Greek to Them

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Arrangements are underway to rescue the Greek government from its crushing debt. Allowing a member of the European Union and euro area to fail, so goes the worry, would trigger contagious panic. Dominoes would fall, perhaps Portugal and Spain. The single currency and even the EU might collapse. A rescue might give the Greek government time for an orderly restructuring — somehow — of its overly generous pensions and public salaries, its lax tax collection, and its reckless borrowing. Severe conditions imposed by the International Monetary Fund might give the government political cover as it tried to comply. Preserving the euro, like maintaining a currency’s gold parity under a genuine gold standard, would strengthen fiscal discipline; for a government cannot just print money to pay its debts.

The most obvious objection is “moral hazard”: the expectation of further rescues would encourage further imprudence. A transfer of wealth from relatively prudent countries (governments, populations) to imprudent ones seems unfair.

Default on debt has often occurred without causing a major international crisis. Government debt is not linked to the rest of the financial system by multitiered leverage as extensive and as complicated as linked Lehman or AIG. Within a single currency area, default and bankruptcy have often occurred without endangering the currency. Nowadays we read of the precarious finances of Birmingham, Alabama; Harrisburg, Pennsylvania; Los Angeles; and the state of California. Bankruptcy of any or all of these jurisdictions, even the secession or expulsion of California from the Union, would not threaten the dollar’s continued existence.

My father’s job on Wall Street in the 1930s was to form committees of holders of defaulted bonds. Each committee would negotiate with the debtor, even if it were a government, for restructuring the debt to keep losses as small and their distribution as fair as possible. This approach, still available today, instead of papering over the waste of resources underlying the default, faces up to this sorry reality.

Failure of a rescue effort (as for Greece) causes more panic than if a rescue had not even been attempted and if the psychology of panic had been better understood. However, a panic generates gripping news, especially when associated with murderous rioting or when registered and magnified by the stock market. It benefits some people, such as government officials. “You never want a serious crisis to go to waste,” Rahm Emanuel, President-Elect Obama’s chief of staff, told a Wall Street Journal conference in November 2008.

In the days of the original exchange-rate-oriented Bretton Woods system, Milton Friedman speculated that many officials relished the currency crises inherent in the system. Flying and telephoning here and there and confronting momentous events in all-night sessions enhanced these people’s sense of importance. I wonder whether similar attitudes may be at work in the Greek situation.

Policymakers and financial journalists should understand the herd behavior and other psychological aspects of such situations. That advice comes too late for this one, but it should be remembered for the future. “Calm down” should be the watchword.

The deficit-proneness of Greece, as of most other governments, illustrates the dangerous short-term-orientation of politicians and democratic government. Saying so is trite, but sometimes trite remarks are correct and important.

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