Comments on Libya and Greece

As usual, some of my friends have strong views of their own and interesting observations to add. Here are a few comments mainly on my Greek referendum blog.

Thanks, Warren

I totally agree with you regarding Greece.  I wonder if a similar referendum might be a good thing for the U.S., with the implication that if the majority of the population does not wish to cut spending and unsustainable entitlements, then the Federal Reserve will be mandated to expand the money supply to cover the shortage by inflation.  Actually, a referendum should put the choice that starkly.

Alternatively, we could rerun the election of 1896  — Fiscal conservative William McKinley versus Inflationist William Jennings Bryan (“free monetization of silver”)…  Then Bryan lost  — I wonder if he would win today.

Obama seems in many ways like another Bryan (without the Bible belt), but where is McKinley when we need him?

Ron [Bird, Virginia]

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I am not that keen on this referendum… It Will take 2 more months to have an answer and as you know, Time is money. Moreover they Will say no, do you know a kid who say yes when his father tell him at a party “do you want to go to Sleep”? They are not masochistic as far as I know.

Finally, it s a complete lack of balls from the politicians who are afraid to take strong decisions. However, that s what they were elected for!

Hugo [Gervais, Paris]

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Warren is smoking crack.

He writes, “If they accept it and embrace and stand behind the reforms

needed, the crisis for Greece will be over.”

And I say that if I grow 10 inches overnight and learn to play

basketball, I’ll be in the NBA.

The only difference between our two statements is that mine has a

.000000000001 chance of happening.

Dan [Mitchell, Washington DC]

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Greetings, Warren

I’m surprised that no one seems as yet to have noticed the irony that the country that invented democracy, and coined the term for it, is the first to be rounded on by a supra-governmental gang of unelected ideologues. I agree with you that the referendum is a good thing but not quite for the same reason you suggest. A ‘yes’ vote might give the Greek government enough political clout to clear out some of the Augean stables. But a ‘no’ vote would be even more fun: it would mean no bailout and lead to default and the exit of Greece from the euro and thus begin the unraveling of the entire misbegotten enterprise. The current prevailing message from the europhiliacs is that the eurozone must not be allowed to fragment, but there may come a time when they see the costs of a no-exit policy as too high and will then ditch the Greeks (and then the Portuguese? and then?) so as to save the currency for the handful of fiscally continent countries still left.

And I’m appalled by the fact that none of the commentators I’ve read has thrown up any hands at the suggestions of ‘closer fiscal union’ as a way of safeguarding the euro. That means, very clearly, taxation without representation, and from there it’s only a small step to tyranny. So the sooner Greece buggers the euro in the grand manner, the better for us all.

Cheers

Martin [Anderson, London]

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hi Warren,

Thanks for sending these.. though I disagree with both. On Libya: it’s way too early to count our chickens. But as I see it, the US got dragged into this by the French and the British on spurious grounds and then overthrew a dictator by force, which was nowhere in the UN mandate, however nasty that dictator was to his own people (for over 40 years, I might add, although we choose to overthrow him only now, and only after he gave up all his nasty weapons and was, so far as anyone could tell, no threat whatsoever to us).

On the Greeks, I’m dumbfounded by the referendum move. Your case makes nice sense in theory but hardly on the ground. How is it possible that Papandraeou, who has been negotiating on a more or less hourly basis with his European counterparts for at least the past six months, could pull off such a surprise? What is really going on? It suggests, at least to me, that the EU is so dysfunctional that there’s nothing to hope for at all. The Greeks voted to join the EU and then the euro. Now is not the time–particularly during the peak of a crisis right after a major negotiation–to second guess that by referendum in the name of validating an EU-wide decision. The EU is not the US but we did away with the doctrine of nullification a long time ago and I suggest the same holds for the EU. This referendum is essentially asking the Greeks to decide to pull out, and if they do it, anyone else can. It’s mad.

Ken [Weisbrode, Boston]

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Ken,

 On Libya, I was saying almost the same thing (see my five earlier warning blogs against getting involved: https://wcoats.wordpress.com/2011/03/10/libya-and-the-drums-of-war/, https://wcoats.wordpress.com/2011/03/13/libya-lets-not-make-it-our-war/, https://wcoats.wordpress.com/2011/03/21/another-long-war/,   https://wcoats.wordpress.com/2011/04/22/libya-further-down-the-slippery-slope/,  https://wcoats.wordpress.com/2011/08/23/libya-part-ii/ ). I am not optimistic about Chapter 2 now starting and glad that we have some chance of staying out of it (though I am worried about that too).

Warren

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Warren

All forms of brinksmanship are pretty much welcome at this point. If you think, like I do, that the problem in Greece and Italy is fundamentally a price competitiveness issue, and not a financing one, then things have to get much worse before people change their ways, start cooperating and stop fighting each other.

It will probably not work out, but hey, that’s cheaper holidays in Italy!

Sahil [Mahtani, Jakarta]

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Dear Warren,

I liked your Greek piece.  Insufferable fools.  They’d trade simple (but not so simple…) bankruptcy for a 50% write down and a road back to prosperity.  I’m going to write about it for my column next week.  I wonder how much looking up at Parthenon makes them still think they’re special? The DNA now is mostly Turkish anyway.

I’ll be back in Manila in time for my book launch with ex-president Ramos in a couple of weeks.  I am starting new quickie the Manila publishers want, “For love of a country: 40 years in and out of the Philippines,” which I can write in my sleep.  Though it is amazing how much comes back one had forgotten. Sometimes it’s just hard to believe we’ve been at this game for over 40 years.

I feel my whole life has been a study of empires falling (UK, now USA), new ones emerging (and in Asia no less).  Obama understands…as you pointed out he did the right thing in Libya.  And isn’t it wonderful to say, let the Europeans do this and that, not coming to us with a begging bowl.  A true silver lining to loss of empire.  George W Bush merely hastened the decline.

