“Yes, Virginia. There is a Difference Between Greece and the US”

By Marshall Auerback*

If we learn the wrong lessons from Greece, our social safety net may wind up in tatters.

Many market analysts, commentators and economists claim to be having a hard time finding a metric in which the US is in better financial shape than Greece. Ken Rogoff, for example, recently warned that a Greek default would usher in a series of sovereign defaults, and suggested recently on NPR that the crisis also had implications for the US. The historian Niall Ferguson made a similar claim a few months ago in the Financial Times. The cries of the deficit hawks grow louder: Repent all ye fiscal profligates, before the “day of reckoning” comes.

Let’s dial down the Biblical hysteria a wee bit while there’s still time for rational debate. The market’s recent response to the intensifying pressures in the euro zone suggests that investors are beginning to differentiate between countries that are sovereign issuers of currency, such as the US or Japan, and non-sovereign issuers, such as Greece or any other nations in the euro zone. The US dollar is rising in value, notwithstanding the federal deficit, while debt distress in the so-called “PIIGS” countries, especially Greece, are intensifying, thereby driving down the euro to fresh 12 month lows against the dollar.

The relative performance of various currencies against the US dollar is highly instructive in this regard. Over the past 3 months, the Australian, New Zealand and Canadian dollars have all registered gains of some 4% against the greenback. The worst performer? Not surprisingly, the euro, down 6.3% over that period. Whether consciously or not, the markets are demonstrating that they understand the distinctions between users of currencies (who face an external funding constraint), and those nations that face no constraint in their deficit spending activities because they are creators of currency.

That the US has the reserve currency is an irrelevant consideration here. The key distinction remains user vs. creator. The euro zone nations are part of the former; Canada, Australia, the UK, Japan and the US are representatives of the latter.

Using “PIIGS” countries as analogues to the US or the UK, as Rogoff, Ferguson and countless other commentators do, is wrong. Their faulty analysis comes as a result of the deficit critics’ failure to distinguish between the monetary arrangements of sovereign and non-sovereign nations. Any sovereign government (none within the EMU enjoy that status any longer) can deal with a collapse in revenue and an increase in outlays from a financial perspective without invoking the sort of deadlocks that are now crippling the EMU zone. That is why, for example, the Japanese yen is not in freefall against the dollar, despite having a public debt to GDP ratio in excess of 200%, almost 2.5 times that of the US. In fact, over the past few days the yen has actually appreciated against the dollar. Now why would that be, if the lesson we were supposed to learn was the evils of “unsustainable” government deficit spending?

Fiscal sustainability has no relevance in a system where there are no operational constraints on the ability of a government to spend. US Social Security checks will not bounce. Nor will the Canadian or Japanese equivalents. Similarly, their bonds will always be able to pay out interest.

Note that this doesn’t mean that there are no real resource constraints on government spending. Let’s be clear: anyone who advances the use of fiscal policy as an effective counter-stabilization tool is always careful to point out that these interventions can come at a cost. That cost could well be inflation if, as a result of the fiscal expansion, we reach full employment, resource constraints begin to appear, but the government continues to spend. But if the economy recovers, tax revenues will increase and safety net spending will fall. In the US, that means we will likely be back to “normal,” with deficits around 2-4% depending on the state of the economy, which is where we’ve been for the past 30 years aside from 1998-2001.

Why won’t these deficits be inflationary? As Professor Scott Fullwiler noted in a recent email correspondence with me, once the recovery is underway and the economy gets to a significantly higher capacity utilization where price pressures could emerge, the deficit will be declining substantially. It will also be at least a partially offset by a fall in discretionary spending on social welfare. It’s axiomatic that the faster the economy grows, the smaller the deficit becomes, unless the government continues to spend recklessly–which we certainly do not advocate.

