Tuesday, July 07, 2015

America on the Greek debt path

The most worrisome aspect are the similar attitudes

Bahamas-based Viktor Kožený, the Pirate of Prague and the first Czech who owned Harvard (and who offered me to become a shadow finance minister at some point), sent me a link to an article
Athens on the Potomac
Maybe it could have been called "Washington on Cephissus" as well. But the point was that with some delay, the U.S. finances seem to follow in the Greek footsteps.

Jon Gabriel who wrote that article also created the graph above. In trillions of dollars, it shows the annual spending (green+yellow), the revenue (green), and the accumulated U.S. government debt (red). It's not hard to see that the debt has been hopelessly growing since 1980, regardless of the party that occupied the White House and the party controlling the Congress; regardless of the booms and busts; regardless of wars and peace. The growth of the debt looked linear for some time; but the slope has visibly increased during the Obama administration.

This evolution is very different e.g. from the Czech Republic. I dislike our oligarch finance minister and his politics for numerous reasons but he also does many things well enough. For example, our public debt decreased in the recent two years. Do you think that America would be able to run a budget surplus next year again? And if you admit that the U.S. has lost the ability to run surpluses, even in the very good years, don't you think that it places the sustainability of the debt in doubts?

The U.S. government debt – check U.S. debt clock – is around 105% of the GDP. By this number itself, the U.S. may be analogous to Greece of 2006 or so. Are nine more years of life awaiting America?

There are tons of differences between Greece and the U.S. The U.S. remains one of the most competitive, pro-business countries in the world while Greece is among the hopeless ones in this respect. Also, almost all the Greek government debt is "external" while about 1/2 of the U.S. government debt is owed to U.S. entities.

This is a great advantage for America. In principle, one could start with some "internal restructuring" of the debt within the U.S. that would turn the U.S. into a less capitalist country – one in which assets may be confiscated for "greater common good" – and America would get a few more years of opportunity not to default to the foreign lenders.

Aside from the differences, however, there are tons of incredible similarities. I think that at the end, even the debt of 300% of GDP may be sustainable with an adequate attitude. Japan's government debt is 230% of their GDP and they are not talking about defaulting anytime soon. It's possible to survive at these debt levels and chances to survive dramatically increase when the nation is sort of disciplined or thrifty.

Many comments about Greece have been posted on this blog. Many of them have shocked me and I was verifying in which country the posters were located. The most insane opinions about the issue of debt were consistently delivered by the Greek commenters. But the Americans, a much larger group – the U.S. Internet users form 50% of the TRF visitors and I think that their share is higher in the comment section – were the second craziest group.

A decade ago, I would view such an observation as highly surprising or paradoxical. After all, the Americans must be more right-wing than the Europeans, right? Even the Democratic Party is on par with the European conservative parties, and so on. I don't know whether it's due to some radical changes in the U.S. society or due to the increasing importance of some topics, I feel that these assumptions about a conservative America are simply no longer true.

In particular, when it comes to the fiscal matters, I think that America is more left-wing than Europe and "moderate" Republicans are actually more left-wing than the European social democrats.

The comparison I have in mind is one between these U.S. commenters – who otherwise think of themselves as conservatives, on one side; and mainstream Western European social democrats like the SPD (Sigmar Gabriel, economy minister) in Germany, a Dutch Labour Party member finance minister Jeroen Dissejlbloem (Eurogroup boss), or the Slovak prime minister and finance minister (Smer/direction social democrats) on the other side.

If you asked a simple question in a survey, like "should the debt be repaid?" and you offered three choices, namely "Yes, It depends, No", then the continental Europeans, including the center-left parties, would answer "Yes". People like the female president of Argentina and the chairwoman of the Greek Parliament would answer "No" (debt is illegal and creditors are defined as swine!) and those Americans would answer "It depends", I think. ;-)

This attitude seems utterly insane to almost everyone in Czechia, Slovakia, Germany, Finland, and many other Central and Northern European countries. Of course, debt has to be repaid. If one doesn't repay the debt, the whole system is breaking down and the debtor commits some kind of a crime by not fulfilling his contract obligations. Because his inability may be due to other things than his "bad will", the default hasn't been classified as a "crime" for a very long time (and prisons for debtors were cancelled at some moment). But default is obviously a similarly critical event as a crime. For the creditor, it means "at most" the financial loss equal to the amount that was borrowed – which usually isn't an existential problem if the lender has diversified. For the debtor, it is a much more serious problem. To say the least, it is the end of his right to have excess finances, at least for many years.