Scott [Thompson, Bali]

The Greek Referendum

The Greek referendum announced on November 1 by Greek Prime Minister George Papandreou is a big gamble and politicians rightly don’t like to gamble. I, on the other hand, like the idea. It will force the Greek public to face up to the fact that the Germans and other northern Europeans are no longer willing to support their habit of living high on other peoples’ money.

The Greek referendum announced on November 1 by Greek Prime Minister George Papandreou is a big gamble and politicians rightly don’t like to gamble. I, on the other hand, like the idea. It will force the Greek public to face up to the fact that the Germans and other northern Europeans are no longer willing to support their habit of living high on other peoples’ money.

Greece and many other governments, banks, and families have financed expenditures above their incomes with other people’s money for too long. The debt burden that has resulted has become too much to carry and lenders are no longer willing to keep on lending. Greece, to focus on today’s headline country, must reduce its debt, and reduce the government’s and the public’s borrowing (reduce spending and/or increase revenue) that created it and keeps it growing.

Some of Greece’s debt is owed to foreigner. Its borrowing from abroad to pay for its imports in excess of its exports can be reduced or eliminated by exporting more and/or importing less. To eliminate its trade imbalance Greek workers and firms must become more competitive with the rest of Europe and the world. Greek labor and produce markets need to be liberalized to become more productive. Retirement at 58 and generous vacations need to be brought into line with worker benefits in other European countries.

In announcing plans for the referendum, Papandreou stated that: “It is ‘time for the citizens to reply responsibly…. Do they want us to implement it or reject it? If the people do not want it, then it shall not be implemented. If yes, we shall proceed.’” [1]

But just what will the Greek voters be asked to decide? “’It’s difficult to see what the referendum is going to be about. Do we want to be saved or not? Is that the question?’ said Swedish Foreign Minister Carl Bildt.“[2]

The referendum might read: “Yes or No: ‘We agree to promptly adopt the market and fiscal reforms that we need to restore fiscal balance and external competitiveness in the future so that Greece will no longer need to borrow and spend other people’s money. As these adjustments will take time to restore competitiveness and eliminate the government’s need to borrow, the IMF and EU are prepared to lend the money needed to finance an orderly adjustment and banks around the world have agreed to write off half of their existing holdings of Greek government debt.’

A No vote would reduce that debt and any debt service payments to zero (full default), but as the government’s expenditures would still exceed its other spending commitments, the government would need to default on other domestic obligations as well (pensions, larger government salary and employment cuts, etc). Greece would be forced immediately to live fully within its much-reduced means and the suddenness of the government’s cuts would temporarily reduce Greece’s output and employment and government tax revenue even more causing potentially significant overshooting.

The beauty of a referendum is that people will need to face the truth and accept it or suffer the consequences of rejecting it. If they accept it and embrace and stand behind the reforms needed, the crisis for Greece will be over. External financing will still be needed as now planned to minimize the loss of output and revenue from the temporary adjustments needed.

The danger of a referendum is that the people will misunderstand the consequences and say no or will throw a childish tantrum and say no. The consequences of a No vote cannot be fully predicted. When faced with the larger cuts and disruptions full default would cause, civil society could explode with unforeseen results. Furthermore, the losses by banks and (largely Greek) pension funds holding Greek government debt would be larger causing larger losses to bank owners and creditors and probably French and other tax payers (the Greeks seemingly don’t pay taxes).

In this circumstance a possible, but not inevitable, further consequence would be Greece’s introduction of its own currency and a redenomination of Euro obligations of the government (at least) in the new currency at a depreciated exchange rate. If the government can force the re-pricing of wages and goods and services produced in Greece in the new depreciated currency, external competitiveness could be established (at least temporarily) with the stroke of a pen and the running of the currency printing presses. It is not obvious, however, that Greek workers would accept wage cuts via depreciation of the exchange rate of their new currency more readily than directly via nominal wage cuts.

To reintroduce its own currency, the Central Bank of Greece would offer to exchange Euros held by its banks and citizens for its own currency, though it is hard to imagine any of them taking up the offer. The real advantage to Greece of abandoning the Euro, and the source of the catastrophe that would almost surely follow, is that the government could now borrow the new currency from its own central bank. Rather than defaulting on many of its domestic obligations and/or implementing sharper than now planned cuts in government salaries and employment, the government could pay them with the new currency printed by and borrowed from the Central Bank of Greece. Printing money is not the same thing as growing food and building things, of course. So the introduction of its own currency would allow the Greek government to finance its continued deficits via inflation, i.e. reducing the real income and wealth of the private sector in order to transfer it to the government sector.

In Greece’s circumstances, monetary/inflationary financing of the government is a very slippery sloop that is likely to degenerate within a few years into hyperinflation as Zimbabwe recently demonstrated. https://wcoats.wordpress.com/2009/05/29/hyperinflation-in-zimbabwe/

Beyond Greece

But what about Spain and Italy? What would be the consequences for their sovereign debt and for the banks and others that hold it of a No vote in Greece? Europe worries much more about this than anything that might happen in Greece. Restoring fiscal balance and improving external competitiveness will be much easier for Italy, for example, than it has been for Greece, if Italy only get on with it. A No vote in Greece would alarm market lenders but would also alarm the Italian government borrower and might well catalyze the reforms needed in Italy more quickly than a Yes vote. The fiscal and structural reforms that have already been discussed with Spain and Italy by the IMF and EU, if implemented, would remove market concerns about their ability to service their debts and thus restore interest rate risk premiums on such borrowing to German sovereign debt rates.

The uncertainty over the coming weeks of the Greek referendum outcome is unfortunate, but Spain and Italy need not wait, nor do they need EU money, to take decisive and credible actions to reassure market lenders.

[1] Howard Schneider and Michael Birnbaum,  “Greek referendum call upends euro plans” The Washington Post, Nov 2, 2011, page A1

[2] Ibid.

Leading from behind in Libya

The U.S does not own what happens next in Libya, and the prospects for a good outcome are better because of that.

