Morici: Lessons from Euroland for the United States
Greece’s finances are out of control. Its bonds are downgraded to junk; and without a German and European Central Bank bailout, it will be forced to restructure its debt.
Greece doesn’t have a liquidity problem—it is insolvent—because no amount of spending cuts or tax increases can cure its budget woes. Investors are demanding such high premiums on outstanding bonds that rolling over debt, as those come due, will be prohibitively expensive.
German and European banks would take huge haircuts in a restructuring; therefore, to avoid immediate pain, the Germans and ECB may find a way to buy more Greek bonds. This would continue the charade that Athens can find a path to solvency through economic reforms and austerity but the longer this folly persists, the greater the haircut for Athens’ creditors.
The United States is losing control of its finances too, and bond rating agencies have threatened to downgrade its debt.
Like Greece, health care and retirement programs are spinning out of control; and Congress has padded the federal payrolls with new programs and bureaucrats that slow, rather foster, growth.
President Obama and principal U.S. creditors—most notably, China—are in denial. The President talks about raising taxes on families earning more than $250,000 but that will hardly dent the problem.
Substantial spending cuts or higher taxes would suffocate the economic recovery, and a second credit crisis and deeper recession would likely cause chaos for China’s exporters and banks. Hence, Beijing continues to print yuan to buy dollars, convert those dollars to U.S. bonds, and suffer rising inflation when those yuan return to purchase Chinese exports.
Eventually, the United States will be insolvent too, the global economy will shatter, and American sovereignty will be thrown into the arms of Chinese creditors.
Europe’s Outsized Expectations for Public Benefits
European voters expect a strong, broad and expensive social safety net—including universal health care, income security and early retirement.
These have so reduced individual risks and rewards that population and economic growth have slowed to dangerously low rates. Without more young people and a bigger economic pie to divide, the social safety net is too expensive to maintain in rich and poor countries alike.
With the commercial integration that followed World War II through the European Common Market, composed initially of six nations, and the broader European Free Trade Area, which encompassed most of the non-communist states, public expectations for benefits in poorer nations and regions, like Portugal, Greece and southern Italy, grew to rival those in richer states. This despite the fact their economies lacked the resources to pay for those benefits, even more acutely than in Germany or France.
Politicians in the South responded by expanding and enriching social safety nets but costs rose too, as doctors, teachers and the like expected salaries and benefits more comparable to their colleagues further north.
"Greece could be the next Lehman Brothers.""
The price tag outran the ability of employers and governments to pay, and inflation and national budget headaches followed.
Until the euro was adopted in 1999, southern nations could let their national currencies gradually fall in value against the German mark and other currencies of richer nations.
That would boost exports and tax revenues. The pensions paid by Greece, Portugal and others, denominated in their national currencies, became worth less if spent in Germany and other northern jurisdictions; however, these Mediterranean states became great places for northern Europeans and Americans to retire and vacation.
After 1999, national governments in Spain, Portugal and Greece, and to a lesser extent more prosperous Italy, faced the difficult prospect of telling their citizens they could not retire as young, enjoy the same health benefits or employment security as the wealthier French, Germans and Dutch.
Instead, these governments borrowed heavily and now face severe retrenchment and perhaps bankruptcy.
The austerity Germany and others will ultimately compel to bail out these floundering governments will shatter the myth that the welfare state can be provided equally across Europe, or Mediterranean states will simply quit the euro and take with them the Franco-German dream of European Unity.
Before Americans and northern Europeans chasten their Mediterranean friends too harshly for living beyond their means, remember northern reluctance to share wealth through a strong central government has much to do with their predicament.
In the United States, the states can’t print money and some spend more aggressively than others but most social benefits are substantially assisted by Washington, which can tax New York to subsidize Mississippi. Brussels cannot tax Germany to help pay for Greek social benefits, at least not as aggressively as is needed.
German and other northern European exporters greatly benefit from a single European market, and the fact that the euro is overvalued for its Mediterranean economies but undervalued for their exports. However, unless the Germans and others are willing to let Brussels tax them as necessary to reasonably equalize social spending between richer and poorer states, the euro will remain an uncertain adventure and European unity a utopian dream.
Monetary union is simply not possible without fiscal union.
"GREECE COULD BE THE NEXT LEHMAN"
The Threat of Contagion and the Future of the Euro
Greece could be the next Lehman Brothers.
