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US and Greece are Western canaries in coalmine

central bank report card 2009

“”I’m very concerned we’re headed down the same path as Greece,” Rep. Cathy McMorris Rodgers, R-Wash., told Fox News. “Greece found itself in a situation where its public debt was 113 percent of its GDP. They had taken on all this debt, expanded programs and America is headed down the same path.” — Cathy McMorris

The parallels between the Greece crisis and the U.S. housing crisis are striking. Each involved the following:

1. Widespread living beyond one’s means enabled by excessive borrowing. Many American consumers and homeowners simply borrowed beyond their means because of the artificially low interest rates set by the central bank (Federal Reserve). Greek government borrowing didn’t merely enrich the upper class: it enabled the government to employ half the population on excessive salaries and ridiculously generous retirement benefits. In the case of Greece, living beyond one’s means includes not paying tax. In both cases, the entire society was involved and must share part of the blame.

2. Excessive borrowing enabled by lax lending standards. Loans to would-be American homeowners were made to persons who should not have qualified and on terms that should not have been given. In the U.S., this was enabled in part by the ability to hide and spread the risk through mortgage backed securities, for which the banks were certainly responsible. As this article demonstrates, loans to the Greek government were excessive and given on terms that should never have been made. This was enabled by the faulty policies not only of the Greek government, but also of the European Central Bank, which allowed banks to use overvalued Greek bonds as collateral (the mortgage backed security equivalent). The ECB and the Fed both kept interest rates too low, too long.

govt debt us eu compared

3. Both crises were caused in part by poor political leadership. Lax borrowing and lending were tolerated and even encouraged by politicians in both countries, but this was in order that they might ingratiate voters and obtain or retain power.

4. Widespread ignorance and the populist desire to single out a few scapegoats rather than the acceptance of responsibility by mainstream populations for their individual and collective role in the crisis and the failure of politicians to confront that ignorance. With respect to the Greek crisis, it is doubtful any of the demonstrators are able or willing to accept any individual responsibility despite the fact that most of the government borrowing was needed to pay their entitlements because the Greeks didn’t have any corresponding responsibility to pay tax.

If the Greeks had been forced to finance their entitlement programs through taxes, those entitlements would have been cut to a more sensible level long ago, and Greece would not be in the mess they are now in.

5. Calls in both countries to devalue their respective currency in order to solve the problems. Will it be a race between the euro and the dollar to the bottom of the global currency league?

Will Greece go bankrupt?

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The current crisis in Greece is partly driven by the actions of speculators in the Credit swap insurance market for sovereign debt. The speculative purchase of swap insurance and the short selling of the debt of the target countries have been used to undermine the exchange rate of the Euro.There are huge potential profits in this and the regulators in Europe need to pay more attention to this problem.

The apparent reluctance of the European Central Bank to acquire more sovereign debt of the targeted countries including Greece, Spain , Portugal and Ireland is also a flawed strategy as it only encourages the speculators and drives up interest rates to absurd levels. The assertion that such a policy is always inflationary in all circumstances is quite false and contradicted by historical and contemporary evidence. Simply examine the U.S recent experience and one can see that.

The threat to the European and global economy at the moment is still not inflation but excessive disinflation and even deflation associated with the deep recession, the financial crash and the high unemployment. Finally , the hysteria over debt and deficit levels that are well below historical limits that were experienced in the 1920s, 1930s, 1940s and 1950s when debt levels as a percentage of the GDP were 2, 3 and even more than four times higher is a very damaging and historically ignorant perspective. These same markets that delivered us the debacle of the crash based on gaming the system are now upheld as paragons of insight about the global economy. It is time that governments moved beyond them and acted decisively to restore stability and optimism.

One Comment

  1. mc mc May 10, 2010

    They will blame the consumers/citizens in America when in fact the Fed and lending institutions are to blame.They will spin this on the people for being bad bad stewards.

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