President Obama and Secretary of State Clinton have come out well with the limited role they gave to U.S. support of the now victorious Libyan insurgents. President Gaddafi was removed from power (and life) without the help of American boots on the ground. It was a victory by Libyans and the outcome, and they are just at the beginning of chapter two, will be theirs to celebrate or lament.

The American approach this time around has several advantages. The hit on our over taxed budget was small and is likely to remain small. But more importantly, the resentment that always follows eventually when our (or any ones) troops occupy a country will be missing. This will also contain long run costs and improve American security.

More important still is the almost certainty that the prospects for Libya to develop a liberal democracy that respects its citizens are larger if they must build it themselves. If they fail, that will be theirs as well.  A viable government that respects human rights cannot be simply stepped into no matter how good a model we might give them. It must be the product of give and take and negotiation amount competing Libya groups. Libya is now entering into such an internal struggle. We should take the side of proper principles of government and human respect, but not the side of a particular group. President Obama’s reserve in limiting American involvement makes such a process among Libyans possible. It will not be easy and I wish them well.

A story of travels to Kabul and a suitcase

Starting in January 2002 my flights into and out of Kabul where on the United Nations Humanitarian Air Service (UNHAS) charter planes between Dubai or Islamabad and Kabul. I would land in Dubai or Islamabad on a commercial flight, pick up my bag and check into a hotel with my other IMF colleagues for the UNHAS flight the next day. In Islamabad we stayed in the Marriott (since blown up by terrorists) and in Dubai we stayed in any number of first class hotels.

Departure the next day was from a remote part of the airport in Dubai or Islamabad to a remote part of the airport in Kabul. The idea of checking my bag through to Kabul for the convenience of not having to go through immigration to pick it up and recheck it (I was almost always in a rush to get there with no time to stop over anywhere) was a number of years off.

With the advent of commercial flights into Kabul and the ending of the UNHAS flights three or so years ago, our Dubai departures (we had given up on Islamabad after the bombing of the Marriott) moved from the small old Terminal 2 to the big modern Terminal 1 (I always found this numbering confusing). However, it was still not possible to check our bags through to Kabul. We had to wait in the immigration line, then wait while the generally unsmiling Arab immigration officer examined, then stamped, our passports, go pick up our bags, and re check them with Safi Airways, re-emigrate and fly on. The immigration officers, by the way, where just about the only Arabs I encountered in the UAE in a working capacity. Cab drivers, porters, hotel clerks, restaurant waiters and virtually everyone else who serviced us in any way were Filipinos, Indians, Pakistanis and sometimes Bangladeshis.

More recently, agreements were struck with United, BA and other airlines and Safi Airways that make it possible to check our bags through from Washington to Kabul. Thus in Dubai I could go directly from my arriving flight to the departure lounge of Safi without immigrating (i.e. transit). Shoppers will enjoy the massive collection of shops and goods in Dubai’s mammoth airport, but I am not one of them. Most of our IMF team choose to hang out in the airport for the 4 or 5 hours between flights rather than enjoy the sterile splendor of modern Dubai. Some of my colleagues worried about the risk of losing their bags if they checked them all the way through, but I preferred to take the risk in exchange for the convenience and never had a problem until the day before yesterday.

For some reason that I do not understand the check through arrangement does not seem to work in reverse. It is not yet possible to check my bag from Kabul to D.C., though there is some confusion about this. My return home from Kabul yesterday illustrates this point.

After a year of difficult and inconclusive negotiations with the authorities, our IMF team finally agreed with the authorities on a program that we thought our Executive Board could support. The measures that had been taken and were agreed to be taken to resolve the failure of Kabul Bank (potentially the largest bank fraud per capital in history) had been the main stumbling block. The amazing and shocking history of Kabul Bank is set out in detail in: http://www.uspolicyinabigworld.com/2011/09/21/the-kabul-bank-scandal-and-the-crisis-that-followed/.

As the prospect of an agreement became clear, our short five-day visit to Kabul was coming to a close, so we delayed our early Thursday morning departure until Thursday evening. To add an extra hour and a half to the time available to us (my colleagues had gone with only a few hours sleep for the last three days as it was), the Finance Minister (our negotiating counterpart) arranged for our boarding cards to be issued and bags to be checked in the VIP lounge before we left for the airport. One of his aids collected our passports and bags and my hopeful instruction to check my bag through to Washington. When he returned to the IMF guesthouse with our boarding cards and baggage claims, he also had a bill for me for $85 for the check through arrangement. It was worth it to me not to have to recheck my bag in Dubai.

We successfully concluded the negotiations, held a donor briefing (World Bank, USAID, DFID, ADB, ISAF, UN, and others), issued a press release from Washington, http://www.imf.org/external/np/sec/pr/2011/pr11358.htm, and headed for the airport. I must say that it almost made flying enjoyable again to be driven through security up to the VIP lounge (rather than having to drag our bags from a remote parking lot), skipping all the security, emigration, and check-in lines. We boarded soon there after and three hours later deplaned in Dubai.

As we entered the terminal, I was expecting to immigrate and head to the local Hilton for a good night’s sleep. But just inside the door stood someone holding up the unexpected and unwanted sign: “Coats, Jr. Warren L.  Why was I being stopped, I asked? “Follow me please.” To make a confusing story short, a reception service had been engaged to take me passed the long immigration lines to the baggage carousel and arrange for my transportation to the Hilton. As this was not what I had paid for nor wanted (though skipping long immigration lines is always appreciated), and the young lady escorting me around had her own instructions, considerable confusion ensued as we walked from one place to another until it became VERY clear that I would not be able to recheck and leave my bag there until I returned in the morning. So be it. I had a good sleep at the Hilton with my bag at my side and lugged it back to the airport in the morning and was soon on my way to London and home.

