Similar to events at the early stages of the sub-prime crisis, the financial predicament of Greece is likely to blow over soon, especially once the unannounced details of the accord reached early today are acted upon. What was once a cradle of civilization now accounts for only 2.6% of European Union output, and the rest of the continent simply can't let its financial system implode just yet.
Orchestrating a rescue is tedious. Although the EU has said each member would contribute according to its size, in reality all may not agree to participate without some quid pro quo. No one will ever know -- but the backroom dealing won't be as blatant as bribing Nebraska with free Medicare to sign on to socialized medicine. In the days leading up to the bailout, some worried about whether German voters in particular could stomach lending to Greece, but those in the know realized this was posturing. Moreover, German politicians would never resort to taxing their citizens when they can use debt or guarantees.
Noise is being made that a clear political signal has been sent to Greece, which will be backed up by IMF monitoring. But in reality major changes will not come to that country any more than they would to Keynesian regimes and quantitative easers such as the United Kingdom or the United States. So today's action sets a precedent which will make forcing financial discipline upon other member nations that much harder. The rationale for providing assistance is that the crisis is extraordinary. Had these been ordinary times, then of course the Greeks would have been considered profligate and more deserving of being subjected to really harsh measures, such as default.
Countries, like individuals, can get overextended. But it is their own doing, a political consequence, not a condition suddenly thrust upon them because the world is falling apart. The upshot of not rocking the boat is that past practices will be repeated. What is sadly fascinating about the situation is that while the media and Wall Street are downplaying it, repeating their panglossian response during the sub-prime period, the Greek tragedy unfolding underscores the underlying problem of moral hazard that this small country, and eventually the United States, will be forced to deal with at some point soon.
Of course there will be some belt tightening. But it is likely to be just that - the cosmetic approach of wearing a girdle rather than going on a serious diet and starting a program of regular exercise. The worse the world financial crisis gets, the better excuse there is to not alter the political framework and its monetary counterpart that in combination enabled heavy spending and borrowing, and in fact Keynesian theory strongly argues for a steroidal version of the status quo. The clever writers of the financial media are quick to tell us that Greece is different - from California, Portugal, Ireland, wherever. We need to revel in the complexity of the situation to know that technocrats at the central banks of the world are the only people who can fix the mess - with exactly the same economic theories that got us here in the first place.
In a brief section of his latest book, The Ascent of Money, Niall Ferguson cuts right to the core of the issue of when government policies of heavily indebted nations cross the Rubicon - or perhaps more aptly - the Styx. He states that hyperinflation occurs when a country's inhabitants and their political representatives are perceived by their creditors as having no intention of repaying their obligations. (He could also have thrown in default along with hyperinflation, and in a way he does, because he goes on to discuss Argentina). But the source of Ferguson's flash of insight is his explanation of why the Weimar Republic became the poster child for a financial nightmare, and not the other indebted nations of Europe after the First World War.1 Recall in the early 1920s, Weimar attempted currency devaluation to provoke a reduction of reparations owed. Like Greece, it was in a box because its obligations were denominated in prewar marks that were exchangeable into gold. With non-payment the object of this gambit, the French soon occupied the Ruhr valley, which then was answered by strikes, a form of passive resistance. Ferguson flatly states that hyperinflation is a political phenomenon.
The modern commentator would instantly say Greece is no Weimar. And it is ironic that the strong hand today was weak a century ago. If Germany and other "rich" EU nations do not rescue Greece, the alternative seems to be Greece would drop the Euro, but still owe debt denominated in that currency. That would trigger devaluation and inflation, an echo of the Weimar dilemma. The other choice which for now has been made is to stay in the currency union and address fiscal issues internally. However, without pro-growth political reform, continued socialism topped off with austerity would produce grinding deflation that will invite social unrest. Again, shades of Weimar, are these not? At the heart of our financial woes, regardless of towards which country in the developed world we look, is the failure of socialist democracy and the moral degradation that makes people think nothing of insisting that others should pick up the tab, be they the Germans or middle class Greek entrepreneurs.
In the U.S., the majority has elected politicians upon the platform of boosting spending regardless whether they are Republicans or Democrats. The former want us to think that simply cutting taxes will force us to think about spending rationally, but then they go ahead and propose additions to budgets anyway. This triggers a need for bond financing. The latter are deluded into thinking that the balanced budget seen at the peak of the internet financial mania signaled the success of carefully planned tax-and-spend policies. Going back two decades earlier, the pair of Nixon and Carter, purportedly opposites but both staunch Keynesians, managed to steer the world economy off a cliff, too.
In reality American governments have been riding a freight train towards disaster since before Roosevelt's time, but more significantly individual citizens have been much more irresponsible with using and giving credit. Why? We operate a fiat currency system that encourages leverage, where even a little bit of inflation every year makes investment in real estate irresistible. Begrudgingly we are getting a history lesson that such a system is a moral hazard and self-destructive. And it doesn't hurt that the government throws gasoline on that fire of malinvestment by co-signing everybody's mortgage, providing a tax credit equal to the down payment, and then providing a tax deduction for the monthly installments.
It should be clear that the Greeks do not intend to repay their debt. Otherwise no one would assume that Germany would "have to" swoop in and save the day. But even more obvious is that we here in the United States have no intention whatsoever of repaying our creditors, either. That we operate the world's reserve currency is mind boggling, for it provides Mr. Bernanke with the ink and the paper to threaten the world with a Weimar solution.
The media have drunk the Kool-Aid that we are in a normal cyclical recovery whilst the recurring theme of default pops up across the globe, first in Iceland, then Dubai, now Greece, and that soon the Fed will engage its "exit strategy." Next to falter is maybe Japan or England. Why won't they ask whether anyone has the fortitude - or the wherewithal - to repay anything that is owed? Only then can we understand the failings of nurturing big government and its lifeline, a banking system that has enjoyed an unlimited license to print money through fractional reserve lending. Often in ancient Greek tragedies, the hero, once ignorant of his mistake, would come to know it. Perhaps before the stage is cleared and the outcome is evident, some heroes among us can release us of our political mistakes, and provide a denouement that leads us toward a more pleasing and rational economy.
1 Niall Ferguson, The Ascent of Money: A Financial History of the World, Penguin Press 2008, pp. 102-105. Note that the Weimar Republic was not alone in its financial demise in the years after World War I. A detailed discussion of that period is in my book, Endless Money: The Moral Hazards of Socialism (John Wiley & Sons, 2010).
William Baker, CFA is the author of Endless Money: The Moral Hazards of Socialism (John Wiley, 2010) and the Editor, ConservativeEconomist.com.
Disclosures: Long and short equities. Long gold, gold derivatives, and gold equities.