And by the time we get to a point where we might have inflation, the deficit is back to 2-3%, which again is where we’ve been for the past 30 years, while average inflation has been about 2%. Note: inflation does not equal default. You and I could well buy credit default swaps on any country in the world, but we are unable to collect if any of the relevant countries register a positive rate of inflation — even a double digit rate of inflation — because inflation is not tantamount to default. Nor do the ratings agencies recognize default in this manner. Default is defined as a failure to perform a task or fulfill an obligation, especially failure to meet a financial obligation. Inflation is not incorporated into the definition when it comes to questions of national insolvency.

By contrast, the talk of Greek default is prevalent across the markets, and that is a reasonable concern in the context of the euro zone. The default option is considered a foregone conclusion, even allowing for the massive 110 billion euro bailout, which was designed to inspire “shock and awe” among investors but instead has simply engendered shock. If Greece costs 110 billion euros to bail out, how much next time for Spain, Italy, or even France?

If the markets have concerns about national solvency, they won’t extend credit. And that is the problem facing all of the euro zone countries. Greece, Portugal, Italy, France, and Germany are all users of the euro-not issuers. In that respect, they are more like any American state or municipality, all of which are users of the US federal government’s dollar.

And deficits per se will not create the conditions for default in the US. If the US continues to run net export deficits (all the more likely given the ongoing fall in the value of the euro), and the private domestic sector is to net save, the US government has to net spend–that is, run deficits. That is a basic accounting identity, nothing more, nothing less. If the US government tries under these circumstances to run surpluses, it will first of all force the private domestic sector into deficits (and increasing debt) and ultimately fail because the latter will eventually seek to increase their saving ratio again.

And the same logic applies for Greece. The call is for the IMF/EU package to reduce its budget deficit as a percentage of GDP from the current 13.6% to 8.1% in 2011. How will they achieve that? Trying to engineer a reduction in the deficit via austerity programs (or freezes or whatever else one might like to call them) at a time when private spending is still insufficient to maintain adequate real GDP growth is a recipe for disaster. It will increase the deficit.

Consider Ireland as Exhibit A in this regard. Ireland began cutting back deficit spending in 2008, when its banking crisis began to spread and its budget deficit as a percentage of GDP was 7.3%. The economy promptly contracted by 10% and, surprise, surprise, the deficit exploded to 14.3% of GDP. We would wager heavy odds that a similar fate lies in store for Greece, given the EU’s inability to understand or recognize basic financial balances and the interrelationships among the various sectors of the economy. Neither a government, nor the IMF, can predict with any certainty what the outcome will be–ultimately private saving desires will drive the outcome, as Bill Mitchell has noted repeatedly.

Why do we have huge budget deficits across the globe? It’s not because our officials have all suddenly become Soviet-style apparatchiks. It is largely because the slower global economy has led to lower revenues (less income=less taxes paid, since most tax revenue is based on income, and lower tax brackets) and higher spending on the social safety net. Gutting this social safety net because we extrapolate the wrong lessons from the euro zone’s particular (and self-imposed) predicament constitutes the height of economic ignorance. It also reflects a transparently political agenda, which the US would be ill advised to embrace. The rescue packages, the IMF intervention and all the talk about orderly defaults cannot overcome the EMU’s fundamental design flaw. Let neo-liberalism die with the euro.

*This post originally appeared on ND 2.0

6 responses to ““Yes, Virginia. There is a Difference Between Greece and the US”

