June 16, 2010
The Hill, June 15, 2010
The Greek fiscal crisis has often been cited by deficit hawks in the United States as a warning of what will happen here if we do not correct our profligate ways. This makes about as much sense as holding up Bernie Madoff’s fund as a warning for bad things happening to TIAA-CREF.
Greece is a small country that is far more dependent on international trade than the United States. Prior to the downturn, imports were more than 30 percent of Greece’s GDP, compared to 16 percent for the United States. Greece also has an enormous problem collecting taxes. According to the Organization for Economic Co-operation and Development, the underground economy in Greece is almost one-third of the size of the official economy – the equivalent of $5 trillion a year in the United States.
Greece’s debt burden is also much larger than the U.S. burden. Greece’s publicly held debt is already more than 110 percent of GDP compared to just over 60 percent in the United States. The U.S. can run 2010 size deficits for five years and still not catch up with Greece’s level of indebtedness.
However, these differences are trivial compared to the most important difference. The United States has its own currency and its debt is denominated in that currency. In this sense, Greece can be viewed as being far more like Arkansas — a small and relatively poor state — than the United States.
To take this a step further, imagine what a debt crisis in the United States would look like. Suppose that for whatever reason investors became worried about the creditworthiness of the U.S. government. Interest rates in the United States would start climbing upward. If we follow the example of Greece, then even in the current economic slump interest rates on long-term government debt could reach 8 percent or 9 percent, levels that would certainly stifle growth and seriously deepen the downturn.
But the United States has an important option that Greece does not have. Because it has its own currency and its own central bank, the Fed could simply step in itself to buy up the debt needed to finance an ongoing deficit. If the economy were operating near full employment the Fed’s purchase of government debt would lead to inflation; however, with the unemployment rate still near double-digit levels, inflation is not a serious concern.
In fact, if the Fed’s purchases of government debt (the Fed has already purchased several hundred billion dollars of government bonds as part of its quantitative easing policy) sparked a modest uptick in the rate of inflation this would be a positive development. It would lower the real interest rate and reduce the debt burden of tens of millions of households, as wages and house prices would rise relative to the value of mortgages and other debts.
Furthermore, the fear of an enormous run on the dollar, pushed by some deficit hawks, makes no sense. Suppose that investors’ fears did lead them to flee the dollar. Its price would then plummet. Would the euro zone countries tolerate an exchange rate of $2 per euro? How about $3? Would the Japanese central bank allow the value of the dollar to be cut in half to 50 yen? Would China suddenly let the yuan soar so that instead of being worth about 15 cents it was suddenly worth 30 cents?
This scenario doesn’t seem very likely. Unlike Greece, the United States is both an enormous market for other countries exports and a huge exporter in its own right. If its currency plunged in value relative to other currencies it would destroy the U.S. export market for many countries. Furthermore, our goods would become super-competitive in Europe, Japan and elsewhere. It is almost inconceivable that these countries would allow their industries to be wiped out by U.S. competition. They would almost certainly intervene to halt the decline in the dollar and sustain its value at an acceptable level. In short, the story of an investor run leading to a dollar crash does not make sense.
While there are many grounds for complaining about both the budgetary process and outcomes, it is silly to build on analogies with Greece that simply don’t fit. Our short-term deficit is overwhelmingly a story of an economy that was badly weakened by the collapse of the housing bubble. The deficit is making up for the enormous loss of private sector demand. If we could simply snap our fingers and make the deficit disappear, we would be rewarded with a weaker economy and higher unemployment.
Over the long-term, the deficit horror stories are driven almost entirely by projections of exploding health care cost growth. If per person health care costs were comparable to those in any other wealthy country we would be looking at enormous budget surpluses, not deficits.
The Greek tragedy might be a compelling story of corruption and sorrows, but it tells us nothing about the U.S. budget situation. We would be better off worrying about our own problems.