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The Euro and the Greek Financial Meltdown -- Can It Happen Here? -- Three Articles

Greece and Contagion - This shouldn't be a repeat of 2008

The Greek Economy Explained - A warning for Europe, Albany and Washington

The Euro's Tribulations - Don't blame the single currency for the failures of Keynesian economics

By Gary Starr for the Neville Awards

May 9, 2010

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The post-war cradle-to-grave deficit spending party in Europe is over. Despite the various bailout plans for Greece and the Euro the writing is on the wall. Those union protestors rioting at the Parthenon have no one to blame but themselves...they elected the socialists who created this mess. To get the bailout money the EU has demanded Greece implement austerity which means the end of the entitlements. That makes the unions very angry.

Margaret Thatcher famously said that socialism is great until you run out of other peoples' money. They've run out of their money. The United States, the largest backer of the International monetary Fund at 17.5%, along with the rest of the EU are now on the hook.

Stuart Varney of Fox Business News said that what we are witnessing with the debt crisis in Greece and the swoon of the markets over the last week and a half is the end of the welfare-state model of governance. The Soviet Union may be no more but its spirit lives on in Western Europe and, to a large extent, in the United States in the form of the bloated welfare state.

John Steele Gordon writing in Commentary

The End of the Welfare-State Model?

For years, democratic governments have been promising citizens ever-increasing benefits in the future to win votes in the present. What they haven't been doing is arranging to pay for them. Instead, they have used phony bookkeeping to make things look under control. New York City did this in the 60s and 70s until one day the banks said they weren't rolling over the city's paper anymore. Now, Greece has suffered the same fate. It lied to the EU to get in and has been cooking the books to hide the gathering fiscal disaster ever since. The market has now made it clear that it thinks Greek bonds are for wallpaper, not investing. With more than 10 billion euros in bonds coming due on May 19, Greece had no choice but to accept draconian cuts in its benefits and strict accountability in the future to be bailed out by its euro-zone partners. They, of course, fear the collapse of the euro as a currency and a spreading contagion to larger countries that have also been doing what Greece has done for so long.

Europe would need $60 trillion in the bank, earning government-borrowing-rate interest, to fund its future welfare benefits. Needless to say, no country has four times its GDP in the bank.

In short, the market has suddenly become aware that the emperor known as the welfare state is, financially speaking, buck naked.

Andy Kessler writing in the Wall St. Journal:

My guess is that the euro will survive, but no one will trust it like they used to. At the end of the day, it's an entitlement problem. In Greece, the public sector makes up 40% or more of the work force, with short weeks, lots of vacation and lavish retirement benefits. All of that needs to be paid for with real income, not debt, and the markets are anticipating the day of reckoning. One can only hope European policy makers listen to the market. I wonder if California and Medicare are taking notes.

One can only hope that after the November elections the new Republican majority in Congress recognizes that the endless deficit spending by the Obama administration will produce the same scenario as is happening in Europe and put the brakes on this insanity and reverse course.

Greece and Contagion - This shouldn't be a repeat of 2008

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By The Wall St. Journal
May 7, 2010

Yesterday's death-defying plunge (and partial recovery) in stocks was due-pick your favorite-to fear of contagion from Greece, a mistaken sell order from Citigroup, the financial regulation bill in Congress, or the rampage of machine trading. The regulators are sure to tell us about any erroneous trades, so our point today is to focus on the risk of contagion.

The Greek economy is indeed a disaster (see below), and the European Union-International Monetary Fund bailout plan will do little to restore growth. But there is no good reason that sovereign debt problems in a country that represents only 2% of the EU economy should send the world into another financial crisis and recession-if our political classes keep their heads.

The world banking system is far stronger than it was two years ago, and U.S. banks in particular have improved their balance sheets. The banks with the most exposure to Greece and the other indebted European nations are German and French. If those banks need to be recapitalized from taking on too much bad sovereign debt, then that will be a task for German and French taxpayers. Far better for taxpayers to put their money into that cause than to guarantee the pensions of Greek civil servants.

The panicky, moonshine cure being offered is to blow up the euro so the debtors can go back to devaluing their currencies. That would lead to more financial chaos, as investors flee the euro for the safety of the dollar, U.S. Treasurys and gold. The pending bailout of Greece has already dented the euro's credibility as a store of value and a system of monetary and fiscal discipline. The world needs more confidence, not more risk aversion from a further run on the euro.

Investors are also worried about the harm if Europe sinks back into recession, but the world economy is also stronger than it was in 2008. The emerging economies-Brazil, China, India-have led the world out of recession, and the U.S. has had three quarters of recovery. A European double-dip would be a blow, but it shouldn't be a replay of September 2008.

Moreover, the flight to dollar assets has given the Federal Reserve a reprieve on its tightening calendar. As demand for dollars increases, the Fed will have to meet that demand to avoid an even sharper euro plunge and deflationary danger. This could mean higher inflation down the road, a prospect that explains the rising price of gold despite the rising dollar. For now, however, the Fed will see its role as fighting any European-induced deflation.