In this 2010 Tea Party-affiliated video, a Chinese professor explains his kids that they could enslave the Americans before 2030 because America had abandoned its values – and probably defaulted. The Tea Party had the fight against the budget deficits, especially huge ones, as its #1 defining topic. By these proclamations, it would be viewed as a bunch of representatives of "common sense" in fiscal matters from the European perspective, probably even the European social democratic perspective.

But despite this completely uncontroversial message, the Tea Party was basically labeled "extreme right-wing" and to a large extent, it has faded away. This means nothing else than the fact that the negation of its warnings – the Greek-style memes about the growing debt's being OK – became overwhelmingly mainstream in America.

We may divide these insane views to two fuzzily separated groups:
  1. it's just OK to pursue policies that make the growing debt unavoidable
  2. it's just OK when the country defaults – a happier future follows after that, anyway
Concerning the first group, several American commenters have described lots of their wonderful beliefs such as "a pensioner is constitutionally guaranteed to have non-decreasing pension". People who point out the obvious – that the U.S. pension system runs huge deficits, is unsustainable, and has to be transformed to avoid the abyss – are being publicly mocked, labeled murderers of the grandmothers in the Grand Canyon, and similar things. The lunatics have largely conquered the media and other important channels while the sane people are being mocked and marginalized.

Concerning the second point, many American commenters have told us about their beautiful solutions implying that default isn't a problem. "One can change the currency and in this way, the debt disappears." Or: "One can unilaterally erase the debt by changing the currency he uses." Or at least: "One can significantly reduce the debt by changing the currency in which it is denominated and by devaluing the new currency." And if someone knows that the previous proposals are fantasies, he at least believes that: "A default is OK, it just means that the two sides agree on a haircut or restructuring and business-as-usual continues."

Back to the first point. The reality is that all expenses of the government simply have to be flexible to allow things like decreasing pensions because the level that has been reached may turn out to be unsustainable. The economy may be in recession for some time. Your exporters may become less competitive. The oil-rich country know another reason very intimately: the oil price drops and because it's a big part of the revenue, the high pensions can't be funded.

But the wages in a company may have to be lowered even if the economy as a whole is growing at a healthy rate. Despite this overall optimistic picture, some companies are in a less rosy situation. It may turn out that their competition is too strong. The overall demand is lower than it used to be. It simply sees that the workers aren't doing enough work for the salary they have been getting. If it were completely impossible for companies to lower salaries, they would have to fire all the workers who become too expensive. That could threaten the companies. Needless to say, if they were not even allowed to fire any employees, they would fail to be viable after the first problems. Setup like this simply can't work: it's communism – but without the alternative communist methods to feed the people. The ability of the employers to reduce the wages and fire the workers is at least as important for the health of the economic system as the chance that the workers see their salaries grow or they have some guarantees against being fired for a while. In average, salaries and pensions are going up but you can't turn this assumption into an absolute law that would stand above the nation's or company's economic survival.

Any healthy price, exchange rate, wage, interest rate, or pension is inevitably the result of an equilibrium between forces or pressures that act in the opposite directions. Someone wants to raise them, someone wants to lower them. In all these situations – prices, exchange rates, wages, interest rates, or pensions – the two sides contributing the opposite pressures must be considered equally legitimate, equally fair etc. If one allows the system to develop a systematic bias, it's a huge problem.

In particular, the U.S. media – and lots of real-world influential people who think "just like the media" – have developed tons of these biases. Many of them may be summarized by the observation that "those who want to do things that increase the debt are being praised and those who want to tame the debt are being demonized". This is dangerous and sick. The "culture of entitlement" was the most important reason that has made the Greek government coffers doomed. But I think that this "culture of entitlement" is alive and kicking in the U.S., too. Too many people have been trained to expect too many fees and advantages and guarantees from the government and these distortions are already an important factor that decides about the results of elections. Once these considerations become dominant, and probably much earlier than that, the country is doomed because it faces a vicious circle of increasingly more populist politicians who pile the ever increasing debt to win; and the voters who consume this increasing spending and demand even more of that by voting for the most irresponsible candidates.