Portugal, Spain and several other countries have similarly shaky finances, and a Greek restructuring could cause investors to demand much higher risk premiums on their existing bonds. Rolling over debt would become too expensive, and those nations could become insolvent too.
European banks, including those in Germany and other wealthy jurisdictions, hold sizeable amounts of threatened countries’ debt, and U.S. banks hold a lot of European debt too. A banking crisis could easily spread across Europe and then to the United States, much as the recent U.S. mortgage and broader financial crisis spread to Europe.
As the crisis in Greece and other countries worsened, ECB could step up purchases of sovereign debt but that would simply replace Greek and other sovereign debt with billions of new euro in circulation and inflation.
At the end of the day—the combination of existing debt and public expectation for a generous social safety net may compel Germany and other richer countries to choose between Greece and other poorer countries quitting the euro—returning to their own currencies—or a combination of high inflation and greater fiscal union in the EU. Regarding the latter, either the North subsidies the South through ECB printing euro and inflation, or the EU transfers tax revenues from richer to poorer countries.
The Germans rightly fear hyper-inflation, but granting the EU broad taxing authority to finance a pan-EU social safety net is unlikely. Instead, countries like Greece may be forced to leave the euro zone or the euro will disappear all together.
This could take several years to play out, but monetary union is simply not possible without fiscal union.
Lessons for the United States
The U.S. government and many states face similar difficulties but for the fact that the United States prints dollars—the global currency—but that could change.
The budget published by the Obama Administration assumes GDP growth of about 4 percent for 2011 through 2015, even though most private economists believe less is likely.
It contains the politically less difficult fiscal levers—repeal of the Bush tax cuts for families earning over $250,000 and cuts in defense spending—and projected revenues and cost savings from the 2010 health care law, including the new interest and dividend tax.
More realistic assumptions about growth and the cost of health care put U.S. projected deficits on the path to unsustainability—more than $1 trillion a year for many years.
Congressional Republicans are throwing around grand numbers—demanding $2 trillion in spending cuts to approve an increase in the debt ceiling. But how those cuts are to be accomplished remains vague, and those come to only about $200 billion a year. Simply, the GOP plan would just boot the problem past the 2012 elections.
At that point, the United States would almost certainly face a downgrade in its bond rating, higher borrowing costs, forced reductions in spending, and significant new taxes.
The Democrats have the value added tax waiting in the wings. However, in the current environment of fiscal indiscipline, a VAT would be a disaster.
The polemic is appealing. Other industrialized countries have one, now that U.S. social benefits are more like theirs with the passage of national health care, the United States should have one too?
Not so fast.
Europeans pay a VAT and have income and corporate taxes too but they pay little for health care and higher education—the government uses those taxes to pick up the tab.
With a VAT, U.S. businesses and individual taxpayers would have tax burdens comparable to Europeans but would still face hefty bills for private health insurance and college tuition that Europeans do not bear.
The reason is simple. Americans pay 50 percent higher prices for health care services than the Germans and most other Europeans, and U.S. universities are chronically wasteful institutions. And U.S. regulatory costs are higher—witness how Initial Public Offerings are fleeing the United States for Europe and other venues, because of higher costs imposed by the Sarbanes-Oxley accounting law.
Obama Care contains firm commitments about scope of coverage and benefits guaranteed each citizen, but offers only vague commitments to reduce higher U.S. drug, medical professional fees, administrative costs, and malpractice expenses.
U.S. governments, federal and state, pay for about half of U.S. health care expenses, and a VAT would take away the pressure to chisel down higher U.S. costs.
U.S. higher education is another big hole in household and state finances. Americans pay too much for what they get, except perhaps from their most modest institutions—community colleges. Too many young Americans are simply unprepared to compete in the global economy.
A VAT, without offsetting reductions in personal and corporate taxes, will only make Americans poorer and with even fewer incentives to work and innovate than the Europeans, cause businesses to offshore even more jobs and tax economic growth to anemic levels.
Without a VAT and absent real and substantial cost cutting for health care and provision of other public services, budget deficits will drive up U.S. borrowing costs to unmanageable levels.
With a VAT and no real cost cutting, the absence of growth will strangle American prosperity, cause the collapse of the dollar standard and throw the United States on the mercy of its principal creditors—read China.
Greece is a warning to governments that promise too much and pay too much for what they promise.
The United States is hardly free of such folly, and Americans should be prepared to someday accept from China the medicine Germany is now administering Greece.
Peter Morici is a professor at the Smith School of Business, University of Maryland, and former Chief Economist at the U.S. International Trade Commission.