America’s exceptionalism and spirit of liberty may bolster us against turning into Greece, but will not prevent us from becoming very Greek indeed. Writing at the American Enterprise Institute for Public Policy Research, Vincent and Carmen Reinhart explain “Five Myths about the European Debt Crisis.”
First, Greece’s predicament is no new phenomenon.
It’s easy to imagine that this is a thoroughly 21st-century financial calamity, wrought by modern financial products and a hyper-connected global economy. But in fact, governments have borrowed to live beyond their means–and have had trouble paying their debts–for about as long as there have been governments. From the 14th through the 19th centuries, monarchies routinely resorted to debasing their currencies, expropriating private property and defaulting on their debts. And their failure to honor their obligations usually produced severe economic hardship for their populations.
Not only are 700 years of history telling, but in the past 180 years alone Greece has been in default half the time. Reasons? Huge, irresponsible, feel-good, welfare-oriented spending motivated by socialistic theory that ignores real-life consequences. The same kind of political irresponsibility pushed the Argentinean economy off the deep end in 2001 when repeated attempts to cut government spending triggered public sector union riots like the riots now occurring in Greece. There are few clearer illustrations of the adage, “Those who do not learn from history are doomed to repeat it.”
America could never degrade into such a violent state? Don’t bet on it.
If attempts to cut education spending can send thuggish teachers’ unions into the streets and a tough Arizona law on illegal immigration can send unions and race baiters screaming, what will happen if Washington politicians ever find the spine to do what has to be done to cut Welfare, Social Security, Medicare, Medicaid, and other government handouts?
Reinhart and Reinhart address the myth that “Small economies such as Greece can’t launch major financial turmoil.” The Reinharts point out that 13 years ago tiny Thailand’s economic troubles sent the entire Asian sector into a tailspin that shrank the region’s economies by 13% even after Thailand severely slashed spending, raised taxes, renegotiated debt, and got foreign help. The writers explain how the economic woes of one small country can spread.
How do crises spread from one country to another? First, many governments have common lenders, including big international banks and hedge funds. If these institutions suffer large losses in one national market, they often pull back their lending to others.
Second, trouble in one country acts as a wake-up call to investors, who scour their global holdings for similar risks elsewhere. When they look hard enough, they usually find something to worry about, triggering even more funding withdrawals. Greece, Ireland, Portugal and Spain may be miles apart, but to a worried portfolio manager, they look similar: They all have ongoing budget deficits and large private and public debts.
We can see where the argument is going, and the picture isn’t pretty. Simply frantically cutting spending “will [not] solve Europe’s debt difficulties.” In fact, at the level at which Europe as a whole, Greece specifically, and also the United States now spend, slashing spending is necessitated by what the Reinharts call “a reality of arithmetic.” The human nature-induced gotcha, as the writers explain, is that…
…fiscal austerity usually doesn’t pay off quickly. A large and sudden contraction in government spending is almost sure to shrink economic activity as well. This means tax collections fall and unemployment and welfare benefits rise, undermining efforts to reduce the deficit. Even if new borrowing is reduced or eliminated, it takes time to whittle down a large debt, and international investors are notoriously impatient.
Human nature makes people impatient. The “reality of arithmetic” is that Greece, Europe, and the U.S. have no choice but to cut spending to begin a slow economic recovery. And raising taxes to “speed up” the recovery will only slow the recovery further due to decreased private sector funds available for investment in the recovery. This makes sense to clear thinkers, who know that expecting fast sustained recovery is unrealistic.
Reinhart and Reinhart point out something critical to understanding how countries get into ridiculous economic situations. To generate the voter feel-good needed to be repeatedly reelected, most politicians are DNA-programmed to spend uncontrollably and tax insufficiently. A reality-blind liberal is a reality-blind liberal, regardless of language, party affiliation, or geographic location.
Let us not confuse “liberal” with “Democrat.” Anyone not realizing that over the past two decades fiscal “liberal” has come to describe Democrats and Republicans is not living life with eyes and ears open. We must reach all the way back to the days of Warren Harding and Calvin Coolidge (1920s) to find a truly fiscally conservative Republican in the White House. (Don’t get me started on The Gipper. Reagan cut taxes, to be sure, but irresponsibly grew spending.)
And now, the biggest myth being touted today: America cannot turn into Greece? A Greek tragedy may not be in America’s immediate future, but as the Reinharts observe…
…a U.S. fiscal deficit at 11 percent of GDP and an overall federal debt level that is rapidly climbing toward 100 percent of GDP are testing the risk tolerance of domestic and international markets. Taking for granted that Uncle Sam can indefinitely borrow at reasonable rates is a risky proposition.
Translation: America is now borrowing every year an amount equivalent to 11% of the country’s entire domestic annual output. The following analogy is not precise, since families have no “output,” but the analogy’s lesson is solid.
Imagine you and your spouse earning $100K a year–after taxes–but having to borrow $11K a year to finance your chosen lifestyle. With annual spending at $111K and intake at $100K, in 10 years you rack up debt of $110K on top of existing debt, like mortgages. So after 10 years you’ve piled up added debt equal to more than an entire year’s intake with absolutely no hope of ever paying the additional debt off.
A U.S. debt level of 100% of the nation’s output translates as just described in our little “what if.” America will soon reach a level of spending and borrowing in which taxpayers–who fund the government–owe as much in loan repayments as the value of the country’s entire annual production.
Welcome to a going-out-of-business scenario on a national scale. Ready for some real riots?
Are we ready to put some true fiscal conservatives in office and demand fiscal conservatism?