The Bear’s Lair: We are all Greek now

The terms offered by Greece to the EU on June 22 have one important feature: they offer almost no reductions in state spending, but instead plan to make the modest savings needed for EU respectability by tax increases on corporations and the middle class. But why should we scoff: nearly all our governments today operate on the principle of sucking up the maximum percentage of the private sector’s resources. In terms of policy, we are all Greece, and all our leaders are Alexis Tsipras. Needless to say, our fate will inevitably lead us in a Greek direction.

The Greek package raises value added tax on some items and removes exemptions that had been granted to the Greek islands. It adds a 12% excess corporate profits tax on all profits above 500 million euros, and raises the overall level of corporate tax from 26% to 29%. It also adds a 3.9% annual pensions contribution to the Greek government’s main pension scheme. On the positive side, the government is eliminating some of the incentives for early retirement, and would raise the retirement age to 67 in 2025, yielding few immediate savings but some longer-term ones.

Still, Syriza’s reversal of the previous government’s reforms, restoring previously cut government jobs and pensions, has been left in place. It now seems likely that the Greek concessions will be accepted (assuming the Greek parliament does not rebel), releasing a little more European taxpayers’ money to the unfriendly hands of Greece’s Syriza government. No doubt future such crises, the first due as early as August, will be dealt with in the same way.

If the radicals within Syriza block the “reforms” in Parliament, then even the feeble EU will have no alternative but to let Greece exit the euro. For the productive Greek middle classes, to the extent there are any, this would be the best possible news. They are as fond as anybody of having living standards higher than would be justified by their output, as they have enjoyed for 34 years, since Andreas Papandreou joined the EU and figured out access to its subsidies. But it is becoming increasingly obvious that any further handouts from EU taxpayers will go to the bloated Syriza government and, to a lesser extent, to Greece’s creditors, while the Greek middle classes will be squeezed by Syriza until the pips squeak. Grexit, putting Greece’s international economic relations back on an arms-length basis, would allow the economy to resume growth, absorbing the lumpen unemployed and giving the middle classes a chance to make some money again.

Whereas Greece remaining in the euro and being bailed out by Northern European taxpayers would endanger the euro, the Argentine precedent suggests that Grexit could still damage Greece. After Argentina abandoned its dollar parity at the end of 2001, the economy suffered for about a year, then enjoyed an astonishing revival as exports became highly competitive at the lower parity. As a result, while the Argentine middle classes suffered from the devaluation, blue-collar workers benefited substantially from the subsequent boom in terms of their living standards, and only began to do worse after 2012 or so, an unearned “party-time” lasting a decade. Needless to say, if the Greek economy recovered following devaluation, Syriza would be cemented in power for ever, which as the Kirchner regime in Argentina has demonstrated, would be terrible both for the middle classes and the country’s long-term economic health.

Fortunately, this appears fairly unlikely, for one reason: Greece, unlike Argentina, does not have a massive agricultural sector for which devaluation would provide the impetus for a huge boom, the proceeds of which could be looted by the government. Instead, it has a services sector (shipping) that does not incur large domestic costs and a set of uncompetitive industries and subsidized agricultural operations that would be only modestly benefited by a currency collapse. Thus the chances are that after a drachma-ization Syriza would find itself unable to fund its grandiose spending projects, and would hence lose office rather rapidly, regretted only by the ideological left and the down-and-outs.

The most important question regarding Greece, in itself a fairly unimportant country since the time of Pericles, is the extent to which the rest of us are following a similar path.

Greece essentially had three problems. First, and most important, its corrupt politicians were locked into spending more money than they received in taxes, and making up the gap by handouts from the EU. Second, partly as a result, wage rates in the Greek domestic economy had risen so far they were hopelessly uncompetitive, and being locked into the euro Greece could not devalue its currency. Third, as a result of the first two problems, the country had accumulated an unsustainable level of debt, and was adding to the debt yearly.

It’s pretty obvious that much of the rich world is pursuing fiscal policies very similar to Greece on its bad days. More than six years after the global recession bottomed out, the U.S. budget deficit is still close to $500 billion and higher than in any year prior to 2008. What’s more, with baby boomer retirements now in full swing, the position will surely worsen, bringing back trillion dollar deficits by 2025 on Congressional Budget Office forecasts, even if there is no further recession and further spending boosts remain implausibly restrained. Britain is fiscally in slightly worse shape; the difference is that the British government is at least attempting to remedy matters, unlike in the U.S. where there are remarkably few attempts to get the deficit down further (promising to balance the budget in 10 years doesn’t count; nobody pledging to do that will be held responsible when it doesn’t happen.) Eyeballing from the Economist’s useful display of forecast 2015 budget deficits, France, Spain, India, Malaysia, Brazil, Saudi Arabia, Vietnam and of course Japan all have forecast 2015 deficits higher than Greece’s 3.7% of GDP, and that’s without including notorious basket cases such as Venezuela.

Debt levels have also risen markedly, and will get to the Greek level within a few years, or as in the case of Japan have already surpassed it. Japan’s case is especially egregious; the Japanese government continues to pass spending “stimulus” programs, year after year, and appears to believe that if Japan’s creditors all close their eyes tight and chant “Ommmmm” for a decade or so they will fail to notice the country’s slide towards bankruptcy. So far this has worked, but it can’t possibly work forever and nothing about the present Japanese government’s policies suggests that it has a solution to the problem. Theoretically a partial default, by reducing the yen to say 200 to the dollar and welcoming a breakout of double-digit inflation, would solve Japan’s debt problem, as it did Britain’s in the 1950s; in practice I doubt it will be so easy.

It is becoming increasingly clear that the rich world also suffers from the third of Greece’s problems: a workforce that is grossly overpaid compared to the value of its output, and cannot become competitive because of rigidities in its financial system. This column has remarked on a number of occasions how improved communications and the consequent closer knitting together of the global economy have caused emerging market workforces to become increasingly competitive against rich country domestic workforces, narrowing wage differentials between them. The last decade of “funny money” has artificially speeded up this process, by narrowing the normal credit cost differential between rich and poor countries. This has produced rich country wittering about “deflation” – the real problem is not that real interest rates in rich countries might rise, but that wage rates in rich countries must fall.

As in Greece, the inhabitants of rich countries are now paid too much for what they produce – because it can be produced more cheaply in emerging markets. The solution is not devaluation; rich countries can devalue against each other but collectively have nothing to devalue against. The best solution is higher interest rates, which would increase emerging markets’ costs, because their capital cost is determined not by the cost of borrowing in their local currencies, in which few foreigners will lend, but by the cost of borrowing in dollars, euros, sterling and yen, the principal currencies of international banking. That would reduce the overpricing of rich country labor, reduce the tendency towards damaging “deflation” and re-balance the global economic system. It would also deflate the world’s stock markets are eliminate the private sector tendency to hopelessly misguided investment, though not the public sector one, which appears incorrigible.

Regrettably, higher interest rates appear to be the last thing we’ll get. In which case, for the rich world: Excessive budget deficits – check. Government debt spiraling out of control – check, some more than others. Overpriced labor forces – check. Barack Obama, Francois Hollande and Shinzo Abe, not to speak of Janet Yellen may lack the raffish charm of Alexis Tsipras, but they are pursuing a very similar policy trajectory. And as with Greece, it won’t end well.

(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)