I use to hate going through London’s Heathrow airport, but with the addition of BA’s Terminal 5, I rather like it. So my three and a half hour lay over in Terminal 5 passed pleasantly (the BA wi-fi pass word for the day was “Singapore”). On the nine-hour flight from London to DC, I watched one movie, and slept the rest of the way, skipping dinner.

My suitcase drama had one more chapter. When I arrived in DC, it didn’t.  In addition, the BA office at Dulles was closed (typical British service) and its mix of automated and live human telephone service was unpleasant. Nonetheless, my bag was delivered to my door one day later (last night), in time for a quick repack and departure for Grand Cayman this morning for this quarter’s meeting of the Cayman Financial Review’s Editorial Board meeting.

Comments on my 9/11 post

Thanks, Warren,

We were then in Bratislava… I was the first to speak after Michael and the Muslim speaker (forgot the name)…  I also remember that we cut the coffee break to listen to Becker’s and Horowitz’ assessments of the impacts — months later it turned out their on-the-back-of-an-envelope calculations were very precise.

Regards.

Krassen [Stanchev]

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Warren

Your “Remembering 9/11..” is eloquent and incisive. Would that we can turn back the unleashed Leviathan; and, with amends, again become a beacon on a hill.

John [Sainsbury

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Dear Warren,

Excellent commentary on 9/11, and the insane government wars in the Middle East……

I was in NY that fateful day, having arrived a week earlier to take over as prez of FEE.  For the next week the phones went dead, nobody called, and we had my first big FEE dinner scheduled in a month at the Harvard Club with Paul Gigot as the speaker.  My first decision was whether to cancel or not.  I decided that if necessary we would hold our first FEE dinner around the dinner table…..Fortunately, the phones came alive and we had over 200 attend.

Did you see that Pres Obama read Psalm 46 yesterday at 911 ceremony?  It’s called Shakespeare’s psalm.  If you look at the 46th word in Psalm 46 and combine it with the 46th word counting backwards from the end of the psalm, you’ll see why……

All the best, AEIOU,

Mark

Mark Skousen

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Dear Warren

Thank you for sending this e-mail…I really liked your article, thought-provoking and balanced. I spent most of the summer in Princeton doing research and missed not getting together with you for lunch during the summer. During one of my visits this fall, let’s try to meet for lunch.

My best.

Iqbal [Zaidi]

Remembering 9/11– Bratislava, Slovakia

As my generation did for many years following the assassination of JFK, we today remember where we were and what we were doing on the day ten years ago that 19 Middle Eastern terrorists hijacked and crashed four American passenger planes into the twin towers of the World Trade Center, the Pentagon, and a field in rural Pennsylvania.

On September 11, 2001 I was in Bratislava, Slovakia (the former Czechoslovakia’s eastern half). I had combined an IMF technical assistance visit to Slovakia’s central bank with a meeting of the Mont Pelerin Society, the free market group established over 50 years earlier by Friedrich Hayek and Milton Friedman. I returned to my hotel room around 3:00 pm (9:00 am in New York and Washington, DC) to an email from IMF security announcing that a plane had crashed into one of the World Trade Center towers. I turned on the television and watched in shock and disbelief as a second plane crashed into the other tower. Then a third plane crashed into the Pentagon, and I wondered if this was the beginning or the end of the attacks.

I called my Icelandic friend Hannes Gissurarson, a member of the board of Iceland’s central bank, who was also attending the MPS meetings. “Hannes, you will not believe what has happened. I don’t want to watch this alone. Please come.”  For the next few hours we sat in front of the television emptying the liquor from my refrigerator and then his. We watched in real-time as the two towers collapsed. I remember thinking that they fell so perfectly straight down that it looked like a Hollywood stunt. I was hoping disparately that it was. We did not see any of the people who jumped or fell to their deaths from the towers, which were not visible or shown at that time (thank God).

Michael Novak, a fellow MPS member, called a meeting to meditate together on these events. Michael has a comforting way of talking about difficult things and the gathering was helpful. Many other friends were there, including Richard Rahn and Marian Tupy.

Later in the evening Hannes and I decided to take a walk. As we walked through the lobby of our hotel, the hotel clerks expressed their heart-felt sympathy. We walked the seven or eight blocks to the American Embassy where we saw people placing flowers and small American flags outside of the Embassy. I was very touched by these displays of sympathy and friendship but felt dazed.

Three days later I was finally able to get a flight home, which was a few blocks from the Pentagon. The hole in western side of the five sided building made by American Airlines flight 77 seemed small considering that it had been made by a very large Boeing 757. It  dramatized just how huge the Pentagon is. Barbara Olson, the wife of the United States Solicitor General at the time (and currently a defender of Marriage Equality in the California appeal of Proposition 8), was one of the 64 people on that plane who died when it crashed into the Pentagon killing an additional 125 people in the building.

The positive side of this tragedy was the outpouring of sympathy and support around the word and the strengthened unity among all Americans. As Ronald Reagan had put it: America is a beacon on a hill. We have created a government that is meant to service us, not the other way around. We have established a society in which very diverse people with very diverse personal beliefs and ambitions live peacefully together (most of the time) because our constitution and our beliefs provide considerable space for such diversity. We require that others respect our property and our space in turn for which we respect theirs. To a large extent we can prosper on the basis of our efforts and the extent to which they satisfy the needs and wants of others in the market place.

The world respected and envied American society. The idea, circulated by a few Neanderthals, that Al Qaeda attacked us because they resented our freedoms, was a silly lie. They resented our troops on their soil (Saudi Arabia) and our intrusions into their countries and affairs. If our leaders had understood that correctly, and fashioned policies accordingly, perhaps we would have retained the respect of the rest of the world over the next ten years after 9/11.

Instead, we have lost thousands of American lives and Afghanistan and Iraq have lost  multiples of that. We have weakened our economic strength and thus our military strength by squandering several trillion dollars in Afghanistan, Iraq and elsewhere. We have traded off more of our liberties and way of life in the name of security (the infamous “War on Terror”) than we should have. We have lost the respect and support of much of the world.

