The Greece Bailout
by Jeffrey Miron on April 30th, 2010
11 Comments
My thoughts, at forbes.com.
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Aaron Durst
I have just read your article on the Greece Bailout, and I have to say I don’t think you have thoroughly thought through the consequences of such an action.
Greece’s debt is a form of money, and part of the world’s money supply. If Greece were to default, a portion of the world’s money supply would instantly become worthless, meaning a contraction in the world’s money supply. If the contraction is severe enough, people will rationally come to expect deflation. Once people expect deflation there is a strong incentive to postpone all possible consumption into the future (i.e., why buy a $500 TV today, when you expect you can buy it in the future for much less?). Of course when people are rationally postponing their consumption, there is no incentive to borrow money, which leads to a further contraction in the money supply as the money multiplier effect disappears, which leads to further expectations of deflation, which again increases the incentive to postpone consumption.
This is exactly what the world saw in 2008-2009, but thankfully Ben Bernanke was able to halt the process by pumping enough money into the economy to reverse people’s expectations regarding deflation.
If Greece defaults, the world might be right back to where it was in 2008-2009 with Ben Bernanke pumping money into the world economy to halt the cyclical destruction of the world’s money supply caused by rational expectations of deflation.
Eric Morey
Two comments:
1) If Greece past laws to reduce pay-scales and benefits for civil servants and cut the number of such jobs, repealed of critical regulations, taxes and policies, would you favor a bailout to close the gap between current obligations and the lowered future obligations? Theoretically this may be best for those outside of Greece (the bailout lenders).
2) You should really consider paying a professional photographer to get a good picture of you with a smile. Psychologically, people are more likely to listen to new ideas and arguments from someone that appears friendly.
Justin P
I’m sure Greece will get its bailout. It might even get the second it will need….but will it get the third and fourth…so on. Greece can’t pay for itself. They will only reduce their deficit when they are forced to (to get a bailout) Eventually the money will run out, what will Greece do then? All this is doing is postponing the inevitable.
Bradford
Some people appear to be very worried about deflation.
If Greece has a budget deficit of 9.1% of GDP this year, this will be a deficit of about 23 billion Euros, a very minuscule portion of the world’s money supply.
Moreover, suppose deflation were to occur, even in the long term, because money growth didn’t keep up with real economic growth. This happened in the U.S. from 1872-1913 at a rate of about 0.5% deflation per year. Meanwhile, annual real growth averaged 3.75%, or 1.7% per capita. All this without Ben Bernanke to step in and cause people to expect inflation. (See measuringworth.com and you can do the math for yourself.)
And what a fortunate thing. It would be pretty depressing if we had no choice but to step in during these crises and act in a way that could only make them more likely to occur in the future.
Aaron Durst
Bradford,
Your last sentence makes it seem if you assume there are only 2 options (i.e., allow Greece to default, or bailout Greece). There is a third option other than bailout and default. The world could say to Greece that it has accrued the debt and it is obligated to make good on its debts, and the world will not tolerate Greece defaulting on its debts. And, if Greece does default, they will have forfeited soveriegnty over their nation and the world will move in to liquidate every thing in Greece it can to make good on the debts. It is in the world interest to make such a threat because the potential economic disaster resulting from Greece defaulting is so great it can’t be allowed to occur. Now, the odds of this occuring are probably zero, but it does not change the fact that Greece can not be allowed to default due to the economic carnage that it would cause.
Now, to the numbers that you mention, it is not Greece’s deficit that is the problem. Instead, the problem is the amount of debt that Greece would seek to default on. That number is much greater than the $20 billion you have mentioned.
In regards to the years 1872-1913, deflation was not an annual thing. Instead you had several years of inflation and economic growth followed by financial panics of deep deflation and deep economic regression. This cycle repeated itself several times during those years. If you wanted to compare the two time periods, it should be obvious that the US would be at the apex of economic and inflationary growth, and should the US enter a peroid of unchecked deflation it would result a trully catastropic economic collapse as 80+ years of inflation would be wiped out in just a short couple of years.
Bradford
I just don’t think it would be right for the world to assert that Greece has lost its sovereignty and take control of the budget unless it is part of a contract Greece has agreed to.
I actually think there is another option. Make a loan at a specified rate of interest, on the condition that failing to pay back the loan authorizes the lending governments to take control of Greece’s budget. But this also would never happen.
P.S. See the U.S. CPI data on measuringworth.com, published by two economists at the University of Illinois at Chicago. The deflation was all but continuous from 1872 to 1900.
Alejandro
Leting Greece default is very simplistic. If Greece defaults, it will have an enormous pressure to abandon the euro, and issue a new currency highly devaluated.
This will cause inflation and more regulation, will put unions in the center and create a chaos.
Bradford
A Greek default will have bad consequences for Greece but in that case Greece, and not other countries, will be paying for Greece’s errors. Deciding what to do is a value judgment, but the answer is obvious to me.
Aaron Durst
http://news.yahoo.com/s/ap/20100506/ap_on_bi_st_ma_re/us_wall_street
Still think Greece default will only hurt Greece?
Like I said, Greece can not be allowed to default. The world should not allow Greece to escape its debt and force the world to pay the consequences for Greek’s mistakes.
Bradford
You’re right that a Greek default will hurt investors as well as Greek citizens–and not just investors in Greek government bonds. Although I was not clear on that, I would like to say that my preference is for investors to be exposed to market risks. As they said in Rome, caveat emptor. The reason for this preference (and it is of course a value judgment) is that investors make a conscious decision to expose themselves to risks. On the other hand, I think taxpayers in country A are right to be indignant when they are forced to pay for the excessive budget of country B, which is used to render services to the citizens of country B. (Moreover, as Miron pointed out, rewarding a fiscal imbalance means that the fiscal imbalance is much less likely to be corrected. Alternatively put, if we acknowledge that people respond to incentives, it’s reasonable to conclude that bailouts beget bailouts.)
There’s a further issue here. For dollar-denominated stocks at least, price-to-earnings ratios are currently above their long-term average going back several decades. Given that the future economic growth outlook for the U.S. is less than rosy, I think it’s safe to say that stocks here may be overvalued. Perhaps we should welcome a stock market correction.
blue monkey
Greece and Spain won’t pay back. This was a calculated Risk, and a Lesson for the Banking System. The only thing Germans can do is:
REPOSSESS 170 Leopard 2AEX Battle Tanks from Greece, and 190 Leopard 2A6E Battle Tanks from Spain.
U.S.A must REPOSSESS 170 F-16 Jet Fighters from Greece, … the rest is gone with the wind …forever …
Greece must stop paying lucrative pensions with borrowed money, reform the free health care system, and cut down, 4 times the military budged.
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