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February 2010 Comment:
Greece: How the bond vigilantes left it in ruins
Today's Sirens are the investors and traders of the global bond market, who lure nations into tapping abundant credit at low rates when times are good. If a nation borrows too much, those open-handed investors abruptly turn into vigilantes who punish the country by making new loans scarce and expensive. Greece has fallen into precisely that trap. It got low-interest loans by promising to behave responsibly and keep its budget deficit low... But because Greece was never tied to the mast, it kept spending. Its debt is now about 125% of gross domestic product, more than double the supposed EU ceiling. Eventually, all that debt brought down the wrath of the bond-market vigilantes...
Modern Greeks haven't had an easy time living up to their ancestors, who gave the world democracy, drama, and philosophy. According to economists Kenneth S. Rogoff of Harvard University and Carmen M. Reinhart of the University of Maryland, Greece has been in default for half of the time since it won independence from the Ottoman Empire in 1829. [...] For now, the Greek government is still saying it can muddle through on its own. Greek Finance Minister George Papaconstantinou told Bloomberg Television on Feb. 8 that "the worst possible signal which we could send out is one calling for outside help."
[I]nvestors have concluded that Greece needs outside assistance to avoid default. If the European Union refuses aid, the government could find itself unable to issue $26 billion worth of debt as scheduled this spring. A Greek default -- still considered highly unlikely -- might trigger a run on the debt of Portugal and Spain ... the financial weaklings of Europe.
LESSON FOR THE U.S. While Greece is uniquely dysfunctional, there's a lesson here for any country with a heavy debt load, including Britain, Japan, and the U.S.: The bond market is treacherous. For now, investors are pouring money into the U.S. Treasury market as a safe refuge. But the U.S.'s ratio of total debt to GDP is likely to exceed 90% this year, making it more indebted even than Spain and Portugal.
...Greece and the EU wouldn't be in this no-win situation if they had followed their own rules from the start. But coming up with a mechanism that forces sovereign nations to do what's right when they feel like cheating is pretty much impossible...
Americans can relate to the European dilemma. Congress had a pay-as-you-go budgetary rule in effect from fiscal 1991 through fiscal 2002, but abandoned it in the name of flexibility in the aftermath of the 2001 recession. Flexibility is great, most of the time. But as Greece vividly demonstrates, any country that doesn't discipline itself is bound to be disciplined eventually by the bond market. And that's a whole lot more painful.
EU pledges to support Greece, but offers no details
A deal to provide financial aid to Greece to stave off a broader crisis in the 16-nation bloc would be unprecedented, riding roughshod through rules forbidding a bailout. [Greece needs to raise about 53 billion euros ($75 billion) this year to finance its budget and refinance its debts.]
EU leaders seem to be hoping in the meantime that words of support will be sufficient to restore confidence in Greece's finances, making any bailout unnecessary.
A Greek crisis is coming to America
For the world's biggest economy, the U.S., the day of reckoning still seems reassuringly remote. The worse things get in the eurozone, the more the US dollar rallies as nervous investors park their cash in the "safe haven" of American government debt. This effect may persist for some months, just as the dollar and Treasuries rallied in the depths of the banking panic in late 2008.
Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase "safe haven". US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941...
Last week Moody's Investors Service warned that the triple A credit rating of the US should not be taken for granted. That warning recalls Larry Summers' killer question (posed before he returned to government): "How long can the world's biggest borrower remain the world's biggest power?"
On reflection, it is appropriate that the fiscal crisis of the west has begun in Greece, the birthplace of western civilization. Soon it will cross the channel to Britain. But the key question is when that crisis will reach the last bastion of western power, on the other side of the Atlantic.