When Benjamin Franklin said "When the people find that they can vote themselves money that will herald the end of the republic", he was talking about nothing else than the situation dominated by the "culture of entitlement" that is gradually emerging in the U.S., too. The Founding Fathers didn't know the modern information technologies and other modern inventions but they knew basically all the important things about the interactions between the government and the economy. And about many related issues. Nothing has changed about these matters. If you showed them a typical overspending liberal of the present era, like Paul Krugman, they would undoubtedly agree with your humble correspondent that he is a toxic pile of crap. And despite their ignorance about the 2 centuries of the U.S. history in between, they would be right.

As I mentioned, the second group of delusions is linked to the default itself. It's not a problem, the debtor may reduce his debt, anyway. The creditor has to agree with such things, and all these things. Well, it's just not the case. The default means that the debtor has failed and extraordinary measures have to be applied by the creditors to get his money back, or at least as big a part of the money as possible.

When company goes bankrupt, its remaining assets are collected, sold, and the money is divided among the creditors who get some universal percentage of their claims. When a person files for the personal bankruptcy in various countries, his assets are frozen, he is given some minimum salary, and the rest is going to the creditors. Perhaps for five years. Sometimes, the debtor faces a softer treatment but it may never be completely soft. A completely soft arrangement would encourage the irresponsible behavior of the debtors too often. It would be too loss-making for the lenders. They would simply not sign to these transactions. They wouldn't lend.

If and when the U.S. defaulted on its government debt, it would almost certainly be a more brutal event than the Greek default. One reason is that the U.S. debt – currently over $18 trillion – is 50 times higher than the Greek debt, $350 billion. And the U.S. is much more interconnected and connected to foreign interests so that the contagion and domino effects would be much stronger.

But even when it comes to the "degree of compassion", one would have to expect a much more stringent attitude of the creditors than in the Greek case (and certainly than in the Ukrainian case – the Ukrainians really do get a privileged treatment). Imagine that the U.S. defaults to the external creditors. I am pretty sure that they would demand the compensation in the U.S. assets of their choice. The White House would become Chinese at some moment, and so would the railways. Hawaii would be retaken by Japan etc. Things could still continue in this way for a while, in the incredibly shrinking America.

If America chose to be as defiant as Greece, it would probably be even worse. Its interests of many kinds would be under blockade and if it really chose "not to repay" the huge debt, I think that a military intervention would become likely if not inevitable. The U.S. has the strongest army in the world. But I don't think it would be enough. It wouldn't be just China who would be against the U.S. Justice would be on the side of the creditors – just like it is now in the Greek case. I guess that Russia and many, many others would side with the Chinese. Lots of people inside the U.S. would realize that China and the other creditors are right, anyway. The U.S. would be more divided than Greece is today. And I think it wouldn't be capable of winning this war.

One can't predict the exact events but I think it is at least "likely" that after the default, the U.S. as we have known it would cease to exist. A default simply has to be considered as the "end of the existence", or at least the end of a major era. And the holders of the U.S. debt are almost certainly less "compassionate" with Americans than the other Europeans are "compassionate" with the Greeks. The Europeans are compassionate with Greece because in some abstract way, they are members of the same confederacy, the European Union. They have been partners in many projects. Lots of tourists have been to Greece and they liked the hospitality of the local people. They felt like among kind relatives. And before Greece realized that the money transfers to Greece were acts of terrorism, the Greeks loved the decades of subsidies from the North, too.

But China and Japan, among other countries that hold the U.S. debt, don't have this close relationship to the Americans. China has been in tension with America for a long time. Before that, the Japanese were at war with the Americans and it was a pretty bloody one. You just shouldn't expect that America would be treated by the creditors in analogy with our "Greek friends". A default is a terrible event in average and there's no good reason to expect that the U.S. government default would be much more pleasing.

Many people in America promote overspending. This has positive implications on the GDP rate, too. If you increase the pensions etc. by 1 percentage point, the GDP may be increased by 0.5 percentage point. And they think it's "good". But when you do so, you also increase the debt and reduce your distance from the default (which we assume to occur at debt equal to 200% of GDP) by about 1%. This dramatic convergence to the terrible event surely has higher costs than the benefits of some GDP figure elevated by 0.5%, a difference that no individual citizen may really "feel".

