Paul Krugman lays out three scenarios for Dubai, ruling out only the first.
First, there’s the view that this is the beginning of many sovereign defaults, and that we’re now seeing the end of the ability of governments to use deficit spending to fight the slump. … For what it’s worth (not much), US bond prices are up right now, suggesting that the Dubai thing hasn’t raised expectations of default.
But there’s a lot of room between fears of “many” sovereign defaults and fears of a default by the strongest sovereign of them all. What about Greece?
Brussels says Greece’s public debt will rise from 99pc of GDP in 2008 to 135pc by 2011, without drastic cuts. Athens has been shortening debt maturities to trim costs, storing up a roll-over crisis next year. Some €18bn comes due in the second quarter of 2010 (IMF).
Modern economies have reached such debt levels before, and survived, but never in the circumstances facing Greece. “They can’t devalue: they can’t print money,” said Mr Christensen. (Bolding added.)
It’s the combination of big debts and a fixed exchange rate that is lethal. As Canada showed in the 1990s, a country with a floating exchange rate can cope with indebtedness easily: Let the currency decline, everybody inside the currency area takes a big pay cut, they consume less, export more, debts are serviced, prosperity returns. In 1993, world markets worried about a Canadian default; today Canada ranks among the least indebted of the advanced economies.
Inside the Eurozone, things are very different. For Greece in 2009, the Euro has the same effect that the gold standard had on a small export economy in the 1930s. Wages cannot be invisibly reduced across the board, they must be cut in nominal terms, firm by firm, industry by industry. Earning export income becomes harder, servicing debt becomes much more difficult. The only way out: either extreme austerity – or else quit (or be expelled from) the Euro. And if Greece – why not Spain? Why not Italy?
Those are the questions my AEI colleague Desmond Lachman keeps asking, and they are haunting.
6 responses so far
1 sunroof // Nov 28, 2009 at 9:34 pm
David, your conclusions beg a question and an explanation.
If the Canadian “solution” is so effective, why are policymakers in the US so afraid of a weak dollar?
And secondly, we in Canada know that the medicine we imbibed in 1993 included deep and often painful budget cuts and the imposition of the federal goods and services tax – Canada’s value added tax. It meant that the military budget was starved, social programs were starved, and so was capital investment in the modernization of manufacturing, because it was easy to make export sales – even with outdated technology. I don’t see any political faction in the US seriously advocating deep cuts to military spending or a significant new tax. The polarization of US politics suggests Americans aren’t nearly ready for higher taxes or cuts to the spending they hold most dear. And yet even bigger pain lies ahead when the big entitlement programs really kick in.
2 About dubai, government bonds, friday, greek bonds, greece, debt, markets | Find me About // Nov 28, 2009 at 10:15 pm
[...] First, there’s the view that this is the beginning of many sovereign defaults, and that we’re now seeing the end of the ability of governments to use deficit spending to fight the slump. … For what it’s worth (not much), US bond prices are up right now …Read Original Story: Wrong Question Professor Krugman! – FrumForum [...]
3 advocatusdiaboli // Nov 29, 2009 at 1:29 am
Good essay and valid point. Many U.S. states are close to Dubai-like insolvency and, after the artificial stimulus wears off and the U.S. economy faces the aftermath of corporate cutting to the bone, we can expect more to join them.
4 ottovbvs // Nov 29, 2009 at 9:58 am
……..Greece is not going to default nor be expelled from the euro and neither are Spain or Italy ……..and the suggestion by advocatus that we are going to see a rash of state defaults in the US is absurd.
5 sinz54 // Nov 29, 2009 at 1:40 pm
advocatusdiaboli:
More likely, Congress will simply dish out more money to failing states (Michigan comes to mind here), and the “stimulus” to those states will become permanent.
6 CO Independent // Nov 29, 2009 at 3:21 pm
“It’s the combination of big debts and a fixed exchange rate that is lethal. As Canada showed in the 1990s, a country with a floating exchange rate can cope with indebtedness easily: Let the currency decline, everybody inside the currency area takes a big pay cut, they consume less, export more, debts are serviced, prosperity returns. In 1993, world markets worried about a Canadian default; today Canada ranks among the least indebted of the advanced economies.”
>> This series of statements is so blindingly stupid that the mind boggles. Currency devaluation is collective economic punishment, period. It is theft. Financially responsible citizens, who work, live within their means, and manage to save up a small amount of wealth have their earning potential and wealth destroyed to pay for the rapacious spending of irresponsible politicians.
Far from being lethal, a fixed exchange rate forces politicians to accept political responsibility for the consequences of their fiscal irresponsibility. By contrast, a floating currency allows politicians to offload the consequences of profligate spending onto the currency. Our current situation in America is instructive. There has been no recovery in our capital markets when measured in real, constant dollars. On a trade-weighted dollar basis the DJIA remains at about 7600. Yet the Obama administration, understanding that Americans are incapable of dividing by decimals, are crooning over a DJIA back up over 10,000.
Moreover, you and Krugman both miss the mark. A fixed currency has nothing to do with the problems facing Greece (or Spain or Italy). The lethal combination for Greece is the combination of an inverted population pyramid due to declining birth rates and a welfare state designed to shift wealth from the shrinking population at the lower end of the pyramid to seniors. I believe it was Maggie Thatcher who said that the problem with socialism is that sooner or later you run out of other people’s money. Greece will soon learn the meaning of this phrase. Italy and Spain, who also suffer from an inverted population pyramid coupled to a welfare state, will follow in due course. California, New Jersey, and several of our other bankrupt states will eventually suffer the same fate unless pension systems are nationalized (look for this in 2013 if Obama is reelected). See the pattern?
Uggh, you Country Club Republicans make me crazy. In your philosophical core you are a statist through and through, indistinguishable from a Democrat. It’s no wonder the Republican party is collapsing. Why bother?
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