The Greek debacle should certainly signal the end of the world's neo-Keynesian spending spree. Investors are shorting Europe because they are worried that politicians will keep spending and borrowing without any discipline. Short of tax cuts, the best U.S. "stimulus" would be no more stimulus at all.

The Greek Economy Explained - A warning for Europe, Albany and Washington

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By The Wall St. Journal
May 8, 2010

The Greeks are giving the world a good taste of their modern politics. Periclean democracy, meet Athenian mob rule: Tens of thousands are rampaging through the capital and other large cities this week in protest against €30 billion in austerity measures needed to secure the €110 billion bailout for the bankrupt country.

The nationwide strike-led by government-employee unions, which threaten further disruptions after parliament yesterday approved the rescue package-was a timely show for Greece's prospective rescuers in Germany and at the International Monetary Fund. The medicine for Greece's deficit and debt woes (at 13% and 124.9% of GDP, respectively, and rising) won't go down easily in Athens. We continue to think the country needs to restructure its debts and adopt wholesale economic reforms.

If you want to understand the reason, as good a source as any is the annual World Bank "Doing Business" survey for 2010. The spark for this financial crisis has been decades of overspending and cooking of the public books, but the survey reveals the underlying causes of the Greek disease.

In terms of overall ease of doing business, Greece comes in 109 out of 183 countries around the world. It is dead last among the 27 members of the European Union as well as the advanced economies in the OECD. You have to go up 30 slots to find the next worst EU performer, Italy. The U.S. ranks fourth and Singapore is first.

At 109, Greece ranks below such models of transparency and free enterprise as Egypt (106), Zambia (90), Rwanda (67) and Kazakhstan (63). A country has to work hard to do this poorly.

The Doing Business survey reveals an economy that's hostile to free enterprise and private property, primed for corruption, lacking in labor and capital mobility, stifled by powerful trade unions and unlikely to grow without deep-rooted changes. The table nearby shows Greece's rank in the 10 categories related to business operations covered by the World Bank survey.

Review & Outlook: Greece and Contagion .Want to start a business in Greece? The country ranks 140 in the world because you'll need an average of 19 days and 15 steps to do it. In the U.S., it takes six days and six steps.

Filing taxes consumes 224 hours a year in Greece. In Luxembourg, the richest European Union state, it takes on average 59 hours. In the U.S., it's 187 hours.

As for protecting investors, the erstwhile cradle of Western civilization ranks 154, which has the obvious effect of scaring good money away. Most glaring are weak laws on disclosure of information to shareholders. By the bank's index, a prospective investor enjoys nearly twice the level of protection in Italy, no stand-out itself.

It's appropriate that Greece's best ranking-at 43-is for the ease of closing a business. Greeks have certainly had plenty of practice.

Ruled by neo-Marxists at the time, Greece scraped into the EU in 1981 and has since lagged behind the rest of the club. Before the advent of the euro, inflation was four times the bloc average. The political-economic default in that era was for the Athens government to devalue its currency, instantly reducing the standard of living of its citizens but avoiding pro-growth reforms.

Athens got an exemption from the EU's debt rules in order to join the single currency bloc in 2001, a year before euro notes and coins went into circulation. The country rode the wave of the stable currency, low inflation and low interest rates throughout the good times of the euro's first decade. Membership in the euro was an incentive for Greek politicians to institute fiscal discipline and carry through reforms to improve their competitiveness. They did neither, preferring the easy path of low-cost borrowing, which is how they got into their current mess.

As a euro member, Greece no longer has the option of debasing its currency, which was one of the main arguments for creating and joining the euro bloc. This means the burden of adjustment for years of borrowing is now falling on the Greek government, which is where it rightly belongs. The realization of this adjustment is what has Greek civil servants marching in the streets. The government could help ease the pain if it pushed such pro-growth reforms as a flat tax and moved Greece up in the Doing Business categories.

All of this ought to be a cautionary tale for politicians in Europe's other high-spending, slow growth states-and for those in Sacramento, Albany and Washington, D.C., too. Greece shows that the welfare state model of development, dominated by public unions, onerous regulations, high taxes and the political allocation of capital, has hit the wall. Down that road lies more Greek tragedy.

The Euro's Tribulations - Don't blame the single currency for the failures of Keynesian economics

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By The Wall St. Journal
May 9, 2010

Twelve years ago, economist Robert Mundell wrote a series of articles in these pages under the headline, "The Case for the Euro," touting the benefits of the single European currency due in 1999. The subsequent decade exceeded the rosiest scenarios set out by the "father of the euro." Sixteen countries came to enjoy prosperity and stability in the world's second most successful zone of sound money and free commerce (after the U.S.).

This year, the party has come to a crashing halt with Greece's financial meltdown, and one consequence has been a run on confidence in the euro. Last week, as the European Union and International Monetary Fund approved a €110 billion rescue and the Greeks adopted an austerity package, the euro tumbled to 14-month lows.

The euro will be tested in the coming months and years by policy makers and markets. The challenges ahead include continued economic weakness, particularly across a Mediterranean flirting with insolvency from Greece to Portugal, political tensions and calls to winnow euroland to the strong economies, or to shelve the euro altogether.