A poll taken in the U.S. near the end of August found that: “Six in ten Americans believe that the U.S. weakened its economy by overspending in its responses to the 9/11 attacks. In particular, respondents felt this was especially true of the U.S. mission in Iraq. Two out of three Americans perceive that over the decade since 9/11, U.S. power and influence in the world has declined. This view is highly correlated with the belief that the U.S. overspent in its post-9/11 response efforts — the wars in Iraq and Afghanistan.”

The “Patriot Act” and the “Department of Homeland Security” are names that could have been proposed by “Big Brother” in Orwell’s 1984. How could our government have chosen such names and more importantly how could we have let it. The constant announcements at airports to be on the alert—the flashing signs along the main streets of Washington, DC to report any suspicious activities to XXXXX, are right out of 1984 and Huxley’s Brave New World. Former Vice President Cheney writes without embarrassment that we were right to torture terrorists. I get extremely uncomfortable sitting in the same room with Paul Wolfowitz at AEI. Hopefully I would get up and leave if John Bolton walked in. What has happened to us?

Big Brother/Big Government, however well-meaning, are dangerous to what made us great. They create self-interests that work night and day to direct government spending and policies to their benefit rather than to the nations benefit. That is just how governments work and why our founding fathers were so concerned to limit its scope as much as possible. Governments work best to serve the broad social (national) interest when they provide impartial enforcement of private agreements (courts) and property rights (police and army) and the basic infrastructure of commerce (roads, water, sewage disposal).

Though with every nibble and further intrusion into what was once the private sector Leviathan grows stronger and more dangerous, we don’t have to lose the principles that made us great and made us the envy of the world. We can again be the beacon on the hill that cares about each and every person and thus mankind and sets an example of respect for our fellow-man that others will want to emulate.

But we cannot each have everything in the social sphere exactly the way we each want it. We must live together in cooperation in the pubic sphere. This requires compromises whenever the government is involved (there are not enough desert islands for each of us to each have everything our own way). Thus the broadly accepted need to eliminate our government’s deficit in the future and bring its cumulative debt down to lower levels relative to our economic output over the coming decade or two can only be achieved if each side compromises a few things in order to reach a common agreement on how to do it (what to cut and what taxes to adjust). The President’s largely ignored Debt Commission set out a good basis for such compromises last year. I hope that we can come together again to find an agreement and again become a nation we can be proud of and that is again respected by our neighbors around the world.

European debt crisis: Causes and Cures

Greece’s debt problems are the fault of its use of the Euro

[Comments from friends have led me to strengthen my arguments in the following slightly revised version of this post.]

Public misunderstandings of economic issues do not go away easily. Recently, I began an e-mail exchange with four Chinese students. Perhaps it is forgivable for them being in one of China’s remote provinces to say with regard to the Greek and Portuguese debt problems: “The root cause is that different developing countries use the same currency, [which] is not appropriate.”[1] While this may sound plausible, some of their other beliefs were totally  bizarre. However, it is not forgivable for the German chancellor, Angela Merkel, to say: “We can’t have a common currency where some get lots of holiday time and others very little.” This is not only ridiculous because Germans have longer vacations than the Greeks (I am speaking only of official time off, not German versus Greek work habits), which they do. It is ridiculous and wrong because it implies that it is not viable for rich people to live in the same country with poor people.

The use of a common currency, the Euro, IS NOT the root cause of Europe’s debt problems. As this does not seem to be obvious to some intelligent people who should know better, let me spell it out in very simple, elementary terms.

A person or family in the United States (or any other country) that spends more than her income for long periods has a potential problem and that problem has nothing to do with the fact that she is using the same currency as everyone else in the country. She may rationally borrow for short periods to cover temporary interruptions in her income or finance large purchases that she has the income to repay over time, but if she continually borrows amounts that she cannot reasonably expect to be able to repay, she and her foolish creditors have a problem. More often (hopefully), debt defaults result from unexpected changes in fortune. All countries have legal procedures (bankruptcy) for dealing with such defaults that avoid sending the defaulter to debtors’ prison. But as long as each person or family lives within its means, there is no reason on earth why their means can’t vary enormously without undermining the harmony of their coexistence. If this is so within countries, it is even more so between them (security concerns aside).

The probability of lending money to someone who cannot repay is directly related to the incentives faced by borrowers and lenders. A debtors’ prison was about as strong an incentive you could have against careless borrowing though they varied a great deal from one country to another. Most took the form of workhouses. In England, a debtor (and often his family) remained in confinement until his debt was repaid. In most European countries he stayed for a maximum of one year. However, from the establishment of the United States, Americans decided that people should be given second chances and abolished debtors’ prisons. In England, the Bankruptcy Act of 1869 abolished debtors’ prisons. We now take second chances for granted. But this does increase the risk that some people will borrow too much.

Who gets credit is almost totally regulated by the requirements of lenders to have confidence that borrowers can and will repay them. No one is forced to lend. Lenders require information from borrowers on their past and expected income and on their track records of repaying earlier loans. They may require collateral to “secure” the loan. Borrowers themselves are deterred from borrowing what they cannot be paid by the penalties imposed by bankruptcy laws should they default even if they aren’t sent to prison. This very fact increases the confidence of lenders to lend in the first place. If the penalties are too severe and/or collateral and other security too costly, less will be lent. A delicate balance is needed to optimize the reallocation of savings to investors (or consumers).

At the end of the day, life is uncertain. Not everything can be foreseen. Some chances are reasonable, however, and worth taking. Some lenders are willing to take larger risks if compensated by higher interest rates on such loans. Thus markets tend to demand higher interest rates (relative to those on safe loans) for riskier loans. Lenders still expect to make a reasonable return on their loans on average with the “risk premium” received from those who repay covering the limited losses on the few who don’t.