Whatever the claimed benefits of the overspending and budget deficits are, it is very clear that the costs are higher. Any rational enough cost-benefit analysis must conclude that budget deficits are very bad, especially the very high deficits above 3% that were common in the U.S. of recent years – despite its booming economy. Incidentally, at these budget deficits, the U.S. wouldn't be eligible to join the Eurozone. The U.S. almost never exceeds the 3% growth these days so this budget deficit inevitably increases the debt-to-GDP ratio. When this ratio goes up even in years when the economy is clearly doing fine, what do you expect it will do when there are some new problems? In average, the U.S. debt-to-GDP is going up almost monotonically and unstoppably.

And the U.S. harbors tons of Krugman-like lunatics who say lots of crazy things. And I think that it's not just super extreme leftists who say these crazy things; it's often the people who consider themselves conservatives, too. These people criticized the decision that the European banking system was strengthened in recent 5 years; or that Germany is careful to avoid budget deficits, except for tiny ones. Germany favors "austerity", we hear, and it is supposed to be a "bad thing". Have you lost your mind?

The recent events showed that it was a great idea for the European banking system to be strengthened – by the extra funds and buffers and by stricter rules demanded from the individual banks. For example, if the Greek bonds hadn't been (largely) moved from the commercial banks to the shared Eurozone funds years ago, the very victory of Syriza in the January election would automatically spark a European crisis. Because of their continuing exposure to Greece, the looming Greek default – which would be as likely as it is in our parallel Universe – would automatically mean an existential risk for numerous Western European banks. The European stocks could crash by 50 percent or more. This would affect not only the banks; it would affect the real economy, the workers etc.

It was a great idea to strengthen the European financial system. Crises of the magnitude comparable to the ongoing Greek hassles take place every other year, roughly speaking. You simply can't put banks on the whole continent at huge risk whenever something like that happens in an irrelevant country – like the election of the fanatical Marxist nuts in Greece.

It's questionable whether Europe's losses would have been higher if it had allowed Greece to default in 2010 or 2012. I am not sure about the answer. It could have been a close call. I surely do agree with the claim that there would be additional losses that would be caused by the Greek default and the bailouts may have been justified. At any rate, the bailouts – some extra loans – took place and these events were legally kosher. Greece agreed with those new contracts, too. There is nothing to debate here. You can't rewrite the history.

Obviously, the bailout money went largely to the banks, the creditors – a trivial point that insane people at many places love to loudly hate. Of course that the bailout money had to go to the creditors: it's what the word "bailout" means. The debtor can't repay by himself so he gets new money and this new money is immediately repaid to the creditor. It is his, the creditor's, money! So why would a sane person suggest that there is anything wrong about these events? Someone is kind to save the debtor's bare life (at least for a while) and the debtor agrees with the solution. So the business-as-usual may continue with this new bailout loan and the lenders are repaid their money that they should be repaid according to extremely clear contracts. What's so infuriating about it? It's common sense. Anything else than this scenario – or the debtor's end of existence – would be infuriating!

Just to be sure. I don't expect the U.S. to default in the next 5 years and almost certainly not in the next 10 years, either. What will happen in the future will depend on the decisions and mood swings from the present to the infinite future. But the main reason to believe that the U.S. is likely to get to the same problems as Greece sometime in the future is the significant change of the public discourse, the aggressive replacement of the common sense assumption that "budgets have to be basically balanced" by something completely different, by a conglomerate of irrational slogans promoting overspending whose only possible "destination" is a default.

The non-Greek EU's debt-to-GDP ratio is close to the American one but the attitudes are healthier here. Countries like mine that do consider excessive deficits a problem – but no one is talking about it too often – are often painted by the U.S. pundits as insane supporters of "austerity". But there is nothing about this "austerity" that could be avoided. We still tend to have deficits and we barely keep our debt constant. It's nothing else than a balanced attitude. This attitude is not only "German" – it is shared by the politicians and the public in German-speaking, post-socialist, Central European, and Northern European countries, if I roughly define the list in this way. And to a very large extent, this attitude was embraced by the former PIIGS countries except for Greece (G), too. Their budgets are just doing fine these days! And it's primarily the attitude that may determine different fates of the bonds in individual countries.

A contrast: George Will and Charles Krauthammer (here at FoxNews) represent the totally sane American attitude to the Greek hassles. On the other hand, Marc Faber at Bloomberg insanely claims that Greece may eliminate all of its debt just by leaving the Eurozone. What!? ;-) Be sure that everyone would leave the EU in that case.

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