how naive people are.

      3. Defense has to be cut.  We spend something like what the next 14 nations combined on military expense.  It is not necessary to keep us safe.  It is necessary to fund a vast military industrial complex of corporations, of which I own shares in many, to have guaranteed business from government contracts, transferring tax payer money to private businesses.  It is reverse socialism.  The existing system is so ingrained, I wouldn’t be shocked if you announced a 50% cut to defense and someone, somewhere in the military staged a terrorist attack or provoked a war to get the money restored.  That isn’t hyperbole.  That is how deeply rooted the interests are.  

      Almost every American citizen as a “holy cow” that they won’t allow to be touched.  That means the decision will be made for us, in a God-awful, horrific economic malaise like Great Britain before Margaret Thatcher was willing to tick everybody off.  It’s the way of the world.  People don’t like doing things until they are forced.  A relative of mine works in a hospital and says that it isn’t uncommon for 500 pound, 50 year old people to walk in the door and insist that they are “healthy except for …” and then start talking about high blood pressure, diabetes, gout, etc.  Same concept.  Denial is powerful.

  • Vic

    Foreshadowing the Brexit vote, right?