Sovereign borrowers, like Greece, are generally considered low risk because they can tax their citizens to repay borrowed money. But as Argentina and Russia have shown there are limits to taxation. Unless lenders (buyers of sovereign debt) think that sovereign borrowers will be bailed out by the IMF or others under all circumstances, they will demand an interest rate that reflects their assessment of the risk that the borrower might default. A higher interest rate for riskier borrowers is a good thing as it provides a financial incentive for the borrower to slow down.

Greece’s adoption of the Euro contributed to its current debt problem only in that it removed one of the risks of lending to Greece—the risk that Greece would devalue its currency and thus reduce the foreign currency value of what it owes (if lenders had denominated their loans in the Greek currency). Greece no longer has its own currency and thus lenders no longer face so-called “exchange rate risk.”

Until recently lenders did not add a risk premium to loans to Greece or Portugal. They charged these borrowers almost the same as they charged the German government. Thus there was little financial incentive from this source for Greece to limit its borrowing. But like any borrower, whether an individual, a company, or a country, the game lasts only as long as lenders believe they will be repaid and borrowers are foolish to borrow what they cannot productively use and repay. That Greece has been foolish is perhaps one of the nicer ways of putting its behavior. Now, finally lenders have become more discriminating and have begun to add large risk premiums to any new loans to Greece and other riskier borrowers. This came late but is welcome.

The above discussion provides background to my views on the proposal now being made by many in Europe to finance national government borrowing with Eurobonds. Rather than individual countries issuing sovereign debt and paying the risk premium the market demands for their particular situation, they would borrow through an EU wide institution, such as the European Financial Stabilization Fund (EFSF). Greece would sell its bonds to the EFSF, which would pay for them with funds raised by issuing its own Euro denominated bonds. EFSF bonds would be backed by the financial resources of the EU (all European member countries collectively) and would thus enjoy the credit rating of the EU rather than of Greece.

Eurobonds (not to be confused with the US dollar denominated bonds of the same name with which many European and other governments and companies have borrowed for half a century) would reduce the cost to Greece of borrowing and would provide a better asset in which central banks and multilateral companies could hold Euro reserves. The latter would facilitate the use of the Euro as an international reserve currency.

The cost of Greek debt service would drop immediately, but without other steps by the Greek government to reduce its bloated budget and to free up the competitive capacity of its economy more debt would be accumulated until it again reached the limits of its ability to service its debts. I outlined the issues and options for Greece in more detail over a year ago (May 2010) at https://wcoats.wordpress.com/2010/05/30/greeces-debt-crisis-simplified/.

The ability of Greece to borrow unlimited amounts via the EFSF at safe Eurobond interest rates would remove an important incentive for Greece to adjust and live within its means. Thus the Eurobond idea in this form is a bad idea and Germany is right to oppose it. The financial assistance now being given by the EU and the IMF carries conditions that Greece address the underlying and real causes of its debt problem (excessive government spending and an uncompetitive economy) and it has been making considerable progress toward satisfying those conditions. Such loans (also at low risk free rates) provide an alternative way of imposing incentives for better behavior by Greece to that of high risk premiums for market borrowing.

Because of this perverse incentive effect of opening Eurobond financing to Greece and other EU members with excessive debt, its proponents speak of the need to combine it with stronger EU control over national fiscal policies. It is not clear what form such tighter control might take and it is frankly difficult for me to imagine France or Italy, for example, allowing EU bureaucrats in Brussels to dictate limits on their national expenditures.

“Eurobonds ‘mean telling the people, the citizenry, that you are ready to share risks,’ [Amadeu Altafaj] Tardio [a spokesman for the European Commission’s economic and monetary affairs committee] said. ‘That would be the strongest support for the euro area. It makes sense in the context of a monetary union. . . . Politically it does not seem feasible.’”[2]

It is instructive to contrast the EU situation with that of the United States. The federal government of the U.S. issues debt securities in its name and with its (now slightly down graded) own credit rating (AA+). The stock of its debt outstanding is approaching $15 trillion dollars, almost half of which is owned (lent from) abroad. Each of the 50 states in the United States also borrow by issuing debt securities in their own names and each receives its own credit rating and pays interest accordingly. The money raised by the federal government is to supplement its tax revenue to finance its own expenditures (though the federal government does grant some revenue to the states from its budget). Thus it has full control (I am ignoring the political dysfunction of our current Congress) over its own expenditures and borrowing needs. States have full control over their own budgets and financing.

The situation in Europe is quite different. The Eurobond proposal is not for the financing of the EU budget (comparable to the federal budget in the U.S.), but for the financing of individual country budgets (comparable to states in the U.S.). This is why advocates of Eurobonds couple their proposal with the need to increase EU control over member countries’ budgets. Such control would be comparable to federal government control over state budgets in the U.S. This seems both politically very unlikely in Europe and, in my opinion, undesirable.

There is a version of the Eurobond proposal that does make sense to me. Bruegel, a European think tank, has suggested an approach that differentiates between debt financing member country borrowing that is less than 60% of their GDP and borrowing that is more. Eurobonds proper would only finance borrowing up to the 60% level. Any country wishing to borrow more than that would need to issue their own bonds and pay whatever risk premium the market demanded of them individually. Eurobonds would have priority standing in the event of default. This would restore the market discipline of excessive borrowing that the open-ended Eurobond proposal would remove, and would be easy to enforce.

Reducing the borrowing cost on debt equal to 60% of its GDP would help make the existing stock of debt more sustainable. But unless Greece and other EU members addressed their fundamental problems, the flow of new debt would continue. The market’s assessment of the prospects of Greece defaulting on such additional borrowing (over 60% of its GDP) would determine the risk premium Greece would have to pay for such borrowing and would provide better market discipline of its behavior than a pure Eurobond scheme.