Europe's unprecedented monetary union can no doubt be improved, but its benefits in economic efficiency and monetary discipline should not be ignored, much less tossed away at the first serious challenge. It's also important to understand that the single currency is the scapegoat du jour for a crisis whose real causes are inconvenient for the political class.

In one anti-euro corner are weak-money neo-Keynesians. Greece was their model pupil, spending its way to supposedly drive growth. But when the time came to pay the piper, the lament now heard from Paul Krugman and elsewhere is that the Greeks are unjustly shackled by the euro. Take back national control over monetary policy and the EU's weak economies can once again devalue their way out of trouble. Blaming the euro for the failures of Keynesianism sets a new standard for chutzpah, and this prescription would debase not only the currencies but the middle class for a generation.

Then there's the idea to save the euro by creating a European super-state to set economic policy, harmonize taxes and ease transfers from rich countries to the poor. George Soros stands in this camp, as does prominent German central banker Otmar Issing, who earlier this year wrote that "starting monetary union without having established a political union was putting the cart before the horse." This is really a call for imposing on all countries the welfare state agenda that got Europe into this jam in the first place.

Before offering cures, let's diagnose the Greek disease properly. Joining the euro gave the poorer southern EU countries a perfect opportunity to "pull up their socks," in Professor Mundell's words. Some, like Italy and Spain, did so for a while. But sitting pretty inside the euro club, many politicians took the foot off the pedal of unpopular reforms, such as liberalizing labor codes or lowering costs to business.

Greek politicians in particular lived beyond their means and put much of this spending, in Wall Street parlance, off their balance sheet. The euro did enable bad habits by letting Greece borrow at German interest rates. This postponed the day of reckoning for the failures of reform, until a new Athens government last year came clean about the lies and the mess. But don't blame a currency for irresponsible leadership.

Europe isn't experiencing a currency crisis. It is a debt crisis driven by overborrowing, large and inefficient government, and insufficient economic growth. Some of the sickest countries use the euro as their legal tender, but others don't. Iceland, Latvia, Romania and Hungary were all forced into the arms of the IMF, though none of them is in the euro zone. Britain is also outside the euro bloc but is facing its own day of debt reckoning.

Iceland is a sobering might-have-been for the Greeks. The small Arctic island's financial crisis was compounded by a currency crisis. It's now fast-tracking an application to join the EU and the euro. The Icelanders understand that small countries with shallow capital markets are most vulnerable to currency volatility in a world of floating exchange rates.

Before Greece or Portugal seriously consider bringing back the drachma and escudo, and devaluing their way out of trouble, recall that Argentina took this advice in late 2001. Dropping its dollar peg, the Argentines beggared their people and avoided policy changes. They ended up defaulting and continue to fall behind Brazil and Chile.

The Greeks can leave the euro if they prefer, and neither Berlin nor Brussels would spill many tears. But the costs of dropping out would be substantial. The bulk of Greek financial contracts are in euros. Were a reconstituted drachma devalued by 50%, the public debt to GDP ratio would essentially double—in Greece's case to well over 200% of GDP. Our guess is that the Greeks restructure their debts or default before they drop out of the single currency.

While not the cause of this crisis, the euro has been tarnished by it. Greece's Madoff-like bookkeeping broke the mutual trust that is essential to any monetary compact, and this will take time to restore.

Shortcomings in the rules governing the euro zone were evident long before this crisis, and they now need to be addressed. In one of his 1998 Journal articles, Mr. Mundell wrote that the rules on fiscal deficits and public debts in the Stability and Growth Pact—adopted by euro-zone countries to govern the single currency—needed bite to guard against the obvious free-rider problem: Countries would be tempted to take advantage of a colossal and low-interest bond market believing that "when the chips are down the union will act as lender of last resort." He essentially predicted the problems of Greece and the proposed EU-IMF bailout.

Fines were decreased and the stability pact was never seriously enforced. Germany and France, which pushed hardest for strict penalties, were the first to break the rules without suffering any consequences. Five years ago, Berlin and Paris shot down the European Commission's proposal to oversee national statistical agencies to safeguard against Greek-like cheating.

On Tuesday, the Commission plans to unveil proposals on closer surveillance of euro-zone budgets. Next it should restore some teeth to the stability pact. These modest steps won't excite euro federalists as much as a grand and unrealistic political union, but they might do some actual good.

The future of the euro in the next decade depends on the will of European politicians. First the beggar-thy-currency crowd must be ignored. The European Central Bank has, at least so far, been a bulwark against such talk. On the other hand, the EU's decision late last night to create a "bailout fund" tells creditors and borrower governments that they will always be rescued, increasing moral hazard and the odds of another crisis. If asked to foot the bill again, unhappy German or Dutch taxpayers may decide the euro isn't worth the price and themselves push for its dissolution.

Above all, the euro will thrive only if Europe thrives. Austerity plans intended to stem the fiscal hemorrhaging are no substitute for policies to promote growth. Should Europe use this crisis to make itself more competitive and rein in the welfare state, the Continent would be even better placed to take advantage of a huge single market underpinned by a stable currency and low inflation. And if that were to happen, the second decade of the euro could turn out to be better than the first.
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