  1. Hi Marshall,I had posted this on NC. Porbably nobody noticed. Posting it again with some additions. I wish to point out that the MMT’ers views are different from the economists at Levy who use the New Cambridge approach. I actually fully understood this only recently – though I had tried to do that many times in the last many months or so. One may argue that the differences in views are minor, but I think they are deeply different. I, in fact think they have a deep point and I think they are right. Recently – in fact – over the last 10 years or so they have been arguing about sectoral imbalances with the rest of the world and that the US Government should do something about it. Don’t think I can be as accurate as them but here is what they seem to suggest: Work with various countries to devaluate the US dollar and encourage them to pursue fiscal expansion so that the US becomes a net exporter to the rest of the world. There is no mechanism for the exchange rate to become devalued and experience has suggested it will resist doing so on its own through market forces. There is one objection one may take to such a view: expansionary fiscal policy of the rest of the world will increase US exports. However, I think this is not sufficient. An increase in exports will lead to a higher aggregate demand of the US as they increase production for exporting and and this will lead to higher imports in nominal value, with the current account still in deficit. I am quite sure that they have used the stock flow consistent models to arrive at this result. The reason they do not like the current account being in deficit is that the US is a net debtor nation as one can see from the Flow of Funds. Of course important things are the flow of income, interest etc. but in fact some of these things have become intractable according to Godley, Zezza and Dos Santos. An even higher fiscal stance is of course important, but the solution is not as easy. Of course this is my understanding of their work, so there are bound to be errors on my part, but I see a crucial difference and wish to point this out.—-Dos Santos has many things to say in his article http://www.univ-paris13.fr/CEPN/IMG/pdf/Texte_cepn_160410.pdfGodley, Dos Santos and Zezza recogize that in some cases the process can continue and the public debt can increase exponentially in one country in a "two-country model" without any trouble whatsover. For example pages 468-470 of Wynne Godley's book Monetary Economics. However, as Dos Santos says in the article I linked above, inclusion of private sector changes things considerably. When one includes the private sector, the external sector can cause a lot of trouble for the economy. A fiscal relaxation in the US is of course good and further need but will not solve all the problems. The indebtedness of the private sector will increase and there is no escape. That is why you see them talking of devaluations and various other things.

  2. I'm all in favor of the death of neo-liberalism, but I suspect it won't happen. In fact, I suspect it's neo-liberalism that will be the death of all of us.

  3. "… to differentiate between countries that are sovereign issuers of currency, such as the US or Japan, and non-sovereign issuers, such as Greece or any other nations in the euro zone." Is the problem of a US state like California not similar to the problem with Greece? California also is a non-sovereign issuer with an economy and an economic problem of a size comparable to Greece, I would estimate. U.S. means United States, in other words, a federation of states, similar to the euro zone. Or am I missing something?

  4. Ramanan, I share your's and Levy people's concern with the continued disequilibrium of the US current account balance. Since government budget deficits can be ramped up to fill in any job losses this causes, all that Americans will experience is an improved terms of trade as a result… At least until there is a shift in savings preference of the rest of the world. Then what happens with this vast accumulation of IOU's they want to spend? Can taxes and tariffs be enough to prevent the economy from going into inflation mode? Will the change be sudden and panicky or something more manageable? If the US experienced export biased growth it will mean worse terms of trade. Maybe worse to a degree Americans refuse to accept, or alternatively our tariffs are so high that it causes other countries feel cheated and erect their own barriers to trade causing a net welfare loss. So I think (could very well be wrong) that it is necessary to worry about the current account balance. Ramanan could you e-mail me? I'd like to discuss MMT with you without annoying the big brains who author these blogs.

  5. Yes, Marshall, there is a difference between Greece and the US. But is there a difference between Greece and California, or between the US and the EU (European Union)?

  6. Too bad we no no longer elect presidents who understand economics.Still in the area of fiscal policy, let me say a word about deficits. The myth persists that Federal deficits create inflation and budget surpluses prevent it. Yet sizeable budget surpluses after the war did not prevent inflation, and persistent deficits for the last several years have not upset our basic price stability. Obviously deficits are sometimes dangerous–and so are surpluses. But honest assessment plainly requires a more sophisticated view than the old and automatic cliche that deficits automatically bring inflation… How, in sum, can we make our free economy work at full capacity– that is, provide adequate profits for enterprise, adequate wages for labor, adequate utilization of plant, and opportunity for all? These are the problems that we should be talking about… http://www.jfklibrary.org/Historical+Resources/Archives/Reference+Desk/Speeches/JFK/003POF03Yale06111962.htm