Don’t blame the Euro. Blame the misbehavior of individual countries. Both rich countries and poor countries can participate in the global economy whether using the same currency or not if each lives within its means. When looking for solutions, don’t destroy the costs of bad behavior and thus the incentives for good behavior. This includes the incentives faced by market lenders (banks and others), who, thankfully, are finally taking some loss in the restructuring of Greek debt, but perhaps not enough to be more careful next time nor to reduce the exciting stock of Greek debt to make it sustainable. In the final analysis, only Greece, like any household, can make the changes that will restore its credit worthiness and its place in the global economy.

[1] Email correspondence with Chinese students who found my address on the Internet.

[2] Howard Schneider, “Europe debt crisis forces officials to revisit creation of common eurobonds”, The Washington Post, August 26, 2011, Page A11.

Libya: Part II

What will happen next in Libya and what should we do?

As we attempt to save the Republic by trimming government back to size (back to what we can afford and back to what only government can do), surely we can forego a few of wars the neocons would like to plunge us into. Actually my warning cries as we were sliding into another one in Libya had much more to do with the unlearned lessons of the past about how best to influence future event for the better than with the wasting of more precious treasure (lives and other resources). To his rather bumbling credit, President Obama gave in to the pressures of the warmongers reluctantly and only partially in Libya. Our involvement has been largely supportive of more direct, though also limited, NATO support for the rebels.

But here we are at the beginning of Part II of the Libya drama. The rebels seem to have finally toppled the truly crazed Gaddafi. We can all cheer his demise, but what will follow? Who are the rebels and where are they planning? We actually know more about them than when we first chose to support them (a collection of different tribes, political philosophies, and religious views, some good and some bad). Who will emerge on top and what will the struggle for dominance of the new regime be like? Will the average Libyan be better off or worse off? It is impossible to know at this point.

Craig Whitlock reports some interesting reactions to the Libyan civil war from the area in yesterday’s Washington Post, “Libyan rebels renew hopes of Arab Spring”

“If the shooting quickly subsides and the Libyan rebels are able to build a functioning central government, it would give further encouragement to protesters in the streets of Damascus and Sanaa. But if Libya descends into factionalism or tribal warfare — with scenes reminiscent of Iraq after the fall of Saddam Hussein — then ardor for the Arab Spring could cool again.

“‘People are going to be looking at how this plays out very, very closely,’ said Jon B. Alterman, director of the Middle East program at the Center for Strategic and International Studies. ‘It’s easy to agree that the leader must go. It’s much harder to agree on what comes next.’

“Some Palestinian activists said that their aspirations, too, had been buoyed by the success of the Libyan rebels but that NATO’s involvement had taken the sheen off the results.

“‘It is getting a cautious welcome because it was achieved with foreign intervention rather than by the people themselves, as was the case in Egypt,’ said Hani al-Masri, a political analyst in Ramallah, West Bank. ‘Some people are calling it liberation through occupation. The Egyptian experience was inspiring. In Libya, we have to wait and see.’”

My pessimism about our ability to improve the world (and our safety) with armies does not mean that I think we should do nothing in Libya or elsewhere to promote a better world (rule of law, respect for human liberty and rights). We know a lot about the blessings of liberty and the institutions (not necessarily, or even very often, just like our own) that help promote and preserve it. We have an interest, both humanitarian and national self-interest, in doing our best to share our knowledge and to promote sound governance and free markets in Libya and elsewhere. This is often done best by international organizations such as the International Monetary Fund and the World Bank. It cannot be successfully imposed from outside. It must to the form of support and encouragement to the indigenous forces for good (if we think we know who they are).

I commend to you the op-ed piece on this subject in the The Washington Post by Stephen Hadley on August 18th: “Our chance to shape change in North Africa and the Mideast”.

Short Travel Notes

At my final breakfast at Afex camp this morning two of my colleagues were laughing at some of the silly things people do on the Internet, such as feeding fish and growing crops etc. When I returned to the table with another cup of coffee, they were both staring intently at (I thought) the Nile next to us. Adam noted that, “they are moving at different rates.” Richard replied “and moving in opposite directions. I wonder how they will pass each other?” Adam suggested, “let’s bet on which group goes over the other.” I strained to see what it was they were talking about and could see only the usual uprooted plants floating down the river, all in the same direction.

What are you talking about, I asked. The ants on the string, they replied. Just next to us in the open air dinning hall was a string fence to prevent people from taking a short cut through the garden. Two long lines of ants were walking along the top of the string in opposite directions. Maybe feeding fish on the Internet is not so wacko after all.

On my flight a few hours later from Juba to Nairobi I came across a quote in The Standard (a Nairobi newspaper) that I can’t resist sharing:  “Tanzania’s culture of skepticism and mistrust of Kenya has been going on for over four decades. The late Julius Nyerere, the founding President of Tanzania, once described the capitalist-aligned and aggressive Kenya as a ‘Man eat man society’. [Kenyan] Attorney General Charles Njonjo retorted by terming the then socialist Tanzania a ‘Man eat nothing society.’”

Travel notes from Juba, South Sudan

 

Amsterdam

Ito and I ended our Italian/French/Netherland vacation (see https://wcoats.wordpress.com/2011/07/23/travels-in-italy-and-france/) in Amsterdam visiting friends (Bill Wirt, Dolph Westerbos, and René van Hell). While there, we enjoyed the usual sights and the coldest July day in the Netherlands (July 24) since 1903! Then Ito took the plane home to Washington DC while I headed on to South Sudan.

While Amsterdam was having its coldest day, Washington was suffering one of its hottest days in history. The same weekend had the only two consecutive days with lows above 84 decrees ever recorded. The high temperature of 105° at 3:52 pm on July 22 at Washington Dulles was a new all-time record, beating the old record for July 22 of 98° in 1998 by 7°. By the 24th Dulles had “cooled” down to a high of 94° (97° at Reagan National).

The average global high may well have been perfectly normal (I couldn’t find such data if it exists), demonstrating that distribution does matter.

