Bust: Greece, the Euro and the Sovereign Debt Crisis (Bloomberg (UK))
July 18, 2011 
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Disappointing,
This book is pretty remarkable. It starts with a correct premise: the global economic meltdown of the last 3 years was fundamentally about debt. It also ends with a correct conclusion: the Euro is a terrible idea. But everything in between is largely wrong on the macroeconomics. It’s a classic example of a journalist taking raw data, analyzing it wrongly, and coming to a conclusion that plays well to a lay audience, but which is fundamentally misleading. While there are too many problems to list (I’ll put aside the abundance of typos; was there no copy editor…?), I’ll focus on two big ones in this review.
First, Lynn introduces Mundell’s idea of Optimal Currency Areas to make a case for why the Euro is a bad idea. It’s the right theory, but a horrific misapplication. Yes, the core European economies (Germany, France, et al.) are fundamentally different from the peripheral European economies (Greece, Spain, et al.), but no more different than, say, New York’s and Mississippi’s economies. So why is the US an optimal currency area while Europe isn’t? The answer is a simple one, which Lynn ignores. It has everything to do with language and labor mobility. In the US, if California’s economy is in deep recession while Arizona’s, or even Florida’s, is booming, people can relocate without much problem. Since everyone speaks the same language and the culture is essentially still the same, the transition is fairly seamless. The implication of that is that the central bank can focus on stabilizing broad aggregates– even if one region’s economy is struggling while the US as a whole is overheated, the Fed can still confidently raise interest rates and know that people will relocate from the depressed area to the one where jobs are in abundance, thereby stabilizing the national economy. That just isn’t the case in Europe, where a Greek doctor can’t get up and relocate to Germany the same way a Californian doctor can move to New York. That has implications for the ability of the peripheral economies to fix their debt issues. To raise the revenue to pay off their debts, those governments first need to put people to work. They can’t do that if credit is tight in their countries because Germany needs high interest rates to keep a lid on inflation. The logical conclusion would be for each of those countries to have their own central banks, so that each can tend to the needs of each country’s distinctive economy. Unfortunately, under the Euro, that’s impossible. That problem is at the heart of the Euro’s problems, and it’s one that Lynn somehow ignores.
His second big problem is his desire to treat all of the peripheral economies’ problems as essentially identical, which is misleading at best but, to be fair, just completely wrong. He conflates public debt with private debt, not understanding that the two are fundamentally distinct, and the levels of each have implications both for the kinds of problems that each country has, and for the solutions to those problems. The reality is that categorizing Spain, Greece, and Ireland (and Italy and Portugal) together is extremely misleading. Spain, for instance, had tightly regulated, well-capitalized banks, relatively low public debt, and a budget surplus in 2007, but it had a massive real estate bubble and over-indebted households. Ireland had low public and private debts and a solid budget outlook, but an irresponsible, unregulated banking sector and a massive housing bubble. Its debt problem comes EXCLUSIVELY from the collapse in revenue from the recession, combined with the government’s misguided decision (pushed on it by Lynn’s heroes, the Germans) to guarantee all of its banks’ debts. Greece, on the other hand, had a government running massive deficits (that it used accounting tricks to hide) and a bloated public sector workforce, combined with a tax collection system that simply didn’t work. These problems are fundamentally distinct, and they require different solutions. That’s what makes Lynn’s simplistic assertion that you “can’t solve a debt problem with more debt” so frustrating. In a country like Spain, which had stable public finances until the recession but massively overindebted households, the best solution to its problems while inflicting the least amount of pain is precisely for the government to run deficits while households repair their balance sheets (Richard Koo has a persuasive argument about the concept of balance-sheet recessions on this concept that’s worth a read). If the government doesn’t spend, the result is an even more prolonged recession, as fewer people are working, meaning that households are going to take even longer to fix their household finances, and aggregate demand will remain depressed for even longer. And for all those problems, government cutting back isn’t even likely to solve its government debt problems, since the government trying to balance its budget while its revenues are…
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|buy it for the first 182 pages,
Great, interesting read that involves; Sarkozy, Merkel, Geithner, etc.. in an enthralling story of the ECB and the European Union. I recommend the book based on that.
but his thesis (I guess I’ll call it that) is that the Euro is doomed. I don’t see that.
Regardless, if your interested in the subject buy the book and enjoy.
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|Useful study of a busted currency,
This is the most useful book on the euro’s disastrous effects. The way that governments dealt with the credit crunch (printing money and lending at 1 per cent) paved the way to the present crisis, caused by the euro. The euro has turned the EU into a debt union, a union of deflation and disaster.
Greece joined the euro in 2001, and was at once allowed to borrow whatever it wanted. Indebtedness doubled to 230 per cent of GDP by 2008. Goldman Sachs arranged swaps that disguised the extent of Greece’s debts. Greece has 300 billion euros of debt.
Spain had a huge property bubble, the world’s second biggest trade deficit (foreign debts were 95 per cent of GDP by 2009), and families owed 130 per cent of their disposable income. Since the euro was launched, Spain’s debt levels have doubled to 366 per cent of GDP.
Ireland’s debt relative to GDP more than doubled to more than 700 per cent of GDP; the financial sector’s debt alone was 410 per cent of GDP. France, Germany and Britain have a combined exposure to Portugal, Ireland, Greece and Spain of $1.2 trillion.
In May 2010, the EU put together a 750 billion euro package to save the euro – 440 billion to a special fund which would sell debt directly to markets and use that cash to buy government bonds of high-deficit countries; 60 billion from the EU budget – the European Stabilisation Mechanism – whereby the Commission can issue bonds, using the EU’s 140 billion annual budget as collateral; and 250 billion from the IMF. Britain is liable for 8 billion euros (corresponding to our 13.6 per cent share of the EU budget), if any country that has received these loans defaults on them.
The bailouts are illegal: Article 104b of the Maastricht Treaty says, “A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law or public undertakings of another state.” So no EU member state should be liable for another country’s debts. The bailouts also tore up the European Central Bank’s mandate.
Greece is caught in a deflationary hole. Lynn notes, “the cuts in public expenditure kept depressing demand and pushing up unemployment. That in turn would depress tax revenues even further, making the debt burden even harder to control.” The cuts are increasing the debt, so that soon it will be paying 30 per cent of its national income to the banks, which is unsustainable. Fitch’s report on Greece said, “even if the program is successful, the sovereign stands to be even more exposed to market risk than it was before.” Cutting debt sounds better than cutting growth.
Default is going to happen, but the Greek people have to choose to get out of the euro.
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