Juba, The Republic of South Sudan

I left Southern Sudan on June 21 and returned on July 27th to the newly independent Republic of South Sudan (on July 9). The introduction of the new South Sudanese Pound (SSP), which our Deloitte team has been helping the local authorities prepare to issue for over a year, had started on July 18th.  The replacement of SDG (Sudanese Pounds) with the new SSP is targeted to be completed by the end of this month (August—a 45 day period).

The establishment of the new Central Bank of South Sudan, though inheriting most of the staff and buildings of the Bank of Southern Sudan (a branch of the Central Bank of Sudan headquartered in the North), is being seriously hampered by the failure so far of the President of the Republic to appoint its new Governor and Board.

The big success on this visit was the launch of foreign exchange auctions after the new central bank law wiped out all of the exchange controls imposed by North Sudan when Southern Sudan was part of it. The Central Bank of Sudan (the central bank for the whole country before the South spit off) was running out of foreign exchange reserves (foreign currency owned by the central bank that it could sell to the market to influence the exchange rate of its currency). It wanted to keep its exchange rate to the U.S. dollar and other foreign currency low so that those holding its currency could buy dollars more cheaply (a so-called “strong” currency). But to do that it had so sell dollars from its foreign currency reserves. When it was running out of dollars, it could no longer support the exchange rate it wanted. So it imposed restrictions on the purposes for which people could buy dollars with the Sudanese Pound (restricting demand) in order to support it’s artificially low (strong) exchange rate. As a result, a spread of up to 1½ percentage points opened up between the official rate and the street (black market) rate.

South Sudan has removed those restrictions and introduced twice weekly auctions of U.S. dollars to the highest bidders. There have been three auctions so far and they are working well as the market gets used to them. The spread between the official and street rate (no longer illegal) has already narrowed to about 25 basis points (a quarter of a percentage point). Today we hit a big bump in the process and the acting governor, responding to political pressure capped the exchange rate for the next auction below the rate of the last one. We expect the announcement of a permanent Governor very soon.

After independence, the Bank of Southern Sudan became the Central Bank of South Sudan (CBSS). The Bank has a fairly large courtyard in the middle where people gather to chat or smoke cigarettes and where the Governor holds large staff meetings. You can see it in the attached picture. I stepped out of my office on to the far edge of the courtyard the other day and was standing next to one of the Bank officials. He was on his cell phone and obviously expecting to meet someone: “Where are you? … You are standing under a tree? … What tree? We have a lot of them.” Every now and then a fairly large monkey drops out of one of them, which always gives me a start.

There seems to be more life around the Bank than before. After all, there is a lot going on (introducing a new currency and starting new foreign currency auctions). Yet the halls of the Bank are still cluttered with employees that are half asleep. I am not really sure what their duties are. Work habits are not very good here. Many of the African Sudanese in the South cling to the habits of the African lion, which lies around and sleeps most of the day, while his lionesses round-up the food and do the dishes so to speak. The entrepreneur spirit is in rather low supply. Many of the businessmen and shopkeepers are Kenyans or Ugandans.

The traditional pastoral and often nomadic lives of many Africans roaming the plains of Sub-Saharan African are not all bad, by any means. You can’t listen to them sing without hearing some happiness there. But it is too easy for those of us not living it day after day to overly romanticize it.

Life at the Afex Riverside Residence at the edge of the Nile remains the same. I continue to be impressed with the timeliness of Deloitte’s team for the morning and after lunch departures of its six cars. In the few minutes before 8:00 am every day except Sunday, thirty or so consultants converge on the car park from several paths and at 8:00 am sharp the cars start pulling out for the drive to the various Ministries (and in my case the Central Bank) at which they work. Often the departure, especially after the lunch break, is virtually simultaneous with all six cars departing from the camp one right behind the other in a caravan. It is an impressive sight.

On irregular trips, the drivers are required to provide a radio report to Base on who is with them and where they are going so that Base knows were every one is. It goes something like this: “Alpha to Base. Alpha to Base…  This is Base.  Leaving Charlie, Charlie, with Bravo D-4 (or whoever) and with, with, and with one “unassigned.”  I am the “unassigned” because I talked Base into not having to carry a bulky two-way radio around, because I almost always travel with colleagues who have one.

A few days back, while eating dinner in the Afex dinning hall—a very pleasant open air facility along the edge of the Nile—a strong gust came up that caused a heavy shower of little black things that covered the dinning room tables, floor, and my plate. I assumed that it was the carcasses of the hundreds of thousands of zapped insects that had given up their lives to the several electric bug killers overhead. I was greatly relieved when I learned that they were little mango seeds that had collected on the canvas roof and were dislodged by the brisk wind.

At dinner this evening our British security officer and another Englishman where telling war stories across the table from me. I was only half listening, but the other Brit’s story about their first-rate French interpreter (they must have been in a French-speaking African country as he is not old enough to be talking about WWII) ended with something like: “he eventually went native on us, drinking red wine and such.” I learn something new every day.

I have been away from home for over a month and need a haircut. My barber for the last 35 years gets very upset if anyone else cuts my hair. During my two month stay in Baghdad in 2004 I was forced to get several and Mike complained for the next two months that it was taking that long to get it back into proper shape. Tuffs of hair now tickle my ears occasionally leading me to fear that a malaria-carrying mosquito has landed there.

Our morning drive from Afex Camp to the Central Bank usually passes a lot of kids on their way to school. The girls and boys dressed in school uniforms is a lovely sight. There is little that is as encouraging and hopeful as seeing young kids smiling on their way to school, especially in a largely illiterate country. So there is hope. There is also little as heart breaking is the face of a child, usually a hungry child, with no hope. The expressionless, unfocused stare of such a child is more than I can bear.

I think that we take hope in American (especially) so for granted that it is hard to imagine a people who have little of it. A great deal of our existence, especially our younger years are filled with the hope that we can build decent enjoyable lives for our selves and our loved ones. What would our youth have been without it? There seems to be a lot of hope in South Sudan now. I hope that it is justified and that it can be sustained.